How interest rate increases can impact your home loan borrowing capacity

As a higher rate means higher mortgage repayments, a lender will assess your ability to service a home loan, based on your current income and financial situation, on this larger payment amount. A higher-rate environment may mean that you cannot borrow as much for a home loan, as you would not be able to afford that loan amount on a current interest rate.

 

In 2022, the Reserve Bank of Australia hiked the cash rate multiple times, including several instances of double hikes of 50 basis points. While homeowners have been assessing the impact of rising rates on their mortgage repayments, first and next home buyers have been left out of the conversation.

 

When interest rates are on the rise, the amount of money you may be approved to borrow for a home loan can fall in tandem.

The last thing you want is to fall in love with a property, only to discover your borrowing power is much lower than expected. The good news is that there are tools available to you today to calculate ahead of time how much you could be approved to borrow. Home buyers don’t have to apply blindly, without knowing their borrowing power ahead of time.

Let’s explore why the Reserve Bank of Australia’s (RBAs) cash rate influences your monthly repayments, what the latest rising-rate environment may mean for your borrowing capacity, and how you can calculate what you could be approved to borrow for a home loan in the current property market.\

 

How does the RBA cash rate affect home loans?

Home loan interest rates are influenced by the RBA cash rate, as well as the current economic environment, and are up to the lender’s discretion. Fluctuating interest rates are expected over a 20-30-year home loan term.

The RBA is responsible for setting and implementing monetary policy in Australia”. The national cash rate is the rate at which the RBA charges banks and lenders on overnight loans. According to the RBA, changes to this rate will impact other interest rates in the economy, “influencing economic activity and inflation”.

Generally speaking, when the RBA changes the cash rate, variable rates on home loans, as well as savings accounts and term deposits, move as well. If the cash rate is hiked 50 basis points, a variable rate home loan customer should see their interest rate increase this much as well.

Banks and lenders may also choose to change interest rates on their products when deemed appropriate. For example, if a lender believes that interest rates will rise, it may begin increasing its fixed rate home loan rates ahead of time, so that these rates are more reflective of the market throughout the fixed period.

Some lenders also may choose to not pass on a cash rate cut or cash rate hike in full to their customers. Again, it is at their discretion, but as a general rule, rising rates are often passed on.

 

 

How do rising rates impact home loan borrowing?

When the cash rate is increased and interest rates move in tandem, this has a considerable impact on the amount an Australian could be approved to borrow for a home loan. In 2022, the RBA hiked the cash rate several times. These back-to-back rate increases were the first that millions of homeowners had experienced in over a decade. As rates increase, customers applying for mortgages will see the maximum amount they may borrow decrease, because they will be paying more in interest.

Banks and home loan lenders also assess your ability to service a home loan on a higher interest rate as part of your stress testing. This rate, also known as a serviceability buffer, is typically around 3% higher than the lender’s current rate. Put simply, as rates continue to rise, it gets harder to pass this test. 

Research from RateCity found that following six months’ of RBA interest rate rises in 2022, the average family’s home buying budget had decreased by an estimated $195,500. In April 2022, they may have been able to borrow up to $995,800, and today this amount is only $800,300.

If a forecast cash rate peak of 3.60% from a major bank comes to fruition in April 2023, this same family would only be able to borrow $728,100. This is a decrease in the amount they could borrow by $268,700.

 

Impact of hikes on borrowing power: Family earning $150,000 in April 2022

 

Estimate of maximum amount they can borrow from the bank

Apr-22 Today Apr-23
Rate 2.24% 4.58% 5.58%
Stress test rate 5.09% 7.58% 8.58%
Max borrowing capacity $995,800 $800,300 $728,100
Difference from before hikes -$195,500 -$267,700

Source: RateCity.com.au

 

How much can you borrow for a home loan?

Before you begin the process of applying for pre-approval, do your own research and calculate how much you could potentially be approved to borrow for a home loan.

Reduce Home Loans Borrowing Power Calculator can help home buyers to shine a light on how much they may be able to afford for a home loan in the current rate environment. Simply:

  1. Enter your ideal loan term (20-30 years).
  2. Enter an interest rate for a home loan you’re interested in, plus three percentage points. This may replicate the stress test a lender may use in your loan application. If you’re not sure where to begin, consider comparing some of Reduce Home Loans’ competitive options. For example, if you liked a home loan with a rate of 4.15%, you would enter it into the calculator as 7.15%.
  3. Enter whether it is a single or joint application.
  4. Enter your income details, including rental income.
  5. Enter your expenses, including living expenses, such as rent and utilities, and any existing liabilities, such as car loan repayments and credit card repayments.
  6. Enter your number of dependents.

You will need to enter a breakdown of your income, as well as your expenses. This process mirrors what banks and lenders do when they are assessing your full application for a home loan. If you’ve ever wondered why a lender asks for a copy of your bank statement when you apply for a mortgage, it is because they are assessing your regular expenses to determine what you could reasonably afford.

Once these details are entered you will then be shown an estimate of how much you could be approved to borrow, as well as an easy to read graph, breaking down your principal and interest repayments over the loan term.

 

home loan borrowing capacity

How to increase the amount you could borrow for a home loan

If you’ve crunched the numbers and your estimated borrowing power is nowhere near where you’d like it to be, there are options available to you. By understanding how a bank or lender looks at your application, you may be able to boost the amount you could borrow for a home loan.

  • Cut down your expenses – Any regular, ongoing expenses you have will be assessed in your application. A lender will generally review around three months’ worth of bank statements, so it’s worth reducing your expenses in this time leading to an application. This can include anything from ditching frivolous spending, such as UberEats or Afterpay, or even pausing your subscription services.
  • Compare your bills – Some expenses are unavoidable, like your phone bill or your energy bill. However, you can compare your options to ensure you’re still on the most competitive plans. If you’re paying more than you should for utilities, consider switching to more affordable options to boost your borrowing power.
  • Boost your credit score – Home loan lenders favour borrowers with higher credit scores, as having an excellent credit score and credit history generally means you’re the least likely applicant to be at risk of default. This also typically entitles you to the lowest interest rates offered by your chosen lender. If you can start your application knowing you’re likely to be tested on a lender’s lowest interest rate, you may be in a better position to gain approval for a higher loan amount. If your credit score is not where you’d like it to be, consider working on this before you apply.
  • Increase your income – This is easier said than done, especially in the current higher cost-of-living environment. However, increasing your income is one of the easiest ways an applicant can increase the amount they may be approved to borrow. Whether this means turning a hobby into a side hustle or speaking to a manager about a pay increase.
  • Joint applications – Speaking of increasing your income, two may be better than one when it comes to bolstering your borrowing power. If you have a spouse or family member willing to come on to the home loan with you, their income could help increase the amount you could be approved to borrow. Keep in mind that this is a major financial commitment, and not one that should be taken lightly. Both applicants will be responsible for servicing the home loan repayments, and face any credit penalties if you were to default.

 

In a rising rate environment, it’s easy to feel like you’re starting on the wrong foot when you’re trying to take out a home loan. Whether you’re a first home buyer or long time property investor, do yourself a favour and calculate an estimate of how much you could be approved to borrow before you apply for a home loan.

For more information on your borrowing power, or any of the competitive home loans offered by Reduce Home Loans, please don’t hesitate to speak to our team of experts today.

 

Any statements are general in nature and do not take into account your financial personal situation, objectives or needs. You should consider whether any statement/s is suitable for you and your personal circumstances. Before making any financial decision, consider your circumstances and the product disclosure statement.

 

1300 733 823