The one size fits all approach simply doesn’t work as personal circumstances can and do significantly affect what is and isn’t affordable.


There’s been a fair bit of discussion and debate over recent years about how to measure and predict when someone is or will suffer from mortgage stress. These measures have been used to help set government housing and income support policies, assist lenders set their underwriting and affordability criteria and of course act as an indicator for perspective borrowers.


In simple terms mortgage stress is the point at which a borrower breaches his or her level of home loan affordability. Collective wisdom suggests this occurs when home loan repayments exceed 30% of gross household income. So this means a family earning $100,000 a year would be in mortgage stress if their loan repayments exceeded $30,000 per annum. Whether this is true or not is debatable.


The problems with current mortgage stress thinking


I believe the 30 per cent benchmark is a flawed measure and should only be used as a very rough guide at best. In fact, if you are considering borrowing to buy a home or an investment property you would be better off ignoring this ratio altogether because it is likely to provide you with a false sense of what you can really afford.


One of the big problems for me is that applying an across the board measure fails to recognise that no two borrowers are the same – we all have differing spending patterns, other financial commitments and income levels. The one size fits all approach simply doesn’t work as personal circumstances can and do significantly affect what is and isn’t affordable.


It is possible for instance for someone to be at only a 20 per cent level and be struggling (due to non-mortgage related issues) while someone else could be sitting at 40% and be perfectly fine because their income and/or other spending patterns support this payment level.


The other big issue is the use of pre-tax income as the denominator in the calculation. We can only pay our bills from what’s left over after the tax office has taken its share and so it is our after-tax disposable and not our gross income that is important. Aligned to this is the make-up of the household income. A one income family earning $100,000 is likely to be paying more tax than a two income family meaning the later probably has more disposable income to meet their mortgage repayments.


The other interesting aspect to this measure is the inclusion of those who pay more through choice and as part of a debt reduction strategy. While their payments may be above the limit, they are doing so because they can afford to and it doesn’t indicate they are facing financial difficulties.


How to measure your own mortgage stress


At the end of the day you and you alone know what you can and can’t afford and therefore you must take responsibility for determining the point at which your mortgage payments exceed your capacity to pay. By all means consider the methodologies used by government, academics and lenders, but it’s up to you to work out your own mortgage stress point.


To do this you should prepare a detailed budget which includes all your after-tax income and expenditure so you can determine how much you can set aside for mortgage payments and how and where you can make savings or generate more income if there are gaps.


And this applies equally to investors. While they have the benefit of a tenant paying rent and contributing towards the cost of mortgage payments, most are negatively geared and have mortgages of their own, so the same principles apply. The main benefit of preparing a detailed budget is that it takes into account household expenses that go beyond mortgage payments and include all property related, living, personal and life-style expenses.


Plus you can flex the budget (like taking into account future interest rate changes and changes in personal circumstances) as well as do ‘what if’ analysis to see what would happen to your finances if say the unexpected happened like a major bill or unemployment.


The most important aspect of preparing and monitoring your own personal budget is that it will reveal the mortgage stress point unique to you. And this will likely be quite different to what the experts say it is.


Source: Yahoo Finance