In this week’s ‘Make Credit Work for You’ we take a look at the biggest form of credit many consumers are likely to take out – finance on a home. Whilst a home loan is a unique form of credit in that it will generally appreciate over time, there are ways it can be an unsafe form of credit. We look at how you can minimise the risk to you and your credit file when you purchase your first home.

By Graham Doessel, Founder and CEO of MyCRA Credit Rating Repair and www.fixmybadcredit.com.au.

In Australian Broker Magazine article FHBs urged to take caution when signing on to a home loan last week, a financial comparison website warned first home buyers they should be looking carefully at purchase price following research showing many are taking on more debt despite the relative stagnation of the housing market.

Research by RateCity shows first home buyers are taking on more expensive mortgages on the back of steady growth in house prices over much of the past 15 years:

According to the site, the national average first home buyer mortgage size almost doubled in the past decade, to $297,100 in January 2013 and FHBs are taking on almost three-times more debt than they were 15 years ago.

 If the average first home buyer loan size kept in line with inflation only over the past 15 years, RateCity estimates first time borrowers are taking on a further $133,869 (or 82%) above the inflation adjusted average loan size…

Michelle Hutchison, spokesperson for RateCity, says that while there are good opportunities to enter the home loan market this year, FHBs need to be cautious about taking on too much debt.

“Australia’s property market is looking positive for first home buyers with record low interest rates making home ownership more affordable and luring some buyers out of the woodwork. While prospective home buyers are starting to enter the property market, borrowers need to be careful about how much debt they can afford to take on.”

If we figure that most home buyers are now falling into the category of Gen Y, Ms Hutchison’s statement is a wise one. Recent reports from credit reporting agency Veda Advantage show that Gen Y has the lion’s share of bad credit at 60% of all defaults. The most important thing for you as a first home buyer to do is to decide on a purchase price that suits your needs now, and in the future.

We can ensure we don’t become part of those statistics and ensure the home is really affordable, by considering three things.

1. Is this mortgage going to still allow me to live?

Just scraping into a sky-high mortgage could be a detriment to your lifestyle and even your happiness. Do you have wiggle room between your repayments and your wages for savings or for lifestyle purchases? What if your income decreased slightly? Leaving a bit of room for emergencies and also just enjoying life can make all the difference and can mean the money you don’t use can go into extra repayments on your loan, and you can pay it off quicker. Having no room for incidentals will invariably mean if life throws a curve ball at you, you’ll be likely to end up in debt and with a default on your credit rating or worse – all because your purchase was too impulsive and just downright too much for you to handle.

2. Can repayments be made with only one income?

This is a big trap for couples – even if they don’t intend to have children in the near future. Accidents, sickness, break-ups and yes, children can put a strain on finances and can mean the mortgage is paid from only one income for a period of time. Can you cope with the mortgage if this happens?

3. How much equity do I have in the home?

This may seem like a trick question, as really first home buyers have very little equity when they first enter a mortgage – but the bigger the deposit in relation to your purchase price, the more equity you will have, and the more freedom you will have. Having equity will make changes such as refinancing easier, and if for any reason you need to sell the home, you will be less likely to be left with a debt.

When we think about equity, we can also consider future equity. To capitalise on equity it may be best to have a good think about the area you are buying in in relation to your purchase price. Is this area likely to grow much over the next 5-10 years? Is the type of property I am buying likely to be sought after in the area? Is it close to the median house price for the area? For instance, you might be better to buy an apartment in an inner city area which is going to see significant growth rather than a four bedroom home in an outer suburb which is surrounded by cheaper properties. Or on the flipside, you may be better to buy a modest home in a suburb surrounded by expensive properties rather than a penthouse apartment which is flagged on all sides by basic 2 bedroom rentals. Real estate has a general rule, buy the worst house in the best street – but of course – if you can’t afford to do renovations – it would be a good idea not to buy the worst house if it needs lots of work!

When making this decision on your financial future, do your homework. Buying a home should not be rushed. Research the area, research what you can afford to pay – and think of this decision like an investor would. After all, the stability of your finances and ultimately the credibility of your credit file rests with it.

The government’s Money Smart website provides good advice on Buying a Home:

How much can you afford?

A good way to find out how much you can afford to spend on a property is to review your household budget. If you don’t already have one, use our budget planner to:

• Take what you’ve saved as a deposit, add in first home buyer assistance (if applicable), then work out how much you can afford to borrow

• Work out how much you can comfortably afford to repay on a home loan each month, and add a bit more to act as a buffer in case of interest rate rises

• Include all the costs that come with home ownership: up-front costs like stamp duty and legal fees, ongoing costs like land and water rates, house and contents insurance, and repairs

This article is intended to give ideas only for general information, and should not be taken as financial advice. We recommend you contact a reputable financial adviser about your unique situation to decide what is best for you.

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