Purchasing your first home can be confusing. The key to being ready to buy is to be organised. Here are 3 things that first home buyers can do today to get ready to apply for a mortgage.
Order their Credit Report
Ordering your own credit report is free. You can a nice and simple indication from Credit Simple or you can get the whole report (I recommend this) from Equifax. This second option can take a couple of weeks (my latest one turned up in 4 days though). This will allow you to see exactly what the bank is going to see about your history. If anything isn’t correct, now is the time to address that.
Tidy up your spending
Look through your last 3 months of bank statements. Are you spending more than you earn or going beyond the limit of your bank account? This is called going into “unarranged overdraft”. To a bank, these 2 words send up a big red flag. Once is usually ok, but more than that and getting a mortgage is going to be difficult.
You can limit how often this happens by setting up a spending account with automatic payments going out. You’ll know exactly how much is going to be spent and how much is in the account.
Key point: don’t have an eftpos account attached to this expenses account. You’ll end up over spending and going into overdraft again.
You can download a copy of The Mortgage Lab’s Excel Budgeting Spreadsheet here.
Get proof of your income
The bank is going to want to see your income and it won’t usually be enough to show them the money going into your bank account. Banks like to see payslips because they show how your income is made up (ie; is it a base salary or commission). The bank will usually want to see the most recent 3 payslips so if your HR department is a little relaxed in this area, get them working on it now.
If you are self-employed, you will need to have this year’s most recent Financial Statements (between October and March). You can see our blog on when you need to update your Accounts. Since Accountants are often busy, these can sometimes take a while to source so talk to your Accountant early.
If you’re ready to apply for a mortgage, it’s also time to look at your Life and Health insurance. You’re going to be signing a contract for a large amount of money and need to make sure you can pay for it. Find an insurance adviser who you like and feel is looking after your best interests. We believe the best advisers only advise on insurance which is why we don’t offer it in our company. They should be comparing several different products and choosing the one that suits you the most.
You can start getting ready to buy today by:
- ordering and checking your Credit Report
- tidying up your spending habits and making sure you are not going into unarranged overdraft
- getting 3 of your most recent payslips or your latest set of business financials
- finding a good insurance adviser and talking to them about adequate cover
Calculating the amount of interest expected in a progress-payment contract on a newly built house can sometimes seem daunting. In this article, we walk you through some easy calculations.
Recently we discussed the difference between Turn-Key construction contracts and Progress-Payment construction contracts. You don’t need to worry about interest payments for Turn-Key contracts. They are built into the price, which is why they tend to be more expensive. The builder has calculated how much interest he or she will pay and added it on to the price of the contract.
But for Progress-Payment contracts, you begin paying money from the minute you settle on the section, and as you continue to draw down money throughout the build project. So how much should you allow for interest costs for the project?
Let’s use an example project to work through some numbers.
Section cost: $300,000
Cost to build: $400,000
Time to build: 8 months
So the section is going to settle, for example, on 1st March and, 8 months later, the house is expected to be built. How much interest would we expect to pay?
From Day 1, we’re going to be paying interest on the section. Let’s assume we will pay around 5% interest on $300,000 for 8 months.
$300,000 * 0.05 (interest) = $15,000 interest in a year
$15,000 /12 (months) = $1,250 per month
$1,250 * 8 months = $10,000
So the section is going to cost us around $10,000 in interest to hold for 8 months.
The builders aren’t going to ask you for a lot of money on Day 1 for the build. Remember, it’s a Progress-Payment contract so they will only ask you for money once they’ve completed the work.
In the beginning of the project, in other words, you won’t be paying any interest on the build part but by the end, you’ll have drawn down all the money. If you average this out, it amounts to you owing half the build cost over the whole project. What does that mean?
In this instance, you could calculate half the build cost ($400,000 divided by 2 = $200,000) and see how much interest you would pay over that amount for 8 months.
$400,000 (build cost) / 2 = $200,000
$200,000 * 0.05 (interest) = $10,000 interest per year
$10,000 / 12 (months) = $833 interest per month
$833 * 8 (months) = $6,666 interest total for 8 months
So, for an 8 month build, we know that:
The section will cost us $10,000 of interest
The build portion will cost us $6,666 of interest
The total cost of interest for this project will be approximately $16,666. Correct?
Actually, not quite. In my opinion, it’s very rare for a construction company to finish a project on time or early. If the company is saying 8 months, I would add 50% to that (in this case, that would make it a year). There is a lot that is outside the control of the construction companies such as Council Permits and weather. Particularly if they are building during winter.
So even though we have calculated the interest cost to be $16,666, I would expect the interest cost to be up to $25,000 to allow for the time being stretched out.
To calculate the interest costs of a Progress-Payment contract, you need to know 3 things:
- What will the section cost?
- What will the build portion cost?
- How many months is the build likely to cost?
From there you calculate:
- The interest cost on the section
- The interest cost on half of the build cost (the average of what you will owe)
Total that all up and add some more time on to allow for unforeseen delays with construction.
While the Reserve Bank has tried to make finance more difficult in the past 6 months, they have also tried to encourage mortgage lending on newly constructed properties. In other words, getting finance is slightly easier if you are purchasing a construction contract than it is for an existing property.
So, if you’ve made the decision to purchase a new home, you will likely be faced with two choices of contract. A “Turn Key” Contract and a “Progress Payment” Contract.
Turn Key Construction Contracts
These are quite simple in their structure. You pay an initial deposit to indicate your interest in purchasing. This is usually around 10% of the total price. You pay the remaining 90% once the house has received it’s Code of Compliance Certificate (CCC). The contract is (as the name suggests) simple enough that you can turn the key and walk in the door. Everything should be ready for you.
- Very simple and does not require any cash (apart from your deposit) until the house is completely ready to go
- Likely to be slightly more expensive contract than Progress Payment. The Developers must wear the cost of all materials during the build and they pass this on.
- Your Offer of Finance typically lasts a maximum of 1 year. If the construction takes longer than this – and it easily can – you may need to reapply and run the risk that you cannot meet the finance criteria. In this case you would need to try to exit the contract (get your deposit back) or sell it on before it is ready.
A Turn Key contract that is due to settle in under a year holds less risk and if you have good income and good deposit, this should be a fairly low risk for you. It is easy on your cashflow (no payments are required after the initial deposit).
Progress Payment Construction Contracts
A bit more work is involved with these. The first payment you’re likely to make is for the Section. You will be able to get a mortgage for 80% of this (you can use equity in your current property to get the other 20% though).
Once construction has started, you will be required to make payments at certain stages (ie; when the foundations have been completed, when the framing is up, when the roof is on etc). The payments are relatively easy to organise; it requires sending the invoices to the bank.
- From the moment you settle on the Section, your finance is locked in. If the construction takes longer than a year, your finance won’t expire.
- Slightly cheaper contract than a Turn-Key as the holding costs are not included. However, you’ll be paying interest on any outstanding mortgage so this is often negated.
- Banks typically prefer these over the Turn Key Contracts as they have a security early on in the contract.
- Slightly more work with the bank. It’s not a set-and-forget contract like Turn Key
- It is harder on cashflow if your income is a little lower.
In general, the banks (and the Reserve Bank) want to encourage lending against new homes but there is a lot of differences between how the banks view each contract. One bank requires you to be able to pay for both your own property and the new property without rental income. Another bank is not lending at all on Turn Key contracts for Investment Properties.
If in doubt as to whether your bank is right for you, speak to your Adviser.