Home loans 101: How much can I borrow?
- Yuan Gao
- Feb 24, 2024
- 9 min read
Your borrowing power helps you know what homes you can afford. Find out how what affects your borrowing capacity and how to increase it here.
Understanding your borrowing power is an important step for any prospective home buyer.
When you know what your borrowing capacity is, you’ll get a better idea of how much your home buying budget is.
In this article, we’ll explain what borrowing power is, how it is calculated, what influences it and how to boost it.
What does borrowing power mean?
Borrowing power refers to the amount of money that a lender is willing to lend you to buy a property. It is also known as your borrowing capacity.
When you have a higher borrowing power, it means that lenders have more trust in you to be able to handle and repay a larger home loan.
How do banks determine how much you can borrow?
Banks have different lending standards, so the process they use to determine your borrowing capacity will likely differ.
Part of the reason for these different processes and standards is the risk appetite of the lender. This in itself may be influenced by the level of insurance the lender has. Some insurers of banks may push for stricter lending criteria whereas others may be more relaxed.
These differences mean that you might have higher borrowing power with one bank than another.
How banks calculate your borrowing capacity
In order to accurately calculate your borrowing power, banks will require you to provide a lot of information about yourself and your finances, including:
• The annual salary of you and any other applicants
• Any additional income (e.g. rental income, second job)
• Your expenses
• Bank statements
• Deposit and savings
• Any investments and assets you may have
• The number of applicants applying for the home loan
• Any dependents
• Any credit cards
• Other loans and debt
• The type of loan, loan term and interest rate.
There are also other factors unrelated to you that may influence your borrowing power such as the property market, interest rates and economic conditions.
Additionally, banks also want to get an idea of how you’d be able to manage your mortgage repayments if interest rates were to increase.
In October 2021, the Australian Prudential Regulation Authority (APRA) increased the minimum interest rate buffer from 2.5% to 3%.
This means that lenders are legally obligated to calculate your ability to make your repayments with an interest rate at least 3% higher than the rate of the home loan.
For example, if you apply for a home loan with a 5.2% variable interest rate, lenders will perform serviceability assessments to see if you could comfortably handle an 8.2% interest rate on that loan amount.
What influences my borrowing capacity?
Let’s delve a little deeper into what can influence your borrowing capacity:
1. Your income
Naturally your salary and overall income is one of the most important factors in forming your borrowing power.
Your income is a direct indication of what kind of mortgage repayment size you can handle.
If you’re applying for a home loan with your partner who also has an income, your joint income could increase your borrowing power.
Remember that a high income doesn’t necessarily guarantee a high borrowing capacity.
Your income is considered alongside a number of other factors. So, if your income is high but you have substantial debt already, your borrowing capacity could be lower than you would expect.
2. How you manage your money
Lenders don’t just want to see that you can earn money – they want to see how you manage it.
If you’re earning $100k but blowing it all on expensive goods and nights out, that can be a red flag in the eyes of lenders.
Most lenders are going to want to see solid, long-term evidence of savings. In the months leading up to your home loan application, really work on building your savings and improving your financial habits.
If you are able to show that you can regularly put money towards your savings, it indicates that you are more likely to be able to keep up with your home loan repayments.
3. Living expenses
Lenders will thoroughly analyse your living expenses – and not just the ‘bad’ ones.
The total sum of your everyday expenses, like groceries, bills and transportation costs can play a role in how lenders decide your borrowing capacity.
Reducing your non-necessary everyday expenses (e.g. an expensive gym membership or subscriptions) can help lift your borrowing power, even if only marginally.
4. Dependents
Whether you have children/dependents – and how many – can affect your borrowing power. This is because having kids can be expensive!
So while there’s nothing wrong with sending your children to a private school, for example, this does increase your expenses significantly. In return, your borrowing power will reduce.
So, whether you have dependents – and how many – will factor into this consideration. Children are expensive, and lenders want to know if you can cover the costs of living for you and your children while repaying a home loan.
5. Existing debts
Having existing debts (e.g. other mortgages, personal loans, car loans and credit cards) can impact your borrowing power.
This is because you’ll have to regularly be putting money towards repaying these debts, as well as your mortgage.
Not only can debt potentially decrease borrowing power, but it could be the reason for your home loan application getting denied altogether. This could happen if the lender believes that the level of debt you owe is too high or complex and presents you as a risky borrower.
6. Deposit size
The higher your deposit, the lower your Loan to Value Ratio (LVR) will be. Having a bigger deposit can suggest that you have good savings habits and may be a low-risk borrower.
In general, you want to have a deposit of at least 20% saved up to avoid being charged Lenders Mortgage Insurance (LMI).
In general, a lender determines your borrowing power by looking at your deposit size in conjunction with the purchase price of the property.
7. Credit report
Your credit history is another factor that could influence your borrowing capacity.
If your credit file is relatively unblemished, this may boost your borrowing power – or at least it won’t negatively affect it.
However, having a poor credit score with a history of late or missed repayments, or even defaults, can negatively affect your borrowing power and your likelihood of getting approved for a mortgage.
