Applying For A Home Loan
The best time to make a difference when looking for ways to be mortgage free is before applying for a home loan. In fact it is before you have even begun searching for a home that you have the best opportunity to make a difference. Many prospective buyers make an appointment with the mortgage broker or banker and then ask the most self-destructive question any home buyer could ask; ‘how much can I borrow?’. This is a recipe for disaster and one of the main reasons young buyers get themselves into trouble. Remember, the bank is there to make money from you, they would like to give you the largest loan they legally can and are not concerned about whether it will meet your financial goals or not. Of course, they don’t want you to default on the loan either because that is a bad outcome for them as much as it is for you but they are not going to quote an amount that will maximize your ability to pay it off early. So it is up to you to make sure that when applying for a home loan it meets the following needs:
- You can comfortably pay each month
- It will allow you to pay it off early
- It will get you into a home that meets your needs
On this page I will give you a personal account of what we did before applying for a home loan and how we set ourselves up to be able to pay it off decades earlier than most.
Before you go to the bank
Before you meet with the bank you should already have worked out what you can afford to borrow and repay within your chosen timeline given your lifestyle plans. Once you have this worked out you can approach the bank with the question; ‘can I borrow x amount?’ This is the question you should be asking when applying for a home loan as it puts you in control. Don't even ask how much they are willing to lend you as it creates too much temptation when out looking at houses on the market. Find your price and stick too it.
We applied for our home loan before the GFC (Global Financial Crisis) and things have changed significantly. Back then the question ‘how much can I borrow?’ would result in a ridiculous answer that far exceeded what we would comfortable be able to repay in any reasonable time frame. Today you will get a for more sensible answer but it is still worth doing the maths yourself first.
There are a number of things you will want to consider before you approach your lender for money. Things to consider are:
- Employment and career goals
- Will you be having children in the near future?
- How long will you live off one income after having children?
- What time frame do you want to pay the mortgage off in?
- How many incomes will you have to pay the loan in the coming years?
- Where do you want to live and what features do you want in your home?
What you really need to think about is how much can you afford to pay per month on your mortgage repayments in the future given your likely circumstances. Let me give you a personal example. When my wife and I were first applying for a home loan we were both working full-time and had no dependents. However, I knew that we were going to want children in the next few years and that would mean just one income and at least one dependant. So,when considering how much to borrow I assumed we would have just one income to pay both the mortgage and to live off.
I then took a look at possible future economic scenarios. When we first applied for a home loan, the typical interest rate was around 7.15% (remember we live in Australia), however, I knew that it could go up very quickly if things in the economy went bad. So I assumed rates would be 10% pa. Given the above scenarios I calculated a mortgage that would allow us to keep up with the payments assuming interest rates were at 10%, we had one child and we would be living off one income for 2 years. The net result was a home loan significantly less than if we had simply walked into the bank and asked for the most they would allow us to borrow. Sure, we purchased a cheaper house than we otherwise would have but we were comfortably able to meet the monthly repayments and have been able to make significant inroads into paying it off faster.
You may be interested to know that less than a year after taking out our mortgage, interest rates in this country rose to almost 10% and for some borrowers went well over. They stayed like this for over a year until the GFC hit and now we enjoy much lower rates. If I had not taken these precautions we could have been put in a very difficult situation that would have created a lot of stress and worry. Now that the rates have dropped we have been able to pay off our mortgage even faster. Not only that but my wife has not needed to go back to work for over 2.5 years since our first child was born and there were no financial concerns about having our second.
I cannot emphasize how important it is to take these factors into consideration before applying for your first home. It could make all the difference and may save your home if the economy changes suddenly.
I should emphasize that when calculating future interest rates you are really just making an educated guess. Obviously if you live in the US you won’t be predicting a 10% interest rate in the near future but I do encourage you to least add 2 to 3 % onto the current rate. A home loan is a long term contract and things can change.
I wish you the best of luck with your future mortgage and the purchase of your home. It is a wonderful and exiting time.