Home Affordability - What Can You Safely Borrow? (NZ)

🏦 How NZ Banks Assess Affordability

Income Assessment

PAYE Salary Income:

• Counted at: 100% of gross income
• Most reliable: Regular employment income fully recognised
• Documentation: Payslips, employment contract

Self-Employed Income:

• Counted at: Average net profit over last 2 years
• More conservative: Based on tax returns, not gross revenue
• Challenge: Minimising tax reduces lending capacity

Rental Income:

• Counted at: 70-80% of gross rental income
• Haircut applied: Accounts for vacancies, maintenance, costs
• Less valuable: Than PAYE income for lending

Bonuses and Overtime:

• Counted at: 50-100% if proven consistent over time
• Scrutinized: Must show reliability not one-off

Existing Debt Assessment

What Gets Deducted:

• All minimum payments: Car loans, personal loans, student loans
• Credit card commitments: 3-5% of total limit (even if balance zero)
• BNPL services: Increasingly scrutinized by banks
• Other mortgages: If you own investment property

The Credit Card Trap:

$20,000 credit card limit reduces borrowing capacity by $60,000-$100,000 even with zero balance. Banks assume you could max it out anytime.

Living Expenses Assessment

How Banks Calculate:

Banks use the HIGHER of:

• Your declared actual expenses, OR
• Their benchmark expenses based on household size

Benchmark Expenses (Approximate):

• 1 adult: $1,800-$2,200/month
• 2 adults: $2,800-$3,500/month
• 2 adults + 1 child: $3,500-$4,200/month
• 2 adults + 2 children: $4,200-$5,000/month

Why Benchmarks Matter:

Even if you claim to live on $2,000/month, if you're a couple, bank will use their $3,000+ benchmark. This protects against understated expenses but may not reflect expensive lifestyles.

Stress Testing at Higher Rates

The Stress Test Rate:

• Banks test affordability at rates 2-2.5% above current market rates
• Example: If current rate 6.5%, tested at 8.5-9%
• Must prove you can service loan at stressed rate

Why Stress Testing Exists:

• Interest rates fluctuate over mortgage lifetime (25-30 years)
• Protection against borrowers over-extending at low rates
• Ensures some buffer for rate rises
• Regulatory requirement from Reserve Bank

Impact on Borrowing:

Stress testing significantly limits borrowing capacity. An amount affordable at 6% may be unaffordable at 9%, reducing maximum loan by $100,000+ for typical household.

Understanding DTI and LVR

Debt-to-Income Ratio (DTI):

• Formula: Total debt ÷ Gross annual household income
• NZ guideline: Maximum 6x annual income
• Example: $100,000 income → max $600,000 total debt
• Includes all debt: Mortgage + car loans + credit cards + personal loans

Why DTI Matters:

High DTI means large portion of income committed to debt servicing. Less flexibility for life changes, rate rises, income drops. Reserve Bank uses DTI restrictions to manage housing risk.

Loan-to-Value Ratio (LVR):

• Formula: Loan amount ÷ Property value × 100
• Standard target: 80% LVR (20% deposit)
• Example: $480,000 loan on $600,000 property = 80% LVR

LVR Impact:

• Below 80%: Best rates, no low equity premium
• 80-90%: Low equity premium added (0.25-0.75%)
• Above 90%: Very limited availability, highest rates

⚖️ Rate Risk and Self Stress Testing

Fixed vs Floating Rate Risk

Fixed Rate Mortgages:

How they work: Interest rate locked for set period (6 months to 5 years)

Advantages:

• Certainty - know exact repayment for fixed period
• Budgeting easier with predictable costs
• Protection if rates rise during fixed period
• Peace of mind for risk-averse borrowers

Disadvantages:

• Break fees if you need to exit early (sell, refinance)
• Miss out if rates fall during fixed period
• Less flexibility for extra repayments (usually capped)
• Refix risk - must refix at prevailing rates when term ends

Floating Rate Mortgages:

How they work: Rate varies with market, typically higher than short-term fixed rates

Advantages:

• Flexibility - make unlimited extra repayments
• No break fees - can pay off or refinance anytime
• Benefit immediately if rates fall

Disadvantages:

• Rate uncertainty - could rise significantly
• Usually higher than short-term fixed rates
• Budgeting harder with variable repayments
• Exposure to market volatility

The Refix Risk Reality:

