Borrowing the max – should you?

I’ve spent a bit of time looking at affordability lately:

• How the bank works out what you can afford
• Making the most of your income for self employeds
• and I even wrote this post for Proadvisor website on the perilous impact of credit cards

But at the end of the day – what the bank says you can afford and what you really truly can afford are two different things – and I don’t always think it’s smart to go to the max. I talk about ticking the bank’s boxes – and then ticking your own set of boxes.

And it comes back to one very simple factor – take a look at this line in my borrowing capacity post:

You might have heard of the “HEM model”, or the “Henderson Poverty index”, these are some of the models the banks work towards.

Read the last half of the sentence again – the reference to the Henderson Poverty Index, that’s poverty with a capital P.

The banks will allow you, if you choose, to put yourself in a position where you are potentially on par with the poverty index should interest rates rise to the point they use in their calculations – don’t bash the banks here, they have to have some reference and plenty of people want to borrow the absolute maximum that they can. The lenders here are making sure you can afford your repayments, your living expenses and everything else you have going on so you can get into the home of your dreams if that is what you want to do – but you are leaving yourself short of luxuries. OK if this is where you want to be – but be wary of doing it for the long term.

But is this what you want? Thats where free will comes in and it would really help you to understand your budget and your goals to make a good decision here.

The most important question I can ask you is “your repayments will be $x – how does that sound to you?” and you are the only one who can answer this.

I might ask what you’ve been saving, and what other payments you’ve been making and gently guide you towards a decision if you need the help.

The second most important question is, “where are you going for the next 5 years?”

You see, noone wants to live in poverty (and remember, the lenders aren’t thinking thats where you’re going to be as soon as you buy the home – they’re forward predicting rate increases when they test you, so even they are playing slightly conservative.) But there are times when you do want to stretch to the max – for example, it will buy you a significantly better home and last you longer – and:

• you know your budget and it’s all completely comfortable,
• or you know you’ve got more income coming to you,
• you’re studying and looking for better work,
• you’re new business is growing and expanding and you predict it will keep going
• your car loan is almost paid off,
• or you’re aware of a cut in expenses, like the kids moving out sometime soon.
• Or it’s a short term plan with a longer term gain and you’re prepared for the pain!

So we talk about numbers and we put a plan in place to make this as affordable as possible –  we might lock rates in to avoid nasty surprises, we could even consider making our commitments interest only for a brief period with a plan of paying off extra in time.

And there are times when you definitely should not stretch to the max

• when you know you have negative income changes coming up – you’re taking up study or you’re having a baby
• when there’s no future events expected to improve your lot
• where you just can’t sleep at night with that big a loan
• or plain and simple when the repayments sound like too much right from the start.

So, moral of the story, while the banks may be prepared to lend you hundreds of thousands of dollars you don’t have to take them up on their offer! Lets have a sensible conversation and all of us sleep well at night.