Is 40 per cent of my income too much for home loan repayments?

Mortgage stress for Australians has reached an all-time high. Across the country, more than one million households are estimated to now be in mortgage stress—meaning their after tax income is not enough to meet their bills and costs of living—which equates to around 30 per cent of owner occupied households with mortgages.

With the old rulebook that said households should not spend more than 30 per cent of their net income on mortgage payments torn up long ago, is the great Australian dream leading us to borrow more than we can afford?  

“Your home repayment should be your first investment in each month,” says personal finance expert Noel Whittaker, Adjunct Professor at QUT Business School. “You have to be comfortable with it. So it becomes not so much a proportion of income, but how much you spend.”

Over the last 27 years, Australia has avoided recession—two or more consecutive quarters where the gross domestic product has fallen—enjoying substantial economic growth. In Sydney, home prices have increased fivefold during this time, and Australians have steadily been borrowing more to keep pace.

Whittaker says that rather than trying to keeping up with repayments of 40 per cent of your take-home pay, borrowers should work backwards in order to understand their limits.

“What a person needs to do if they want to buy a house is find out how much they can comfortably borrow, then get the best house that suits their criteria.”

There’s plenty borrowers can do to be prepared for any changes to house prices or interest rates, says Miranda Marquit, financial expert and founder of the website Planting Money Seeds.

“Monthly cash flow is important, and everyone has a different level at which they're comfortable. The rule of thumb says to keep your housing payments at 30 per cent of your monthly income or less,” she says.

“It's important to not assume that your personal finances will be comfortable if you go up to that limit. Can you comfortably contribute toward the important goals in your life with your house payment? If the answer is no, then the home payments are too much. Personally, I limit my total housing costs to 25 per cent of my after tax income because I don't want to be house poor—and I have other goals I want to meet.”

Marquit believes that new borrowers in particular need to be aware that the cost of a home loan is more than just principal and interest.

“You have council rates. You have insurance. Your new home is probably bigger than your last dwelling, so your utilities will cost more. There's a lot that goes into getting a home, and a mortgage is just the beginning.”

She advocates the “one per cent rule” when budgeting for expenses on top of your mortgage repayments.

“Figure that you'll need one per cent of your home's cost each year for maintenance. If your home cost $250,000, you need $2,500 a year. Set aside that money each month in a separate home maintenance and repairs fund. There's a good chance that you can go a while before you need to tap into it, giving it time to grow.”

On top of maintenance costs, homeowners need to realistically factor in a wide range of bills they will need to pay. ME Bank’s Household Financial Comfort Report found that 17 per cent of Australian households couldn’t always pay their bills on time, while 19 per cent of Australians had sought financial help from friends and family in the past year, and 15 per cent had sold or pawned something to pay for necessities.

Meanwhile, a Bloomberg report found that Australians are stuck with the highest household debt levels among G20 nations, at some 120 per cent of gross domestic product—and the only country above 100 per cent.

“Wage growth is elusive as indebted workers struggle to cling to their jobs, and consumption—which makes up more than half of the economy—is pressured as households scrimp to meet mortgage repayments,” the report’s authors say. But they believe national household debt, at 189 per cent of disposable income, means that the Reserve Bank will need to tread warily when it comes to raising interest rates.

In spite of this, Noel Whittaker warns that Australians may have gotten too used to historically low interest rates, and that when we need to factor in this unusual state of the market when we are working out how much we can realistically afford to pay each month.

“I’m very concerned that we’re encouraging people to take out loans where they’ll quickly be in over their heads when rates go up,” he says.

“At some stage, interest rates are going to rise—and Australians need to ensure that their house in order.”

Compare home loans from all of Australia’s major banks, credit unions and non-bank lenders here.

The information contained on this web site is general in nature and does not take into account your personal situation. You should consider whether the information is appropriate to your needs, and where appropriate, seek professional advice from a financial adviser. If you or someone you know is in financial stress, contact the National Debt Helpline on 1800 007 007.

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