This section of the Building A Home In New Zealand deals with obtaining a credit limit and determining your budget through applying at a lending institution. This section should be read before Locating Land, Choosing A Builder, or Designing A House because your budget will dictate all of the choices that you make later.
The first step in building a home is to sort out the lending. The main reason to do this is to have the banks look at your financials and see how much they are comfortable in lending you. The bank can then pre-approve you for a specific amount when building a house. This pre-approved number will give you a maximum budget for your entire home.
Currently there are some regulations on how much is required for a deposit, but these have been relaxed recently to 10% for those that are building a primary residence vs. buying an existing home or rental property. It may be advantageous to know this before initial discussions with your banker. They may not volunteer this information and suggest that you put down a higher deposit amount.
After visiting your bank, we recommend that you take an additional look at your current and future finances to determine if what the bank has done is in the best consideration of your future. The bank considers your risk in the very short term using short term forecasts. These forecasts are unlikely to apply in the long term.
In the US, all banks offer 30-year fixed mortgages. This means that the rate of your loan is fixed at a known specific rate for the full 30 years of the loan. This provides some security in your life because you know how much your monthly payments are going to be for the full life of your loan. If interest rates rise in the future, your payments won’t. If the interest rates drop, you can refinance into a lower interest rate to get a lower interest rate. If you have good credit, you will ordinarily qualify for a loan with no penalties for paying the loan off early, as is what is done during a refinance.
Regardless of where you live, with inflation and increased job experience, your income typically increases over time meaning that your fixed house payments become a lower percentage of your monthly income and your home becomes more affordable over time. In this instance, people have more security in borrowing the maximum allowed knowing what all future payments will be.
The US also offers 2, 3 and 5 year fixed term 30 year loans; where this is the only option in NZ. For these loans, you know what your payments are going to be only during the short duration of that loan. At the end of that short term, you are subject to the prevailing interest rate. This was one cause of the 2008 Global Financial Crisis. Banks calculated how much a person could afford during the initial portion of the loan and people borrowed that maximum amount. At the end of that term, the interest rates increased, and people couldn’t pay the increased mortgage payments.
Unfortunately, this short-term fixed loan is the only option that is available in NZ. To further threaten a NZ Financial Crisis, the mortgage rates in NZ are the lowest that they have ever been. Therefore, the likelihood that your interest rates will increase over the life of the loan is certain. How much could this affect you? What is a possible future mortgage rate? If you look at the mortgage rates of about 30 years ago (the average expected loan term), the home loan interest rate for October 1987 was 20.2%. The current (01 May, 2019) 2 year loan at ANZ is 3.99%. The current $700,000 mortgage payment at 3.99% is $2,384 /mo. If the rate was to increase back to 20.2 within 30 years, that payment would be $8,437 /mo. For many, that is unaffordable. Even if the rate only went back to 10.4%, the rate from Sept 2008, that would increase the payment to $4,536 /mo. That is nearly double the current payment. Economists think that the mortgage rates will remain low in the short term, but it is up to you to ensure you can afford increased mortgage payments in the future, not your bank.
In summary, the bank will be the first place to start to give you a price range of your maximum budget, but that value should not be a target for everyone. Nobody knows what the future holds, but it is almost certain that interest rates will increase during the 30-year life of a loan and that is a consideration you need to factor when building.