Borrowing Power Calculator: Understanding Your Borrowing Power

When it comes to securing a home loan, understanding your borrowing power is a crucial first step. Whether you’re a first-time buyer, an investor with a growing portfolio, or somewhere in between, knowing how much can I borrow will help you make informed decisions. In this guide, we’ll break down how borrowing power is calculated, what can impact it, and why some people can afford loan repayments but still struggle to secure the loan amount they need.

What Is Borrowing Power and Why Is It Important?

Your borrowing power refers to the maximum amount a lender is willing to lend you based on your financial situation. It determines your capacity to repay a mortgage while covering other living expenses. Understanding your borrowing capacity ensures you:

• Choose properties within your budget.
• Avoid overcommitting financially.
• Know where to adjust your finances to increase your borrowing power.

For experienced investors, borrowing power is especially critical when leveraging existing equity or financing multiple properties.  Knowing how much you may be able to borrow will determine what your investment strategies are going to be.

How Borrowing Power Is Calculated for a Home Loan in Australia

Lenders calculate borrowing power using detailed assessments of your income and expenses, including:

• Income: Salary, rental income, dividends, and other earnings.
• Expenses: Living costs, debts, credit card limits, and other liabilities.
• Loan Structure: Type of loan (e.g., principal and interest) and repayment term.
• Interest Rate Buffer: Lenders assess your ability to repay the loan using an assessment rate, typically 3% higher than the actual interest rate.

Example: How Borrowing Power Is Assessed when you borrow for a home loan

• Income: $100,000 annual gross income.
• Expenses: $30,000 annual living costs + $10,000 existing debt repayments.
• Loan Repayment Capacity: The lender applies a 9% assessment rate (3% above a 6% home loan interest rate) on the requested loan amount.

If the calculated repayment exceeds your capacity based on the assessment rate, your borrowing power will be reduced, even if you can afford the repayments at the actual interest rate.  Interest rates are subject to change but the current assessment rate buffer of 3% will not change unless ASIC, the regular of responsible lending decides to reduce it or even increase it.

What Can Reduce Your Borrowing Power?

Several factors can lower your borrowing capacity when you apply for a home loan:

1. High Expenses: If your income and expenses show limited surplus cash flow, lenders may reduce how much you can borrow.
2. Existing Debts: Credit cards, personal loans, and car loans reduce your disposable income.
3. Short Loan Terms: A shorter loan term increases monthly mortgage repayments, reducing your borrowing power.
4. Interest Rate Buffer: The 3% buffer applied by lenders can lower your assessed repayment capacity.
5. Lenders Mortgage Insurance (LMI): If your deposit is below 20%, you may need to pay LMI, which could further impact your borrowing power because the LMI premium that is added to the loan will utilise the borrowing capacity.

What Can Boost Your Borrowing Power?

If you’re looking to increase your borrowing power, consider these strategies:

1. Reduce Existing Debts: Paying off or reducing credit card limits or personal loans can free up disposable income.  Similarly, when you reducing existing loan amount might result in an increase of your borrowing power.
2. Minimise Discretionary Spending: Lenders scrutinise your spending habits, so reducing unnecessary expenses can help.
3. Extend Loan Terms: Opting for a 30-year term lowers home loan repayments, boosting borrowing capacity.
4. Increase Income: Additional income sources like a second job or rental income from another property improve your capacity.
5. Partner with a Guarantor: For first home buyers, a guarantor can reduce upfront costs, including LMI so more of your borrowing power can be used towards the purchase of the property instead of it being utilised to cover the increased LMI you have to borrow.
6. Choose a Different Lender: Some lenders have more lenient borrowing criteria or lower assessment rates or the lender’s credit policy can be more favourable to your particular situation.  Some of these differences relate to how non-regular base income is calculated, such as bonus income, overtime, allowances and employee share options.

Why Can Some People Afford Loan Repayments but Not Get Approved?

It’s a common frustration: you know you can comfortably afford the loan repayments, but lenders won’t approve the loan amount you need. This often comes down to how borrowing power is assessed.

The Role of the Interest Rate Buffer

Lenders calculate your borrowing power using a buffer of at least 3% above the actual loan’s interest rate. This ensures you can manage repayments if rates increase.

Example: The Impact of the Assessment Rate

• Loan interest rate: 6%.
• Assessment rate: 9% (6% + 3% buffer).
• Actual monthly repayment on a $500,000 loan: $2998 (6% interest, 30-year term).
• Assessed repayment: $4024 (9% interest, 30-year term).

Even though you can afford the actual repayment, the assessed repayment may exceed your borrowing capacity. Therefore, the amount you can borrow will be determined by the assessed repayment instead of the actual monthly repayment.

Who Can Work Out Your Borrowing Power Amount?

There are several ways to estimate your borrowing power:

1. Use Our Borrowing Power Calculator: Input your income, expenses, and other financial details to estimate how much you can borrow.
2. Mortgage Brokers: A broker can compare multiple lenders and help you find options to maximize your borrowing power.
3. Lenders: Lenders perform detailed assessments, considering their specific criteria and risk tolerances.

Why Your Borrowing Power Is Important

For both first home buyers and seasoned investors, knowing your borrowing power is essential to:

• Help you understand your purchase budget based on a loan you qualify for.
• Avoid falling in love with properties you can’t afford.
• Plan your property purchases strategically to avoid unwanted surprises that will create stress and frustration during your home buying journey.
• Understand your financial limits and where adjustments can improve outcomes.

Using a Borrowing Power Calculator

A borrowing power calculator is a helpful tool to estimate how much you can borrow. By entering details like your:

• Income and expenses.
• Loan type (e.g., principal and interest).
• Interest rate and repayment term.

You’ll get a clearer picture of your home loan borrowing power. While calculators are great for preliminary insights, always consult a broker or lender for a precise assessment.

Frequently Asked Questions

What expenses do lenders take into account when assessing borrowing power?

Lenders take into account your basic living expenses and discretionary living expenses.  Basic living expenses are your necessities such as groceries, utilities, transport, education etc.  Discretionary living expenses can include childcare fees, private school fees, personal insurance such as life insurance.

Lenders also use a benchmark to determine what the minimum living expenses for your situation will be, so if your actual living expenses are below this benchmark, the lender will use the benchmark to calculate an estimate of your borrowing capacity.  This benchmark is known as the Household Expenditure Measurement (HEM).

Can my borrowing power differ between lenders?

Yes, different lenders have varying criteria, including how they apply the assessment rate and calculate living expenses.

Different lenders also have different ways to verify your income to calculate how much you can borrow.  For example, for self employed borrowers, some lenders will verify your income based on the average of your last two financial years while other lenders will verify based on the latest financial year.  This can make a huge different on how much you can borrow based on your actual situation.

This is why it’s so important to speak to a mortgage broker so they can determine which lender will give you the best borrowing power.

Does paying Lenders Mortgage Insurance (LMI) affect borrowing power?

Yes, LMI increases your upfront costs, reducing your available funds for the property purchase.  It’s important to understand that the once off LMI premium is added to your actual home loan, which means this will utilise your borrowing capacity.

Some lenders have special credit policies to waive LMI based on specific occupations, such as physiotherapists, optometrists, lawyers, accountants, engineers etc.  Make sure you speak to a mortgage broker to determine whether your occupation qualifies for LMI waiver.

Conclusion

Understanding your borrowing power is key to navigating the home loan process. Whether you’re a first home buyer or a seasoned investor, knowing how much you can borrow empowers you to make informed decisions. Use our home loan borrowing power calculator to assess your capacity, identify opportunities to improve your finances, and plan your next property purchase with confidence.