MAKING CENTS: How much should you borrow?

In the past couple of weeks, I’ve had a number of people contact me who are currently renting but who have now reached that stage where they’re ready to purchase a property.

And their ask of me was to help them identify how much they should borrow?

And the obvious answer is influenced by two things, (a) how much a bank is prepared to give them and (b) what the asking price of a property is, in the area they’d like to live in, and whether that fits in with the amount they can borrow and what their level of savings are.

I’ll come back to all of that in a moment, but before I do, there are other factors that you can apply and use to determine what the optimum amount you should borrow is.

And when you know what that is, you’ll be able to see if what the bank is prepared to give you is enough or too much or too little for where you want to live.

Let me explain in more detail

One of the people who contacted me was a single lady, who was aged 40. She was buying in her own name and was currently paying rent of €1,600.

Before we got to the simple, she could borrow four times her gross salary multiple, I looked at three different monthly repayment scenarios. I wanted her to know what each would translate into, in terms of what the mortgage amount would be, and how aligned they were with what the bank would give her. I also wanted to see what impact these mortgage amounts would have on other aspects of her finances.

And those different scenarios were:

Mimic her rent repayment

If her new mortgage repayment was to mimic what her current monthly rent payment was, it would mean borrowings of about €320,000.

And if she contributed the minimum 10% deposit, it would mean she could look at properties costing €355,555.

So, now she knew if she wanted a monthly mortgage repayment that was going to equal her current monthly rent payment ( which she was comfortable with by the way), she knew two numbers - (a) borrow €320,000 and (b) buy a property not greater than €355,555, if she contributed 10% towards the purchase.

Rent Repayment + Monthly Surplus

When we looked at her monthly income and outgoings, we could see from a cash flow perspective she was carrying a monthly surplus of about €378 which, in theory, could be added to the amount she pays in rent.

And if she did this, it would bring the amount she could borrow up to €395,000, meaning a purchase price of €438,888, again with a minimum 10% contribution from her.

Rent Repayment + Monthly Surplus + Monthly Savings

This was a third option where she could use some of the amount she saved each month and redirect it to a mortgage repayment instead.

She was saving €750 per month, so if she used €250 of that and added it to her rent and monthly surplus numbers, it would increase her borrowing to €445,000, meaning a purchase price of €494,444.

I’m not suggesting she should use her monthly surplus and dial back the rate she was saving, but she could, if she absolutely needed to.

I liked looking at these types of options because they are connected to her finances as a whole and she could see what impact the amount she’s going to borrow was going to have on her entire finances, rather than just looking at one area i.e. how much her new mortgage repayment is.

You must know how that new monthly repayment fits into your finances and what impact it has on cash flow, on savings and on everything else.

And having those reference points will help you figure out what the optimum amount you should borrow is.

Now, this lady knew the asking price for properties she could look at fell somewhere between €355,555 and €494,444.

This is quite a difference but she now knew what the trade-off would have to be, depending on the amount a bank was willing to lend her.

And the amount a bank was willing to give her, using the four times gross annual income rule, was €400,000, which meant an asking price of €444,444 if she contributed 10% herself.

Of the three options I just outlined, the closest one to what the bank's was, was the second one i.e. her current monthly rent payment and the cash flow surplus she was carrying each month.

The problem with that option was that it wouldn’t leave much wriggle room, because at best she’d end up at break-even each month which isn’t ideal.

I think her sweet spot in terms of the amount she should borrow is c. 34% of her net monthly income.

Which would mean borrowing €353,000 and that would mean an asking price not greater than €392,222.

If she followed this advice, she wouldn’t have to reduce her savings rate, but she would have to use some of her current monthly surplus.

But even if she did, she’d still be carrying a surplus of about €209 per month, and I personally like having that type of buffer rather than being at the limit each month and having to watch every cent you spend.

But all of these options are predicated on the asking prices of properties in the area she wants to live in.

It’s all well and good me saying don’t buy a property greater than €392,000, if the properties where she’d like to live are €420,000.

Sometimes it can be all too easy to get carried away with buying a property and taking on a mortgage without giving it the thought it deserves.

I believe you’ve got to stand back a little and run the numbers and look at your options, because taking on a mortgage is one of, if not the biggest financial transactions you’re ever likely to undertake, which is why you’ve got to be careful.

And buying a house is a big deal and it’s exciting, but from a financial perspective you want to get it right as well.

You need other reference points that relate not just to how much you can borrow, but how that amount translates into a monthly repayment and how it impacts not just your monthly cashflow but every other area of your finances as well.

The ideal outcome is having enough to buy in the area you’d like to live in, as well as knowing that what you’ve decided on won’t put you in a vulnerable position if things don’t go according to plan, and no matter what happens you have the ability to control the situation.

Liam Croke is MD of Harmonics Financial Ltd, based in Plassey. He can be contacted at [email protected] or www.harmonics.ie