gaugeWith interest rates in the low 4’s at the moment, it’s easy to let your first home buyer heart skip a beat in the hope of finally getting in the door. And fair enough, those interest rates do make the weekly payments easier.

What they don’t do though, is tell you that the bank uses a totally different interest rate to decide if they’ll lend to you or not. So while you’ve cracked all the figures in your head and know you can nail a mortgage at say 4.25%, the bank’s putting you up against a much harder test rate to check if you can put your money where your mouth is when interest rates rise.

The banks also want to see you pass an even tougher debt servicing test when your deposit is less than 20%, as well as put you up against an unrealistic interest rate.

They’re testing you against an inflated rate because they want to make sure you’d be good for it even if rates were 2% higher than they are today. It’s called planning for the worst, and you should be doing the same thing when looking at how you’ll manage the mortgage going forward. For small deposit borrowers they make you jump that higher hurdle because frankly, there’s bugger all equity to lean on if the mortgage goes bad so they need to make sure you’ve got what it takes income wise.

Which is why the calculators you see on bank websites are generally shite. Transforming your weekly rent into a notional mortgage amount isn’t much use if your deposit is only 10%. You’re better off to try our calculator instead…

While banks will never disclose these rates publically, some mortgage brokers believe it’d be a good thing for people to know and understand how they work.

My thinking? Well yes, while it’s great for buyers to have a deeper understanding of the affordability criteria and just what they’re borrowing on, these test rates are pretty outlandish figures. Nothing to get het up about, which may just be the case if the bank did release them. They’re predictions not reality. They’re a stress test is all. And if you bandied about with two different figures – a real interest rate and a test interest rate – you’d end up confusing the bejesus out of people.

Though the banks don’t ever disclose these figures to the public, we’re seeing the test rate sitting at between 7-7.5% at present. That’s actually a good proxy for you to use when planning your budgets post house purchase, and if you can pay your mortgage at that rate from the start well, you’ll be well positioned for the future.

For example…

Some clients want to buy a house and start a family, which is a cool, so they need to plan for a period of time on one income. One possible solution is to use a revolving type of facility and overpay as if interest rates were higher thereby building up some ‘savings’ which can be drawn out later when that income drops away.

Another example…

Some clients see investment property as something they’d like to get into, and a very safe strategy to build equity (so that you can make that next step into a rental investment) is to smash the mortgage on your home by paying it as if rates were higher.

Test out a few different interest rates on our mortgage calculator and see whether you can stretch the distance. Our job is to give you the best shot at getting a mortgage, whether you’re working towards a first home or the next step in life – so give us a call and download our e-book ‘The bank said ‘YES’!

About Campbell Hastie

Cam is one half of Auckland based mortgage brokers, The Go 2 Guys.

He makes a living by sharing what he knows about mortgages with people, arranging mortgages for people and then insuring people.

He doesn't claim to know everything about mortgages himself which is why he teamed up with David Mercer — hence the ‘2’ in Go 2 Guys.

He writes posts regularly on his blog and has been told he has an ability to share his knowledge in a simple and sometimes memorable way.

Feel free to comment and ask any questions. Contact Campbell Hastie m: 027 697 7789.

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