Borrowing Power: Things that are considered calculating that magical number!

Aug 30, 2024

5 min read

When it comes to securing a mortgage, one of the most common questions potential borrowers have is, "How much can I borrow?" The amount you can borrow from a lender in Australia is determined by several factors that reflect your financial situation, lifestyle, and the property you wish to purchase. This article will delve into the various elements that lenders consider when calculating your borrowing capacity, providing a clearer picture of how much you can expect to secure for your home loan.

Income

Gross Income

Your income is the cornerstone of your borrowing capacity. Lenders primarily consider your gross income, which includes all earnings before tax and other deductions. This can consist of:

Salary or Wages: The fixed income from your employment.
Bonuses and Commissions: Any additional earnings tied to your performance.
Other Income Sources: This may include rental income, dividends, and any government benefits.

Stability and Consistency

Lenders prefer stable income sources. For those in casual employment, lenders may calculate income less advantageously, as it is viewed as a more volatile employment position. If your income fluctuates, this can affect how much lenders are willing to offer.

Adjusted Net Income

Certain deductions can impact the net income used for assessing borrowing capacity. Voluntary salary sacrifice for superannuation, HECS repayments, and post-tax salary packaging can reduce the amount of income considered by lenders, affecting your overall borrowing potential.

Overall Spending/Living Expenses

Lenders assess your overall spending to understand your financial commitments and ensure that you can afford the repayments on a mortgage. This includes both basic living costs and discretionary spending.

Basic Living Costs

These are essential expenditures that lenders commonly consider, including:

Housing Costs: Current rent or mortgage payments, utilities, and other property-related expenses.
Food and Groceries: Monthly spending on food and dining.
Transportation: Costs associated with owning a vehicle, fuel, and public transport.
Technology: Monthly expenses for phone, internet, and subscriptions.
Clothing and Personal Care: Spending on clothing, grooming, and hygiene.

Discretionary Spending

Discretionary spending encompasses entertainment, travel, and other non-essential expenditures. Understanding your overall spending pattern is crucial, as it affects your borrowing capacity.

Additional Expenses

In addition to standard living expenses, lenders often add private school fees, private health and life insurance premiums, and strata/body corporate fees on top of your overall spending. These additional commitments help lenders calculate what usable income you have for servicing a mortgage, ultimately influencing your borrowing capacity.

Credit History

Your credit history is a vital component in assessing your borrowing capacity. Lenders review your credit report to gauge your creditworthiness.

Credit Score

Your credit score is a numerical representation of your creditworthiness, typically ranging from 300 to 900 in Australia. If your credit score and past financial behaviour don't allow you to use a mainstream lender, you may be pushed into a lender that is more accepting of previous misconduct. However, these lenders often charge higher interest rates, resulting in less uncommitted monthly income and, therefore, lower borrowing power.

Past Financial Behaviour

Lenders will examine your repayment history, including any missed payments, defaults, or bankruptcies. A clean credit history with timely repayments can significantly enhance your borrowing potential.

Other Liabilities

Other liabilities, including credit card debt, personal loans, car loans, HECS debt, and "buy now, pay later" schemes like Afterpay, can significantly impact your borrowing capacity.

Impact on Surplus Income

The repayments on these liabilities reduce the amount of surplus income you have available to service a mortgage. As lenders calculate how much you can afford to borrow, they will consider these existing obligations, which can result in less borrowing power.

Managing Existing Debts

If you have existing loans or credit card debts, reducing these obligations can improve your overall financial situation and enhance your borrowing capacity.

Loan-to-Value Ratio (LVR)

The Loan-to-Value Ratio (LVR) is an important financial metric that lenders use to evaluate the risk associated with a mortgage. It expresses the ratio of the loan amount to the appraised value of the property being purchased. The LVR is calculated by dividing the total loan amount by the property's value. For instance, if you’re purchasing a property worth $500,000 and you borrow $400,000, your LVR would be 80%.

Impact on Borrowing Capacity

While many lenders prefer an LVR of 80% or lower—requiring a deposit of at least 20% to avoid Lenders Mortgage Insurance (LMI)—there are plenty of options available for those who may not have that sizable deposit. Many lenders will consider applications with an LVR above 80%, and some even allow borrowing up to 85% LVR without the need for LMI.

While this opens doors for many buyers, it’s important to understand that borrowing above 80% may come with some trade-offs. For example, loans with higher LVRs could have slightly higher interest rates, which may result in larger monthly repayments. Additionally, if LMI is required, it can be added to your loan amount, impacting your total borrowing power. However, these options allow you to enter the property market sooner rather than later, making homeownership more accessible.

Saving for a Deposit

Accumulating a larger deposit not only reduces your LVR but also enhances your overall borrowing capacity. A substantial deposit signals to lenders that you are financially responsible and committed to your investment, making you a more attractive borrower. Moreover, having a larger deposit can open up better interest rate options and potentially save you thousands over the life of your mortgage. By prioritising savings for your deposit, you can improve your chances of securing a larger loan and better terms, paving the way for a more favourable home-buying experience.

Property Type and Location

The type and location of the property you wish to purchase can also significantly affect your borrowing capacity. Lenders may impose lending percentage caps based on these factors.

Lending Caps

Different property types, such as apartments, houses, and commercial properties, may come with varying lending caps. For instance, lenders might be more conservative with their loan offerings for certain high-risk property types. Similarly, the location can also influence the maximum percentage of the property's value that lenders are willing to finance.

Impact on Capital Required

These lending caps do not just affect how much you can borrow; they can also impact the amount of capital you need to have available for purchase. If a lender sets a lower lending limit for a property in a less desirable area, you may need a larger deposit to meet their criteria. Understanding these dynamics can help you make informed decisions about the types of properties you pursue and the areas you consider for your next home.

Conclusion

Understanding the various factors that influence how much you can borrow is essential for anyone looking to secure a mortgage in Australia. By considering your income, overall spending, credit history, other liabilities, LVR, and property specifics, you can better prepare yourself for the home-buying process. Knowledge of these elements will not only help you determine your borrowing capacity but also empower you to make informed financial decisions as you embark on your journey to homeownership.