Most NZ borrowers fix for 1-3 years, then refix. When your fixed term expires:

• You must refix at whatever rates are available then
• If rates have risen, your repayment jumps immediately
• No protection from the previous fixed rate
• This is when maximum borrowing bites - sudden unaffordability

Stress Testing Your Own Budget

Step 1: Calculate Current Repayments

Use mortgage calculator with:

• Your proposed loan amount
• Current market interest rate
• Typical term (30 years for most first home buyers)

Step 2: Calculate Stressed Repayments

Recalculate with:

• Same loan amount
• Current rate PLUS 2-3%
• Same term

Step 3: Compare to Income

• Comfortable threshold: Mortgage payment under 30% gross household income
• Stretched: 30-40% gross income
• Stressed: Over 40% gross income

Example Stress Test:

• Household income: $120,000 gross ($10,000/month)
• Loan amount: $600,000
• At 6.5%: $3,792/month (38% of gross income - stretched but manageable)
• At 9.5% (stressed): $5,050/month (50.5% of gross income - unsustainable)

Step 4: Add Other Housing Costs

Mortgage is only part of ownership costs:

• Rates: ~$2,500-$4,000/year ($200-330/month)
• Insurance: ~$1,200-$2,500/year ($100-200/month)
• Maintenance: 1% of property value annually
• Total housing cost should be under 40% gross income

Step 5: Check Emergency Fund

• Can you maintain 3-6 months expenses in savings?
• After deposit and purchase costs, is emergency fund intact?
• Homeownership creates new emergencies - need buffer

Step 6: Assess Lifestyle Impact

• Can you still save for other goals?
• Room for discretionary spending (dining, entertainment, holidays)?
• Comfortable lifestyle or constant deprivation?

Safe Borrowing Decision Tree:

• ☑ Comfortable at current rates? → Continue
• ☑ Affordable at +3% rates? → Continue
• ☑ Emergency fund maintained? → Continue
• ☑ Total housing costs under 40% income? → Continue
• ☑ Can still save and live well? → SAFE TO PROCEED
• ✗ Any "no" answers? → REDUCE BORROWING AMOUNT

💰 Hidden Costs, NZ Scenario, and Checklist

Hidden Costs of Ownership

Rates (Property Taxes):

• Annual cost: Typically $2,000-$5,000 depending on location and property value
• Auckland higher: Can be $3,000-$6,000+ for average property
• Paid: Quarterly or annually to local council
• Increase: Typically rise 3-5% annually

Insurance:

• Home and contents: $1,200-$3,000/year typical
• Earthquake risk: Significantly higher in Wellington, Christchurch
• Mandatory: Bank requires home insurance as loan condition
• Increase: Rising annually, especially in high-risk areas

Maintenance and Repairs:

• Rule of thumb: Budget 1% of property value annually
• Example: $600,000 property = $6,000/year maintenance
• Irregular: May spend nothing for 2 years then $15,000 on roof
• Essential items: Roof, hot water cylinder, appliances, painting, plumbing, electrical

Utilities:

• Often higher than renting: Larger properties cost more to heat/power
• You pay all: No landlord covering any portion
• Seasonal variation: Winter power bills substantially higher

Body Corporate Fees (Apartments/Townhouses):

• Monthly/quarterly: $200-$800+/month depending on complex
• Covers: Building insurance, common area maintenance, management
• Can increase: Unexpected major works can trigger large levies

NZ Scenario: Jess and Tom, Tauranga First Home Buyers

Background:

• Jess: 32, nurse, $75,000 salary
• Tom: 34, teacher, $80,000 salary
• Combined gross income: $155,000 ($12,917/month)
• Saved $170,000 deposit (KiwiSaver + savings + family gift)

Bank Pre-Approval:

• Maximum approved: $850,000 loan
• Purchase price: Up to $1,020,000 (with their deposit)
• Feeling: Excited they could afford $1M+ property

The Numbers at Maximum ($850k Loan):

• At 6.5%: $5,376/month (42% gross income)
• At 9.5% (stressed): $7,153/month (55% gross income)
• Plus rates: ~$4,000/year ($330/month)
• Plus insurance: ~$2,000/year ($165/month)
• Total at 6.5%: $5,871/month (45% gross income)
• Total at 9.5%: $7,648/month (59% gross income - unsustainable)

Their Concerns:

