So you’re looking to purchase. Could a flatmate help you purchase a more expensive house? Will a bank take that extra income into account? How much interest will flatmate income actually save you in the long run?
We look into the strategies, pros and cons of getting a flatmate in to help you with your mortgage. (Here’s an article if you’re looking for the basics on getting a mortgage)
When you are applying for a mortgage, you will quite often hear your mortgage broker talking about “boarder income”. Is there a difference between boarder income and flatmate income?
The banks view boarder income and flatmate income as one and the same. If you hear a mortgage broker talk about boarder income, they mean getting someone in to rent a room and (hopefully) help pay your mortgage. For mortgage-affordability calculations, there is no difference between a flatmate and boarder agreement.
In this article, we will refer to only flatmates.
When you are talking boarders and flatmates for tax purposes, there is a clear difference. A flatmate is someone who rents a room from you and may share the costs of other expenses (such as utilities, food etc). A boarder typically receives additional services on top of the room such as laundry or prepared meals included in their weekly rent. For more information on the tax treatment of boarders and flatmates, see the article here or talk to your Accountant.
Having enough income is one of the 2 main hurdles to getting a mortgage (here's an article on "the income hurdle"). First home buyers are often keen to get in a flatmate to supplement their income and allow them to borrow more (ie; purchase a more expensive house).
Banks only allow a maximum of $150 - $200 per week to be used to pay a mortgage. In some cities (we're looking at you Auckland), it is easy to get more than that as rent. New home purchasers can often be frustrated with this.
But the banks don't want to assume the very best-case scenario. The banks want to use a worst-case scenario to see if you can afford a mortgage. Sure, you may be able to get $250 for the room now but in a couple of years, if the market for flatmates has decreased, you may not be able to get that any more. So they cap the amount of income at a more reasonable, conservative amount.
Prior to the Covid19 lockdown, banks would often allow up to 2 flatmates to supplement income. Increasingly we are seeing banks reduce the maximum number of flatmates to 1 (as above at the $150-$200 per week income). This isn't because banks are forecasting a reduction in flatmates. It is because banks want mortgage applicants to be able to pay for the mortgage with their own income. They don't want them solely relying on income from flatmates.
As we have discussed multiple times in our articles, 80% LVR is the magic mortgage amount (here's our incredibly popular article on the best deposit to have). Mortgages that are over 80% of the value of the home are viewed by the banks as "riskier". Clients must be able to stand on their own feet on over 80% mortgages. What does this mean? It means the client's income has to be enough to pay the mortgage. Until very recently, banks wouldn't use any flatmate income to make an over 80% mortgage affordable.
Once you've purchased your home you can, of course, have as many flatmates as you like. But for the purposes of getting a mortgage, the banks only allow you to factor in a maximum of 2 flatmates and, as mentioned above, some banks are starting to limit that number to just 1. These will be at $150 - $200 per week for a maximum total additional income of $150-$400 per week depending on which bank you go to.
Something else to note; if you get a mortgage pre-approval based on you and 2 other flatmates living together, and then put an offer on a 2 bedroom property, there will be an issue. You can't have more tenants than bedrooms so if you're relying on 2 flatmates to make the mortgage work, make sure you're shopping for 3 bedroom places.
Couples don't count as 2 flatmates.
The banks are well aware that promising to get a flatmate is used to boost up your mortgage affordability. They have, in previous years, pretty much turned a blind eye to this practice. If you didn't get a flatmate in after the mortgage, there was really no follow up unless you started to miss mortgage payments.
But things have changed. With the Responsible Lending Code now firmly in place, the banks are starting to check. And if they see no flatmate income coming into the account after settlement, there is a possibility that you will receive a "please explain" letter from the bank. It may be that you just haven't found the right flatmate yet. It may be that you're just settling down into your new house, or waiting until a better time of the year - for instance, January is a good time to look for a flatmate. But don't think that you can suggest you will get a flatmate these days without the bank potentially following up on this.
So you've got an extra $200 per week coming in from your new flatmate. The most important thing to remember is that this extra income isn't spending money. Your income (after your minimum mortgage payment) is your spending money. Flatmate income should ideally be used to pay off your mortgage even faster.
To understand the huge benefits of this consider that, on a 30-year mortgage, $1 extra paid off your mortgage saves you roughly $5 in interest in the long term. So putting that $200 towards your mortgage will be saving you around $1,000 of interest on your mortgage... every week!
(*fine print: based on assumed interest rates and a 30-year mortgage. Shorter mortgages have diminishing returns)
Given that putting $200 on your mortgage, saves you approximately $1,000 in interest on a 30-year mortgage, does it make sense to put money on your mortgage if you have Credit Card debt?
At the end of the day, mortgage rates are below 4% pa whereas Credit Cards can be up to 20% pa, so it would seem far better to pay down your Credit Cards first. Generally, you would always pay down your higher-interest debts (ie; credit cards, hire purchases) first.
There is one caveat to this though. If you are putting the extra income onto your Credit Card, only to spend it again next month, you are not moving forward... you are using the extra flatmate income as spending money, not for debt reduction. For the money to be useful, you might consider cutting up your Credit Card and then put the extra flatmate income on the card to reduce the amount due. And once the Credit Card is paid off, close it down. Have a read of our article on good debt versus bad debt.
Let's say you've got a mortgage and this article has convinced you to get a flatmate (or two). How do you make sure the money goes onto your mortgage rather than getting spent? And, importantly, how do you make extra payments without incurring break fees on your mortgage?
Some banks allow you to increase your regular payments by a certain amount without penalty. Sometimes it is up to $1,000 per month that you can increase it. Sometimes it is whatever you like, as long as you don't pay more than 5% of the mortgage off in a year as a result.
If you have a Revolving Credit or Offset account, you can put your extra payments onto these. This will reduce your mortgage instantly. Be careful with this strategy though. There is a temptation to use available Revolving Credit money on luxury purchases (holidays, new TVs etc) which removes the long term benefits.
If your bank only allows "lump sum" payments on your mortgage (and you don't have a Revolving Credit account), then you may have to stick your flatmate income in a separate savings account until one of your fixed-rate account matures or you have enough to make a worthwhile lump sum payment.
A quick phone call to your mortgage broker will tell you how your current bank treats break fees on fixed-rate accounts.
Obviously the income is a huge benefit to your mortgage. We have seen above that the additional income can save you around 5x that amount in interest on your mortgage. But what are the cons? Some things to think about with flatmates are:
Additional people in your home means additional wear and tear. More scuffs on the wall, more marks on the carpet, more loads in the dishwasher. It would be unlikely that the true cost of this is more than the extra income generated (unless you've got some really delicate carpet!) but is worth bearing in mind.
Once your flatmate has moved in, they have the right to expect a stable accommodation contract. So you won't be able to decide to remove them very easily if you decide you want to live alone again. If it all falls apart, it is possible that homeowners will be stuck with an unwanted (and unhappy) flatmate for a few months while they find another place.
Income from flatmates can quickly reduce your mortgage but you must make sure that the money is used to pay down your debt - not used as additional income for day-to-day expenses.
The potential income can be used to increase the amount you can borrow, particularly if you borrowing under 80% LVR but only for 1-2 flatmates and typically only at a rate of $150-$200 per week.
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