Thinking about buying a property? Here’s how to calculate your borrowing power.
If you’re thinking about taking the plunge into the property market, it’s important to have a clear idea of your borrowing power before you start your search.
With Australia experiencing record low interest rates and soaring property prices, many people are stretching their budgets to get a foot on the ladder. Recent data shows an estimated 669,000 households are currently experiencing mortgage stress, a number which is expected to rise if interest rates jump.
Knowing how much you can safely borrow will ensure you limit your search to properties you can afford… whatever the future holds. So how do you work it out?
Here are the six main things lenders look for when they are deciding how much to lend you, and tips to help you calculate your borrowing power.
1. Income and living expenses
The higher your income compared to your living expenses, the more money you have left over to service a loan and the more lenders will be willing to lend you.
Lenders like to see clear records of a secure income over time. For people earning a salary this is usually easy to do, but if you’re self-employed, freelance or work in seasonal or commission based roles you’ll need to provide comprehensive records.
When it comes to expenses, all lenders are required to build in assumptions about standard living expenses when they review a loan application based on ABS data. Don’t rely on them. Set up a budget and track your spending over a month or two to see if what you think you spend lines up with track what you do.
Be honest with yourself, and don’t forget to factor in “hidden” property costs such as inspection costs, legal fees and stamp duty, as well as upcoming life events like a wedding or a baby.
2. Existing debts
Any existing debts you have will dramatically reduce the amount you can borrow. Yes, even credit cards that you pay off in full each month.
Car loans, personal loans, credit cards, store credit and any other type of loan will all count against you, as they eat into your income and reduce the buffer you have to meet your home loan repayments.
Want to make yourself more appealing to lenders? Repay as many of your existing debts as possible before applying.
3. Interest rates and loan terms
Generally speaking, the lower the interest rate the more you can afford to borrow, as repayments will be lower.
However, keep in mind lenders build an interest rate buffer into their calculations, which means what you think you can afford may not match up with what they do.
For example, if you’re applying for a variable rate home loan with an interest rate of 4%, your lender may be looking at what would happen if interest rates jumped to say 7 or 8%. They do this to prevent borrowers from maxing out their budgets at low interest rates, only to default once interest rates inevitably rise.
Other things to consider are a longer loan term or an interest only loan mean repayments will be lower, but you’ll pay more interest paid over time.
4. Your credit score
Any black marks on your credit report such as missed bill payments or defaults on debts will negatively affect your borrowing power.
Not sure what’s on your report?
Request a free copy from Veda Advantage, and don’t fall into the trap of paying for one of their premium services.
5. Your deposit
When it comes to borrowing power, the larger the deposit the better.
A larger deposit shows lenders you are able to maintain good financial habits over time, and also means you’ll have to borrow less to buy the house, which will save you on interest and help you pay the loan off faster.
The minimum deposit you’ll need is 5% of the property value, but a deposit of 20% or more will mean you avoid paying Lenders Mortgage Insurance, which can be a significant cost.
6. Your assets and the type of property you’re buying
Assets you own outright may favourably influence a lenders’ decision, for example a car, shares or another house.
The type of property you want to buy will also play a part, for example a house versus a unit, or investing versus buying to live.
So… how much can I actually borrow?
The best way to work out how much you can borrow is to use a borrowing power calculator before applying for a loan.
See how the following scenarios affect what you can borrow:
- Increasing income and/or decreasing expenses
- Reducing debts
- Changing the loan purpose.
And remember, just because you’re eligible to borrow a certain amount, doesn’t mean you should!
While lenders are inherently conservative (it’s in their interest to only give loans to people who can afford to repay them), that doesn’t mean they will get it right. It’s up to you to be realistic about your situation and make an informed decision.