Affordability calculation: how much money do you need to purchase your own home?
Affordability is a key concept in financing and the mortgage business. It refers to the relationship between income on the one hand and the costs of owning a home on the other. It is expressed as a percentage and represents a key figure for the affordability of a loan.
Anyone wanting to find a home for less than a million francs in popular residential locations in the greater Zurich or Lake Geneva region has to search for a long time nowadays. Prices in many “hot spots” of the real estate market have risen sharply over the last 10 to 15 years. And as incomes have not increased to the same extent, it is becoming more difficult for some households to meet the requirements for taking out a mortgage.
Mortgage affordability: the right way to calculate
What is the right way to determine the financial affordability of a mortgage? The guidelines of the Swiss Bankers Association (SBA) state that affordability must be ensured in the long term and must therefore be based on sustainable revenue and expenditure components.
The “golden rule” of financing is clear: the mortgage is generally considered to be affordable if the total cost of home ownership does not exceed one third of gross income (income before social security contributions such as AHV, ALV, etc.).
On the revenue side, documented and sustainably achievable income must be taken into account in the affordability calculation. This includes income from gainful employment verified on the basis of documents such as the salary statement, including the 13th month’s salary. Any bonus payments or forthcoming salary increases can be included to some extent, provided they are regular or well documented. A second income from the spouse may be added provided that it is sustainable. This means that income that is merely temporary – that is only generated in one year, for example – cannot be taken into account. At the same time, however, the couple must be jointly and severally liable for all obligations arising from the loan.
Affordability calculation: the cost side
The following costs must be added together to check affordability:
- Mortgage interest (calculated with an imputed interest rate of five percent)
- The required repayments or amortization
- The maintenance costs and incidental expenses of the house or apartment (rule of thumb: one percent of the value).
Verifying affordability is an essential step on the path towards owning your own home. The basic question always remains the same: “What’s the maximum price of my new home?” key4 by UBS automatically calculates affordability with just a few pieces of information.
Mortgage affordability: caution is the watchword
There are two valid arguments for being prudent when calculating affordability:
- The threshold of one third of gross income is undisputed. Otherwise, many households – especially those from the middle class – would have to make excessive cutbacks elsewhere, for example on vacations, restaurant visits, leisure activities etc.
- The conservative calculation of affordability with an interest rate of five percent includes a safety margin. Future purchasers who fulfill the affordability calculation could usually cope with a higher interest rate level. This massively reduces the risk that owning a home could lead to over-indebtedness.
The third cost factor is incidental expenses. Here it is customary in the industry to use one percent of the property value. For a single-family house at a purchase price of one million francs, 10,000 francs would have to be budgeted each year. This includes various expenses: heating or energy, electricity, water, maintenance, repairs, building insurance, garden maintenance etc. In the case of an apartment (condominium ownership), the shared costs in the building are also included in incidental expenses (cost contributions for administration and maintenance, or payments into a renovation fund).
This one percent rule is used for the affordability calculation during credit checks and advisory sessions. Older properties may also incur higher maintenance and renovation costs.
Conclusion: the following motto clearly applies to the purchase of residential property: first budget and calculate, then buy. It is in the client’s own interest to carefully observe the rules of affordability. This prevents financial difficulties later on and guarantees that you can enjoy your own home without anything to worry about.
The Example family has a gross income of 150,000 francs and would like to buy a house for 820,000 francs.
The affordability calculation for the mortgage compares their income with the imputed costs:
Affordability calculation: monthly cost of home ownership in relation to income
The affordability calculation shows that the home and the mortgage for the Example family would be easily affordable – about 31 percent of gross income would go to the “own home” account.
Cost of residential property as a % of
total income (gross)