# Borrowing capacity explained

By Ericka Pingol

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?

Lenders calculate your borrowing capacity using an assessment rate to examine your application. They have their own assessment rate and it’s 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 by a buffer and account for all your incomes. Your financial dependants are also considered when assessing your borrowing capacity.

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

• 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

Sample computation:

 Number of applicants 1 Number of dependents 2 Annual salary before tax \$82,000 Rental income \$0 Other regular income \$0 Living expenses (monthly) \$2,500 Other loan repayments (monthly) \$1,000 Other commitments \$0 Combined limit of credit cards, store cards, and over drafts \$1,500 Estimated amount you can borrow (based on a 5% interest rate over 25 years) \$226,202

For example, you would like to apply for a mortgage yourself, you have two dependents and earn \$82,000 annually before taxes. You do not have any other income aside from your annual salary; you have monthly living expenses of \$2,500 and have other monthly repayments totalling \$1,000. Your credit cards, store cards, and overdrafts’ combined limit is \$1,500. The estimated amount you could borrow is \$226,022 based on a 5% interest rate over 25 years.

This means you may be able to borrow up to \$226,022 for a mortgage. However, this is only an estimate and you need to consult your lender to get the exact amount you can borrow.

If you would like to get a rough idea of how much you can borrow, use our Borrowing Power calculator.

Borrowing capacity and affordability may seem like they are interchangeable, but they are not. Your affordability has more to do with your lifestyle and the choices that you make daily. How people spend their money differs. Therefore, the cost of living lenders uses to determine borrowing capacity seldom matches your actual spending pattern.

Also read: Housing affordability explained: what does it mean for you?

Your income and any financial dependants that you have affect your borrowing capacity. Other factors that affect your capacity are:

• Your 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, get a copy of your credit history and see if there are any problems you can address before looking for financing. You may get a credit report for free using the national credit reporting bodies (CRBs) such as Equifax Australia, Experian, and illion.

• Your expenses. Your living expenses include school fees, childcare fees, etc. A lender will take this into account when assessing your borrowing capacity. Once you know your borrowing capacity, it may be a good idea to take a closer look at your living 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.

You may also use our Income and Expenditure calculator to have a rough idea of where your money is going every month.

• Your records. Your financial records like your salary slips will affect your borrowing capacity. These records support your application with proofs of any bonuses or overtime pay you regularly receive. Your records may also include rental and other income from investments—all of which will 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:

 DOCUMENT CHECKLIST (PROOF OF FINANCIAL RECORDS) Payslips 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

• The type of loan you want. The type of loan you are applying for vastly affect the amount you can borrow. Lenders generally determine your repayment capacity at an interest rate that is approximately 2.5% 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. To find a mortgage broker near you, use our Find a Mortgage Broker page.

• 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. Consult a professional to give you pointers on how you can increase your borrowing capacity.