Understanding what your borrowing capacity is, and how to increase it, is important when beginning your homeownership journey as it dictates not just what you can afford, but also shapes your property search and purchase strategy.
So how can you increase your borrowing power to secure your dream home?
How to increase your borrowing capacity
- Manage your debts. Paying off high-interest debts, especially credit cards and personal loans, can significantly boost your capacity. Lenders view debts as a risk, and reducing these liabilities can paint a more favourable picture of your financial health.
- Increase your income. Stable and consistent income is a green flag for lenders. If you're self-employed or work in the gig economy, showcasing a steady income stream can be beneficial. Additionally, any extra income, such as rental income, should be documented and presented as it adds to your repayment capability.
- Know your credit score. Your credit score is a reflection of your financial reliability. A higher score often translates to better borrowing capacity. Regularly checking your credit report, paying debts on time, and correcting any errors can maintain or improve your credit score.
- Ramp up your savings. A substantial deposit not only reduces the principal amount but also demonstrates financial discipline. A history of consistent savings can tip the scales in your favour when it comes time for lenders to assess your loan application.
- Cut back on expenses. High living expenses can dent your borrowing capacity. Lenders consider your lifestyle costs when calculating how much you can borrow. Trimming unnecessary expenses and maintaining a budget can increase your borrowing power.
- Demonstrate job stability. Frequent job hopping or moving to a less stable sector can raise red flags for lenders. Demonstrating a stable career path in a steady industry can positively influence your borrowing capacity.
- Choose the right home loan product. Different loan products come with various features and flexibility. Opting for a home loan that aligns with your financial goals and situation can impact the amount a lender is willing to offer.
- Consider a joint loan. A joint loan can significantly enhance your borrowing capacity, particularly if both applicants have strong financial backgrounds. By pooling resources and creditworthiness, applicants in a joint loan can often access higher credit amounts than they could individually.
- Get a longer loan term. A longer loan term will reduce your monthly repayments as you’re spreading them out over a longer period of time. For example, a $750,000 loan borrowed over 25 years at an interest rate of 4.50% p.a. rate equates to a monthly repayment of $4,168. But if you were to increase your loan period to 30 years, your monthly repayments would be $3,800.
- Use a mortgage broker. Each bank has its own method for determining borrowing power, and a skilled mortgage broker can identify the banks that might view your financial situation more positively. They're not just intermediaries; they provide essential guidance through the home loan application process, enhancing your chances of obtaining the necessary financing.
Buying a home or looking to refinance? The table below features home loans with some of the lowest interest rates on the market for owner occupiers.
| Lender | Home Loan | Interest Rate | Comparison Rate* | Monthly Repayment | Repayment type | Rate Type | Offset | Redraw | Ongoing Fees | Upfront Fees | Max LVR | Lump Sum Repayment | Additional Repayments | Split Loan Option | Tags | Features | Link | Compare | Promoted Product | Disclosure |
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
6.04% p.a. | 6.06% p.a. | $3,011 | Principal & Interest | Variable | $0 | $530 | 90% | 4.6 STAR CUSTOMER RATINGS |
| Promoted | Disclosure | |||||||||
5.99% p.a. | 5.90% p.a. | $2,995 | Principal & Interest | Variable | $0 | $0 | 80% |
| Disclosure | |||||||||||
6.14% p.a. | 6.16% p.a. | $3,043 | Principal & Interest | Variable | $0 | $350 | 60% |
| Disclosure |
What is borrowing capacity?
Borrowing capacity is essentially a calculation by lenders to determine the amount you can secure for a home loan. This calculation includes various factors including age, income, expenses, existing debts, and employment status, along with family responsibilities like having children.
A key component in this assessment is the Household Expenditure Measure (HEM), which considers the borrower's living location, number of dependents, and lifestyle choices (e.g. do they have champagne taste on a beer budget?). Additionally, lenders review your financial obligations such as credit card debts, personal loans, car loans, and others.
Taking into account all these elements, lenders provide an estimate of your borrowing ability, which can be surprisingly high for households with dual incomes, stable employment, and controlled debts and expenses, especially in a low-interest environment.
Knowing your borrowing capacity is key in plotting out your journey to buy a home. By figuring out your borrowing ceiling early on, you can zero in on homes that are realistically within budget, saving you time and heartache.
How do banks calculate your borrowing capacity?
Banks calculate borrowing power using a formula that assesses several financial aspects of a potential borrower. This typically includes evaluating income (both regular and additional sources), existing debts (like loans and credit card balances), and regular expenses. The borrowing capacity formula also factors in the individual's credit history and score, which helps the bank assess their creditworthiness and potential risk. Each bank might have its own specific methodology, but the general principle involves balancing the borrower's income against their liabilities to estimate how much they can comfortably repay without financial strain.
How much can I borrow for a home loan?
Without knowing the specifics of your individual financial situation, it’s hard to estimate how much you could borrow for a home loan. However, lenders consider multiple factors when assessing how much you can borrow for a home loan, by looking at your expenses, including day-to-day living costs and other financial commitments. Existing debts such as personal loans, car loans, and credit card debts significantly impact the calculation.
Another factor is the number of dependents you have, as this influences your overall financial responsibilities.
Lenders also consider the loan's interest rate and the loan term, alongside your credit score and history, which reflect your reliability as a borrower. It's essential to provide accurate and comprehensive information to the lender to get an accurate assessment of your borrowing capacity.
You can calculate your borrowing capacity by using our borrowing capacity calculator.
Image by Drazen Zigic on Freepik
Collections: Borrowing Power
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