Stretching yourself into a big mortgage
This week in the NZ Herald ‘Ask an Expert’ I got the following question ... "I have just fallen in love with a house which is probably about $100,000 out of our price range but I figure my income can only go up and interest rates are so low. My question is, is it outrageous to take on a big mortgage in this climate? We have a $200,000 income and that will hopefully rise in the coming years as the kids get older. The purchase of this family home would give us a new mortgage of around $500,000 - we are in our mid-40s and our current home is too small for the teenagers our kids will turn into in three years' time. My argument is nobody retires these days, I'll still be working when I'm in my 70s, so what harm can a big mortgage do?"
I've never really been too afraid of debt, although I like to pay it off quickly. I'm a little bit sensible with money (zero consumer finance debts) but my home is still my castle! So my first seriously big mortgage was over $700,000 and the mortgage is still over $700,000 (too many renovations) but the house has doubled in value in the meantime. Seven years on there is no way we could buy our place now, so I’m glad we took the plunge when we did. We made a conscious choice to buy a property that fitted our lifestyle and family and boy did it stretch us! The thing is I’m not sure that "trading up" is ever going to be all that rational.
Based on your income of $200,000 your borrowing power is around $800,000 so I’d say a mortgage of $500,000 is well within your budget. With bigger mortgages, clients get more nervous about interest rates. The easy way to solve this is set your repayments based on a mortgage rate of 8.50%. By setting your repayments higher, you will initially pay the mortgage off faster. When mortgage rates eventually increase your repayments do not need to change.
The other common concern is the time it takes to pay off a mortgage. Based on a 20-year term, setting your repayments based on 8.5%, your monthly repayments would be $4,340 or only 37% of your take home pay. Based on an actual mortgage rate of 7.00%, the initial term of the mortgage drops to 16 years.
Once the kids leave home, if you could apply an extra $1,000 per month onto the mortgage, the term then drops to 12 years. And whilst all of this is happening, your property and income are, at worst, increasing at the rate of inflation – so servicing gets easier over time. If all you did was put 50% of your salary increases against the mortgage you would shorten the life of a 25-year mortgage by 9 years.
In reality, if you are buying in Auckland, then over the long term your property will do better than inflation if only because of population growth. This is especially true of properties closer to the centre. Look at Melbourne and Sydney (simply in terms of population demographics) and you can see the future. Most of your other risks and concerns can be reduced or eliminated with insurance. In particular, make sure you have suitable life and income protection policies. In your forties you have less time to dig yourself out of trouble if something goes wrong.