Before you apply for a home loan, make sure you know what’s in your credit report. If your credit rating could be better, it might be a good idea to work on improving it for a while.
You can access your credit report for free every 3 months from a credit reporting agency like Experian, Ilion or Equifax.
8. Assets
Do you have any assets in your name? Well, these could potentially influence your borrowing power for the better.
Whether it’s other investment properties, a healthy share portfolio, a car, boat or other vehicle – it indicates that you are able to save money and put it towards investments.
Additionally, these are assets that you might be able to sell (or that the lender can seize) to improve your cash flow in the case that you are struggling financially.
9. Loan type, interest rate and repayment term
The type of loan, as well as its term and interest rate can play a role in shaping your borrowing power.
A loan with zero fees and a low interest rate would mean that your repayments would be lower. As a result, your borrowing power would increase.
Similarly, if your loan term is longer, your monthly repayments will be lower and you may be able to borrow more.
On the other hand, a shorter loan term would make your monthly repayments higher and your borrowing power might decrease. On the plus side, paying off a loan earlier means you’ll save on interest.
How do you increase borrowing power?
Luckily your borrowing power isn’t an immovable force. There are ways to increase it, but many of them take time, hard work and patience.
Here are some ways that you can increase your borrowing power:
1. Increase your income
Think about any ways that you can increase your income. Maybe that means scheduling some time with your boss to ask for a pay rise if it’s long overdue.
If your employer won’t budge on your current salary, you could look for a new job that pays better.
Alternatively, if you have the time, you could look for a second job or side hustle to bring in some extra dollars.
Having a higher income gives you a greater capacity to handle larger home loan repayments.
And don’t forget to claim all of your income on your home loan application.
Many lenders class rental income, superannuation and government payments as different income streams – just make sure you have proof in the form of tax returns and pay slips.
2. Work on paying off your debt
Spending a few months paying down any debt as much as you can before lodging a home loan application is another way to increase your borrowing power.
This helps because you’ll have less debt and more money to service a mortgage. This debt can include other home loans, car loans, personal loans and credit cards.
3. Review your budget and spending habits
Taking the time to analyse your spending and see where you could potentially make changes in your budget could boost your borrowing capacity.
For you, this might mean reducing any ‘unnecessary’ spending (e.g. online shopping, frequent dining out) and seeing where you can make savings.
You might be able to negotiate better deals on your utility bills and internet, for example. Or maybe you can cancel your streaming service subscriptions for a few months.
For most home loan applications, lenders will request bank statements dating back 6 months prior to lodging the application. They want to see long-term saving habits and responsible spending.
4. Develop your credit score
Having a good credit rating and healthy credit history can boost your borrowing power. It indicates to lenders that you know how to responsibly handle credit.
Being aware of your credit history is the first step towards improving it. You can check your credit score for free every 3 months and it’s smart to take advantage of this. Focus on paying your loan and credit card repayments on time, as well as paying any bills on time.
5. Lower credit card limits
Did you know that lenders consider your monthly credit card limit a potential debt?
Yep, that means that even if you aren’t maxing out your credit card each month, lenders still see a high credit card limit as a risk. Your borrowing power may be negatively affected as a result.
Consider lowering the limit prior to a home loan application. If you don’t really need your credit cards, think about cancelling them – at least temporarily.
6. Choose a lender that suits your needs
If you’re a borrower in a more complicated situation, you might want to find a lender that specialises in helping people like you.
For example, self-employed people can face a tougher time getting approved for a home loan – especially if they’re unable to provide sufficient supporting documentation regarding income.
Luckily there are lenders that specialise in providing loans for self-employed individuals, or individuals with poor credit, for example.
A specialty lender might grant you a greater borrowing power too. Book an appointment with your local FND Broker to find a lender that could suit your needs.
7. Keep your employment stable
Frequent job hopping can make you look like a bit of a flight-risk in the eyes of some lenders.
While it’s normal to infrequently change jobs (e.g. to get a better salary), be smart about your employment choices.
Many lenders prefer to see that you’ve been at your current job for at least 3 months and completed your probationary period.
Maintaining consistent employment can help evidence that your income is stable and you’ll be in strong position to repay a mortgage.
8. Save up a large deposit
As obvious as it may sound, having a larger deposit means you won’t have to borrow as much money from the lender when purchasing a home.
Because you’ll be lower risk to the lender, your borrowing capacity will likely be greater.
Do savings affect borrowing power?
Yes, your savings can affect your borrowing capacity.
Lenders want to see evidence of ‘genuine savings’. This refers to money that you’ve saved over an extended period of time. It indicates positive financial habits and presents you as a lower risk borrower.
Having more money in your savings also likely means that you’ll have a higher deposit, meaning that you may not require as much money from the lender. Alternatively, it could help you borrow more money to buy a more expensive property.
If you want to get an idea of what your borrowing capacity could be, try out FND’s Borrowing Power Calculator today.
Still have questions about your borrowing power? Book in an appointment with an FND Broker to learn about how much you could borrow for your next home loan.
