Each time a client asks us to assist them with finance we prepare an affordability calculation as part of our loan proposals. Interestingly, when people are buying NRAS properties, more often than not our calculations show people have more discretionary income after they buy the property than before.
We show you here two typical examples of these calculations.
The Affordability Assessment we do is unique. It differs from the way the banks do their assessment because it is designed to help a property buyer/borrower make their own decision about affordability rather than help the bank decide if they are going to provide the loan.
We compare the purchaser’s current position to their position after the property purchase. Furthermore, as a simple risk assessment, we calculate the position as if interest rates were 1% higher.
The bottom line figure in our assessment is Discretionary Income. Discretionary Income is calculated as income less finance commitments. So the current Discretionary Income is the available funds that our client has available to spend on their lifestyle.
By comparing the Discretionary Income between current, post-purchase, and “post-purchase with a 1% higher interest rate” the client has a very simple means of assessing the impact on the funds available for their lifestyle.
It is normal for the banks to exclude tax depreciation benefits from their affordability calculations and we have done this as well because this is usually an unknown figure which requires an assessment by a quantity surveyor on each property. The impact of this is that we are likely to be under estimating the Discretionary Income post-purchase. For this reason our post-purchase figures are conservative.
Couple Purchasing NRAS Property
In our first example a couple are buying a NRAS Property – we’ll call them David and Jenny. David earns $72,000 per annum and Jenny earns $33,000. In the table below the left hand column shows their current situation. Their current Discretionary Income is estimated at $78,897.
Because the NRAS property has positive cash flow they end up with a higher Discretionary Income after the purchase.
The impact of a 1% interest rate rise is smaller than you might expect because the increased interested payments are balanced by increased tax deductibility. In this example the rise in interest rate brings them back to a marginally lower current Discretionary Income.
The assumptions and considerations behind these calculations are:
- Rental income – 80% of gross rental to allow for costs
- Tax – Tax calculation incorporates tax on earnings and allows for deductible interest on investment debt repayment. No allowance for depreciation has been made. Further inclusion of depreciation should reduce the tax payable
- Loan Repayment – We have calculated loan repayments using the current loan repayment plus repayments on new debt using interest only payments.
Individual Purchasing NRAS Property
To show you another example, Alan earns $81,988 per annum. He has an existing mortgage and is buying a NRAS property. In his case his Discretionary Income increases from $47,305 to $48,923. Again, even with a significant increase in interest rates of 1%, he is still almost cashflow neutral.