Deciding on How Much Mortgage to Borrow
When it comes to the question of “How much mortgage should one borrow?”, we have to consider two main factors.
Your Level of Income
The first is of course your income. Your level of income is a general indicator of your cash inflows. It is assumed that the higher your income, the more money you can set aside to service your loan repayments. From here, the lender will analyze how much loan you can take on, your current outstanding loans (mortgage, credit card debt, personal loan etc.) and finally determine how much additional loan or mortgage you can still shoulder.
Some people prefers to borrow as much as they are eligible for. For example, if their income allows them to borrow $200,000 mortgage, they will take the whole $200,000 mortgage. They reason that interest rates is low and over the long term property values will appreciate at a rate higher than the interest rates. This will enable the borrowers’ net worth to grow.
Others prefer to borrow only what they need to finance their purchases, say maybe between 60% to 80% of the amount they are eligible for. Hence they pay a lower monthly repayment. Interest rates rise and fall over time. And when interest rate rises, the monthly repayment becomes higher. But since they didn’t borrow the maximum mortgage available to them, they will still be able to service their repayments comfortably. However, a borrower who borrows up to the max and has high monthly repayments may find it difficult to meet his repayments when his repayment becomes higher due to rising interest rates.
Nobody can predict the future. What if you have to take a pay cut or switch to a lower pay job or your business income suffers? If your montly repayment is high, you might not be able to cope with the monthly repayment. All these come into consideration when deciding how much mortgage you want to borrow.
The Purchase Price or Value of the Property
The second factor to consider is the purchase price or the value of the property. Generally the mortgage will be securitised with the purchased property as collateral.
Again some people prefer to borrow as much as the lender allows them to, maybe between 90% to 100% mortgage financing. This is because they could buy a more expensive property with the money they have. If they opt for 80% financing, then they would have to buy a cheaper property.
Some people borrow as much as possible not because they don’t have money. It is because they don’t want to tie down their money. Instead, they borrow more so that their own cash is free up and they can use the cash to invest in other ventures. And if they could earn a higher rate of return than the mortgage rate, then they will gain. The profit they earn from other ventures is more than the additional mortgage interest.
There are also people who prefer to borrow less, maybe between 60% to 80% of the purchase price or value of the property. These people may prefer the peace of mind of shouldering lower debt.
When the real estate market crashses, property prices do fall. Assuming the property values fall by 15%, then now the property is worth 85% of the purchase price. If the borrower had taken on 90% mortgage financing, he will find that his mortgage is higher than the value of his property. And if he is forced to sell the property at this time, he will still end up owing the lender 5%. However, if the borrower had taken a 80% mortgage and he is forced to sell his property, he will have about 5% cash left in his hand.
In summary, these are the two main factors to consider when deciding how much mortgage you should borrow. Other factors to consider are your future plans and your risk appetite.