A property purchase and subsequent mortgage is one of the biggest financial transactions you’ll ever undertake in your life Picture: Pixabay
AS PROMISED, this is my follow up article to last weeks, where I want to look at best practice when someone is buying a property on their own.
Last week I spoke about having the need the have a higher deposit and holding an emergency fund in place post purchase. My third piece of advice is to:
Create a buffer where your present income can take a 15% loss
Obviously if you borrow less, your monthly repayments are lower regardless of whatever rate is being charged, and maybe that has to be the case, just in case your income was to reduce.
The woman I referred to last week knew she was commanding a high salary and perhaps that wasn’t always going to be the way. She thought if her employer told her, her time was up with them, getting another comparable job that would pay the same would be difficult. And she believed if she did have to find a new employer, she could expect a €15,000 drop.
She was being realistic which was great and wasn’t thinking that her income was always going to be as high or keep increasing for that matter. It worried her which is why she mentioned it to me and I’m glad she did.
You’ve got to be careful not to borrow money based on what a future income might become, but you can’t borrow money based on a worst case either. You’ve got to be realistic and run sensible numbers. If your assumptions are that your income will increase and they are well founded and based on fact, then use them. If they’re not, then be careful.
With all that in mind, I think having a monthly repayment that isn’t greater than 28% of your net take home pay is a good number to have.
The amount the bank was willing to give the woman I encountered was going to be €1,164 per month which was 33% of her net monthly income.
If her salary was to reduce by €15,000, that same monthly repayment was going to account for 40% of her take home pay.
And that increase in the % of what’s taken from your income each month, can be much more easily absorbed if there are two incomes, but when there’s just one, it’s a big jump.
Which is why, I like starting off with the 28% number for single owners.
If her salary was to reduce by €15,000, her mortgage repayment would now only account for 34% of her new income, which I think would still be manageable, rather than 40% which is a number I think is just too high and one where it’s much easier to miss or fall behind with repayments.
The downside of course to having a lower monthly repayment is having a higher deposit but when you put both assumptions beside each other, it might make the case for delaying a purchase and saving harder and probably longer, much stronger.
There’s another reason why having a higher deposit and a subsequent lower monthly repayment is advantageous and it’s just dawned on me as I was writing this, and it’s to protect yourself against future interest rate increases.
If rates increased by .50% or 1%, would you be able to comfortably carry the increase?
What if rates went up 2%, what then?
If rates went up by 1% for the lady, I spoke with a deposit of 10%, it would mean she’d go from 33% of her income servicing mortgage repayments to 36%. Again, not a number I like but it could be manageable, nonetheless, and could be cushioned if her income was to increase to compensate for the extra amount. But if it didn’t, again you are getting near an uncomfortable number for a single borrower.
If she had a 20% deposit, her repayments would go from 28% of her income to 31%, which is a much more manageable number whether her salary increases or not, but the good thing in this instance is that it doesn’t have to increase.
What I’ve outlined in the past two weeks is in an ideal world and may sound great in theory, but in reality, it might be very difficult to satisfy everything I’ve recommended. But take from it what you need. And perhaps you need to buy out of necessity in the short term and waiting to accumulate a 20% deposit is not doable because it will just take too long. And that’s fine as well, completely understand, but having 6-month buffers in place is possible and re-visiting the amount you are going to borrow to compensate for a possible loss in income or interest rate rises is something you hadn’t thought of and perhaps now you might.
Believe me when I tell you that people get into trouble on the basis of incorrect guesses i.e. their income is only ever going to increase, as opposed to also looking at, what happens if it doesn’t, or what happens if the value of the property decreases etc.
When looking at your finances, acknowledge that at this point in time the future is unknown, and your numbers are pretty rough. Back of the envelope numbers might suggest you can afford the repayments and you’ll have plenty of money left over each month but are they really accurate or are you manipulating them because you want them to work because you’re so invested in buying a property, you’ll do anything to make the numbers look as strong as possible.
You’ve got to stand back a little and ask yourself what assumptions need to prove true in order for you not to get into trouble. At the top should be what’s most important, they being, permanency of employment and incoming remaining at current levels and/or increasing. At the bottom are those areas that are least important and most certain.
Once you understand what each of these things are and you test each assumption i.e. income continuing to increase or not, likelihood of never being out of work or not, maintaining adequate savings levels or not, you can then give yourself the green light to borrowing more with less of a deposit or borrowing less with a higher deposit.
A property purchase and subsequent mortgage is one of the biggest financial transactions you’ll ever undertake in your life which is why you’ve got to be even more careful when you’re doing this on your own. The ideal outcome is getting a sense that what you’ve decided to do, 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.
And the purpose of writing these articles over the past two weeks wasn’t to frighten or put anyone off from buying. Its purpose was to learn from the mistakes others who were in a similar position, made before them. The past leaves clues and we should learn from them, which is why it’s essential you think this thing through well in advance because whatever you do, could and will impact your finances for a number of years, and potentially decades to come, which is why you want to be best prepared and have yourself set up no matter what happens, good or bad.
Liam Croke is MD of Harmonics Financial Ltd, based in Plassey. He can be contacted at firstname.lastname@example.org or www.harmonics.ie
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