• Planning to start family in 2 years (Jess taking parental leave)
• Tom's teacher salary unlikely to increase significantly
• Both value travel and experiences - don't want to feel trapped
• Want emergency fund maintained for peace of mind

Their Decision:

Instead of borrowing maximum $850k, they chose $680,000 loan ($850,000 purchase price):

• At 6.5%: $4,301/month (33% gross income - comfortable)
• At 9.5%: $5,722/month (44% gross income - stretched but manageable)
• Total with rates/insurance: $4,796/month at 6.5% (37% gross income)
• If Jess on reduced income: Still manageable on Tom's salary + parental payment

What They Gave Up:

• Slightly smaller house (3 bed instead of 4 bed)
• Less trendy suburb (still good area, just not top tier)
• Smaller section

What They Gained:

• Comfortable repayments with room to breathe
• Maintained $20,000 emergency fund
• Still save $800/month for goals and holidays
• Flexibility for future family plans
• Sleep well without financial anxiety
• Enjoying homeownership not resenting it

18 Months Later:

Jess became pregnant. When she went on parental leave, household income dropped by ~60%. Thanks to borrowing conservatively, they managed comfortably on Tom's income plus parental payment. Friends who'd borrowed at maximum were forced to make difficult cuts or dip into emergency funds.

Affordability Checklist

Income Assessment:

• ☐ Gross annual household income: $_______
• ☐ Stable income or potential changes next 5 years?
• ☐ Dual income - what if one stops/reduces?

Debt Assessment:

• ☐ Total monthly debt payments (all loans): $_______
• ☐ Credit card limits (total): $_______
• ☐ Can debts be cleared before purchase?

Expense Assessment:

• ☐ Monthly essential expenses: $_______
• ☐ Monthly discretionary spending: $_______
• ☐ Lifestyle important to maintain or willing to cut?

Borrowing Stress Test:

• ☐ Proposed loan amount: $_______
• ☐ Monthly repayment at current rate (6-7%): $_______
• ☐ Monthly repayment at stressed rate (+3%): $_______
• ☐ Repayment as % of gross income at current rate: _____%
• ☐ Repayment as % of gross income at stressed rate: _____%
• ☐ Under 30% at current, under 40% at stressed? ☑/☐

Total Housing Cost:

• ☐ Mortgage repayment: $_______/month
• ☐ Rates: $_______/month
• ☐ Insurance: $_______/month
• ☐ Maintenance budget (1% property value): $_______/month
• ☐ Body corporate (if applicable): $_______/month
• ☐ Total housing cost: $_______/month
• ☐ Total as % of gross income: _____%
• ☐ Under 40% of gross income? ☑/☐

Safety Buffers:

• ☐ Emergency fund after purchase: $_______
• ☐ 3-6 months expenses covered? ☑/☐
• ☐ Ability to save $______/month after all costs?

Future Plans:

• ☐ Children planned next 5 years?
• ☐ Career changes possible?
• ☐ Other major expenses coming?
• ☐ Borrowing leaves room for these changes? ☑/☐

Final Decision:

• ☐ Maximum bank approval: $_______
• ☐ Safe borrowing amount (after stress test): $_______
• ☐ Chosen borrowing amount: $_______

Final insight: Home affordability in NZ: bank maximum approval is not safe borrowing. Banks assess ability to service loan at stressed rates using standardised benchmarks, optimising for loan repayment not your quality of life. Assessment includes: income (PAYE 100%, self-employed averaged, rental 70-80%), existing debts (all minimums plus 3-5% credit limits), living expenses (benchmarks by household size), stress testing at +2% rates. DTI (total debt ÷ income) guideline max 6x. LVR (loan ÷ value) preferred <80%. Fixed rates provide certainty but refix risk when term expires. Floating rates have flexibility but rate volatility. Stress test yourself: calculate repayments at current +3%, ensure comfortable, maintain emergency fund, total housing under 40% income. Hidden ownership costs: rates ($2-5k/year), insurance ($1-3k/year), maintenance (1% property value), body corporate (if applicable). Tauranga couple approved $850k but chose $680k - maintained lifestyle, flexibility for family plans, avoided stress. Affordability checklist: assess income, debts, expenses, stress test borrowing, calculate total housing cost, verify safety buffers, consider future plans. Safe borrowing means comfortable at current rates, sustainable at higher rates, emergency fund intact, room for life, enjoying homeownership not resenting it.