What can I afford to pay for my first home?

In our first chapter, we’re going to address one of the first — and most important — question that goes through any first home buyer’s mind: What can I afford to pay for my first home?

You might have already spent some time trawling brokers and banks’ websites, and even played around with a few online calculators.  But can you trust the results that they give you?

Buying your first home is one of the largest financial decisions of your life. When you’re borrowing hundreds of thousands of dollars from the bank, you want to make sure that you can afford it.

The last thing you would want to do is to overextend and get a loan that puts you in financial stress. Believe me, I know. I’ve been there.

Let me start with a quick story

Way back in 2009-2010 I was on my way to becoming a property mogul (in my own head). I had just bought my second property, a small unit on Newton Street in Alexandria which I was planning on renovating and flipping for a massive profit… so I thought.

The unit I nearly lost from overextending myself.

It was around this time that the Reserve Bank of Australia (RBA) started increasing interest rates, and in the space of six months, the interest rates had increased on my loan by 1.50%.

My interest rate went from a barely manageable 6% to 7.50%. That may not seem like much, but my monthly interest repayments went up from $3500 — which I could only JUST afford — to $4375 per month. That’s a jump of $875 per month!

Being the gung-ho property investor that I was, I hadn’t left myself any room for increased payments. I literally had no money left when I was paying $3500 per month, so finding $875 was literally impossible and I was in deep, deep mortgage stress.

I managed to maintain my repayments for a short time (using borrowed money and a cash advance on my credit card) but I ultimately had to sell my second property quickly to prevent myself from getting into more and more debt.

I walked away having made no profit on the entire exercise and put myself through hell in the process. I even risked losing my home!

The lesson: Overextending is bad. Make sure you know what you can afford to borrow.

So, how exactly do you find out how much you can borrow? And once you know how much you can borrow, how much should you borrow?

It starts with understanding some of the basics of loans and finance.

The home buying equation is simple how much you can buy only depends on 2 things – your income and your deposit.

Your borrowing power = income + deposit

The first step in understanding how much you can afford to borrow is to learn about borrowing power.

Borrowing power is a term the banks use to talk about the maximum loan amount that a bank may offer you based on your current circumstances. This is based primarily on your income and your deposit, although a few other factors do come into play as well.

We’ll go further into the details of your borrowing power and how it relates to your home buying budget in more detail as we go along.

For now, think of borrowing power as similar to the credit limit on your credit card.  The bank is telling you how much money they would offer to you, but you don’t need to borrow the whole amount. Just like a credit card, our goal is to maximise your borrowing power. Not so you can go out and spend it all, but because it gives you more options.

There are three more financial terms that you need to be across before we get into the details: LVR, LMR and Genuine Savings.