Q My wife and I are looking to buy a larger family home.  My wife works part time and we have a baby who is outgrowing our unit.  We have been shopping around for a mortgage and we are quite shocked by the variation in how much banks will lend.  We are making a large financial commitment and want to make sure that we make the right decision on how much to borrow and how to structure the loan.  How do banks determine our capacity to borrow and how much should we borrow without overextending ourselves.  What we can afford and what the banks will lend us appear poles apart!

A The evolution of the mortgage has meant that a loan facility has become a commodity that mortgage holders should reassess on regular basis based on their needs.  With the average life of a loan in the Australian market being 4 years, the evidence suggests that Australians will shop and change based on who offers the more competitive features and benefits at the right cost.

Broadly speaking your lending eligibility is determined by your current income, your living expenses, your existing debts and the amount of equity you will have in the new property. Each lender will have a varying array of criteria and policies in terms of determining how much they will lend you.

Lenders will consider if anything will affect your future family income and hence your ability to make future loan repayments for example change of employment, pregnancy, extended leave or  sabbaticals.

Some but not all lenders will allow regular bonuses or commissions to be included to determine your capacity to borrow.

Lenders will assess your capacity to service a loan with a buffer of around 2% in case of interest rate rises as opposed to the advertised rate.

What lenders count as living expenses will vary.  Lenders have their own measure of what they include and what they feel is reasonable.  Typically the figure is based on ABS data, determined by the number of dependents in the family and where you live.

Depending on your occupation, you may be able to borrow a higher amount against the value of the home without paying Lenders Mortgage Insurance (LMI).  For example if you are a Doctor, some institutions allow you to borrow up to 90% without LMI.

Limits on how much you can borrow may vary depending on a banks existing exposure to a region or to an actual development.

How much you should borrow should be determined by you and not the bank.  Have a very clear understanding of what your income needs are for living expenses.  Build in a buffer  for future changes.  Do you plan to have another child?  What is the outlook on the employment front?  If interest rates were to rise how would that impact you?

You need to build a strategy around how you plan to pay off a debt.  Whilst Interest Only means your minimum payment will be lower, how do you plan to attack paying off the principle? An offset account is a popular alternative to a line of credit if you are looking to have your income reduce the daily costs of interest on your loan.  You may structure a variety of sub accounts to manage you debt facility; you may have a portion at variable rates and choose to fix a portion of the debt to manage the risk of interest rate rises or to provide certainty of costs.

The cheapest advertised rate may not be the most appropriate for you.  A good broker or debt advisor will be able to structure a loan based on your needs both now and into the future; balancing your lending needs in an appropriate structure and at the right cost.