Whether you’re a budding investor or a first home buyer, you need to understand what borrowing capacity is - it’s the cornerstone of your home buying process, after all.

Simply put, your borrowing capacity is the amount of money a lender will loan to you, but how is this assessed?

How lenders calculate your borrowing capacity

Lenders calculate your borrowing capacity using an assessment rate to examine your application. They have their own assessment rate which is based on their appetite for risk, which is why your borrowing capacity may vary from one lender to another.

Aside from the assessment rate, a lender may also consider other factors and will load your existing loans with a buffer and account for all your incomes. Your financial dependents are also considered when assessing your borrowing capacity.

Common information needed to calculate your borrowing capacity

To calculate your borrowing capacity, you may need to provide the following information to your lender:

  • How many applicants are applying for a mortgage
  • Number of dependents
  • How much your annual salary is before tax
  • How much rental income you receive from properties
  • Other regular income
  • Living expenses
  • Other loan repayments
  • Other commitments
  • Combined limit of credit cards, store cards, and overdrafts

Our Borrowing Power calculator provides a convenient and simple way of estimating your borrowing capacity.

Borrowing capacity versus affordability

Borrowing capacity and affordability may seem like they are interchangeable, but they are not. Borrowing capacity is calculated by lenders based on their assessment rate, allowing them to assess whether your current financial circumstances will allow you to service your mortgage over the specified loan period.

Meanwhile, affordability has more to do with your lifestyle and the choices that you make daily - how people spend their money differs. Therefore, the costs of living lenders use to determine borrowing capacity seldom match your actual spending patterns.

Factors affecting your borrowing capacity

Your income and any financial dependents that you have may affect your borrowing capacity. Other factors that affect your borrowing capacity are the following:

1. Credit history

Your credit history plays a huge role in determining your borrowing capacity. If you can prove that you are a reliable and responsible borrower who meets their financial obligation on time, you may be able to borrow a higher amount. However, if your credit history is tarnished by missed bills and credit card payments, it may work against you.

Before going to a lender, you should get a copy of your credit history and see if there are any problems you can address before looking for a loan. You can get a credit report for free using the national credit reporting bodies such as Equifax Australia, Experian, and illion.

To get your credit report history, you may need to provide your full name, address, date of birth, previous address, and/or driver’s license number.

2. Expenses

A lender will take into account your living expenses including school fees, childcare fees, etc when assessing your borrowing capacity. Once you know your borrowing capacity, it may be a good idea to take a closer look at your day-to-day expenses to see how repayments will fit in.

Make sure to calculate your living expenses before filing a loan application as lenders will take all your expenses into account. To evaluate your living expenses, you may use the Household Expenditure Measure (HEM).

HEM is developed by the Melbourne Institute and is the standard benchmark lenders use to estimate your annual expenses. The figure may become part of a lender’s calculation when assessing your borrowing capacity.

It uses a median expenditure on basic expenses (e.g. food, children’s clothing) combined with 25% of spending on “discretionary” expenses (e.g. eating out, childcare, alcohol). Non-basics like vacations are excluded from the calculation.

3. Other financial records

These records support your application with proof of any bonuses or overtime pay you regularly receive. Your records may also include rental and other income from investments—all of which can significantly affect the assessment of your borrowing capacity.

A checklist to organise all documents you may need to submit to your lender may be helpful. Here are documents you may need, transformed into a sample checklist:

  • Pay slips or invoices for at least three months
  • Tax returns (from the last 2 financial years)
  • Bank statements over the past 3-6 months
  • Proof of current debts
  • Proof of assets

4. The type of loan you want

The type of loan you are applying for vastly affects the amount you can borrow. Lenders generally determine your repayment capacity at an interest rate that is approximately 3 percentage points higher than the rate at which the loan is offered. However, if you’re applying for a fixed-rate loan, the repayment capacity may be assessed without any buffer.

You may consider consulting an expert, such as a mortgage broker, who may be able to help you find a loan that fits your financial situation. A broker has access to a range of home loan products through a panel of lenders he or she is accredited with.

5. Your deposit

The amount of your deposit greatly affects your borrowing capacity. Lenders all have varying criteria for assessing your capacity and allowing you to use a certain amount for your deposit. The larger the amount you have saved for a deposit, the easier it may be to obtain financing and increase your borrowing capacity. On the other hand, if you have barely saved for a deposit, your borrowing capacity may suffer.

Lenders like to see that you can save money over some time. Generally, most lenders require a 5% “genuine savings” for your deposit. Saving a larger deposit can help you borrow more. It will also show lenders that you are capable to save for your loan. Some of the steps you may consider taking to save more for your deposit are:

  • Reduce your debts. Paying off your debts may help you save for a deposit faster. Consider paying off high-interest debts such as credit cards so you may be able to keep a little more for your deposit.
  • Cut your expenses. You may trim your expenses by preparing food at home more frequently instead of eating out or try cutting back on movie dates. The money you save from doing these changes may go to your home deposit fund instead.
  • Find a second source of income. Making a bit of extra cash on the side may help you save for a deposit a lot faster. For example, consider some of your hobbies and see if you can make a profit out of them.

If you are looking to buy a home to live in or as an investment property, you should always consider your borrowing capacity. By having a clue of what you can borrow, you can adjust your expectations and narrow your searches. Calculating home loan costs is crucial. Consult a professional to give you pointers on how you can increase your borrowing capacity.

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