A couple earning $120,000 combined annual income wants to buy their first home for $650,000. What is the maximum they could typically borrow under standard lending criteria using a 6x income multiple?
Correct Answer
A) $720,000
Using a 6x income multiple, the couple could potentially borrow $120,000 × 6 = $720,000. However, this is subject to other lending criteria including debt-to-income ratios, expenses, and LVR restrictions which may reduce the actual amount approved.
Why This Is the Correct Answer
Option A is correct because the calculation is straightforward: $120,000 annual income × 6 (income multiple) = $720,000. This represents the maximum theoretical borrowing capacity under standard lending criteria using a 6x income multiple. While actual approval may be lower due to other factors like LVR restrictions, debt servicing ratios, and living expenses, the question specifically asks for the maximum under a 6x income multiple, making $720,000 the mathematically correct answer.
Why the Other Options Are Wrong
Option B: $650,000
Option B ($650,000) represents the purchase price of the home they want to buy, not their maximum borrowing capacity. This confuses the property value with lending capacity. The income multiple calculation is independent of the specific property price they're considering, and their borrowing capacity actually exceeds the purchase price in this scenario.
Option C: $600,000
Option C ($600,000) would represent a 5x income multiple ($120,000 × 5), not the 6x multiple specified in the question. While 5x is a conservative lending multiple some banks might use, the question specifically asks for calculation using a 6x multiple, making this answer mathematically incorrect for the given parameters.
Option D: $550,000
Option D ($550,000) is too low and doesn't correspond to any standard income multiple calculation. This would represent approximately 4.6x their annual income, which is below typical lending multiples. This answer likely results from calculation errors or confusion about standard lending ratios used in New Zealand mortgage lending.
Deep Analysis of This Finance Question
This question tests understanding of income multiples in mortgage lending, a fundamental concept in New Zealand real estate finance. Income multiples are a primary assessment tool banks use to determine maximum lending capacity, typically ranging from 5-7 times annual income depending on the lender and borrower circumstances. The 6x multiple represents a common benchmark used by major New Zealand banks. While this calculation provides the theoretical maximum borrowing capacity ($720,000), actual lending decisions involve comprehensive assessment including debt-to-income ratios, living expenses, credit history, and Loan-to-Value Ratio (LVR) restrictions under Reserve Bank of New Zealand guidelines. Understanding these multiples is crucial for real estate agents advising first-home buyers on realistic price ranges and helping them understand pre-approval processes. This knowledge directly impacts transaction success rates and client satisfaction in the competitive New Zealand property market.
Background Knowledge for Finance
Income multiples are a key lending assessment tool used by New Zealand banks to determine maximum borrowing capacity. Typically ranging from 5-7 times gross annual income, these multiples provide a quick calculation method for initial lending assessments. The Reserve Bank of New Zealand's LVR restrictions and debt-to-income ratio guidelines also influence final lending decisions. Banks consider gross household income, existing debts, living expenses, and credit history alongside these multiples. First-home buyers often face additional considerations including KiwiSaver HomeStart grants and Welcome Home Loans. Understanding these calculations helps real estate agents provide realistic guidance to potential buyers about affordable property price ranges.
Memory Technique
Remember 'SIMPLE': Six times Income Means Potential Lending Estimate. Visualize income as building blocks - stack 6 blocks of $120,000 to reach $720,000. Think of it as 'income × 6 = lending height' like stacking money towers.
When you see income multiple questions, immediately identify the income amount and multiply by the given multiple. Remember that 6x is a common benchmark - visualize stacking 6 income blocks to get your answer quickly.
Exam Tip for Finance
For income multiple questions, identify the annual income and multiply by the stated multiple. Don't confuse this with property price or other figures in the question. Always use gross household income, not individual incomes separately.
Real World Application in Finance
Sarah and Mike, both teachers earning $60,000 each, visit your office wanting to buy a $650,000 home. Using the 6x income multiple, you can quickly calculate their maximum borrowing capacity as $720,000 ($120,000 × 6), showing they're within lending limits. However, you'd explain that final approval depends on their expenses, existing debts, and current LVR restrictions. This calculation helps them understand they can afford the property and might even consider slightly higher-priced options, giving them confidence in their house-hunting budget.
Common Mistakes to Avoid on Finance Questions
- •Confusing property price with borrowing capacity
- •Using individual income instead of combined household income
- •Applying wrong income multiple (5x instead of 6x)
Related Topics & Key Terms
Key Terms:
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