“How much will the bank lend me?” is a vital question. “How much debt do I feel comfortable with?” is a completely separate one.

Before taking out a loan, you need to calculate your capacity to repay that loan – month after month, year after year and it is not just about paying the minimum repayments, you need to consider how much extra can you pay, especially when interest rates are so low.

To calculate your capacity, you need to see how much of a ‘gap’ there is between all the money coming into your bank account (salary, dividends and any other income) and all the money going out (mortgage repayments, council rates, school fees, petrol, groceries, holidays, etc).

Your income may change significantly if one member of your household gets a promotion, switches career, stops work to have a baby, returns to work after having a baby or starts a business.

Your expenses may change significantly if you start paying childcare or school fees, stop paying childcare or school fees, change your holidaying habits, sell a car or upgrade a car.

You also need to think about your risk appetite. If you’re confident about the future, you may feel comfortable with a relatively large mortgage (compared to your household income). If you need more security to help you sleep at night, you might prefer a smaller mortgage.

So, there is no right or wrong answer to the question “How much debt do I feel comfortable with?”
It, all depends on your unique circumstances.

‘Deposit’ can be a confusing word because it can mean two different things. First, you will need to pay a 10% deposit as part of the Contract. Next, a lender will expect you to have a deposit before as part of getting a loan.

It is your total contribution that we ate looking at here and it can be made up of different things:

• Savings
• Family gift
• Family equity guarantee
• Government grants

Whether you want to take out a loan for a renovation project or a new build, the lender will expect you to make some sort of contribution.

A 20% contribution is typical, although you could contribute just 10% if you were willing to pay lender’s mortgage insurance.

One way to pay that contribution is through cash savings. Another is to borrow against the equity in your current home, and use that new loan as your contribution.

Savings:

The simplest way to fund your contribution is to dip into your savings, because you have instant and guaranteed access to the money.

However, you might not have enough savings to fund your contribution. Or you might have enough savings, but prefer to leave that money untouched so it’s on call for some other use in the future. In that case, if you’re a homeowner, you might be able to tap into the equity of your current home.

Borrow against your equity:

Equity is essentially how much of the home you own (as opposed to how much the lender owns). Let’s say, your home was valued at $850,000 and you had $500,000 left on your mortgage, your equity would be $350,000.

We have talked in detail above about how banks value a property and how this may be relevant to you and how it can impact what you are trying to achieve.

If you want to tap into your equity, lenders will generally allow you to borrow 80% of the property’s value minus the outstanding mortgage. In this example, your available equity would be $180,000:

It is possible to borrow more than 80% of the value of a property, but as soon as you do you will pay Lenders Mortgage Insurance (also called LMI).

When building we do need to be careful to understand each lenders policy on LMI loans with construction to make sure it is possible and we pick the right option. Each leader will have different LMI fees and different interest rates, so we need to take time to make informed decisions.

Once you know how much you can borrow, how much you feel comfortable borrowing, how much of a contribution you’d make to your loan and how you’d pay it, you’re ready to calculate your purchasing power.

Purchasing power refers to the maximum amount you could spend (and would be willing to spend) on the land and building your new home. It may not quite be the right word when you are renovating your existing property, but hopefully you get the point.

It’s the final figure and includes all associated costs to give the full picture of that is possible.

For example, when you renovate, you’re not just paying for construction labour and materials. There are other costs, such as hiring an architect, lodging a development application, and applying for a loan.

When you build, you might have all those costs plus stamp duty, conveyancing, and valuation.

Once we have worked through all four pieces of the puzzle, we can start talking about lender options and finding a loan and lender suited to your unique circumstances, and then apply for a pre-approval on your behalf.

Ready to start planning your renovation or construction project?

(* If you buy a property in a strata complex, you need a strata report. If you buy any other type of property, you need a pest and building report.)

Imagine this was your situation – that you had a home purchase price of $500,000. You would then need to ask yourself what sort of property you could buy for $500,000. You might need to refine the number.

You might conclude $500,000 is too low, because you want to buy a better (i.e. more expensive) property. Or you might conclude it’s too high, because you’d struggle to make the mortgage repayments on a $450,000 loan.

Don’t be discouraged, because you’re not locked into your initial purchasing power number. Now we’ve got somewhere to start, we can work on it together, and move it up or down, depending on your situation.

This is an important process to follow. Once it all comes together, you will feel confident about your financial position and ready to buy your first home.