Whether you’re planning to purchase your first home or daydreaming about your next property, it can be hard to compare your options without knowing what you can afford.
If you’re considering taking out a home loan for your first or next property, it’s worth taking some time to calculate how much you can borrow for a mortgage. After all, you won’t know what property prices to filter by online unless you have an idea of your buying power.
What is your borrowing power?
Your borrowing power is another way of describing how much money you may be eligible to borrow from a lender based on your individual financial circumstances.
When you apply for a home loan, a lender will assess your personal financial situation, including requests of your bank statements and proof of income. They will then make a note of:
- Your income (salary or additional income, such as earnings from assets and rental income).
- Living expenses (everything from your utilities bills to what you spend on children’s swimming lessons and UberEats is categorised and accounted for).
- Debts and financial commitments (any current loans, including personal and educational, as well as your total credit card limits, and any dependants).
Lenders will look at much more than how much of a deposit you’ve saved to determine the amount you can afford to borrow for a mortgage, including your income, time spent in your current role and your credit score. This is regardless of if you’re a first home buyer, shopping around for an investment property or considering buying a new home build.
For the most ideal borrower to be approved for a bigger loan amount, you will typically:
- Be 18-years or older
- Be an Australian citizen or permanent resident
- Be employed full-time for at least 3-6 months (some may favour 12 months)
- Have a lean budget with limited expenses
- Have little to no outstanding debts, including personal loans, car loans or credit card debt
- Have a good to excellent credit score and credit history
To gain home loan approval you may only need to tick a number of these boxes, but to be eligible to borrow the most amount of money for property and to potentially be offered a lower interest rate, you may need to meet all these requirements to boost your borrowing capacity.
You can discover your borrowing power now by using the Reduce Home Loans Borrowing Power Calculator. Simply enter your income, expenses, and cash surplus to discover if this is enough to afford your ideal loan size.
How to boost your borrowing power
If your calculations aren’t aligning with your dream property, or if you’re concerned that values may be rising in your ideal suburb and you want to borrow more, it may be worth considering how to boost your borrowing power.
Cut down expenses
It goes without saying but the fewer expenses you have, the more money you may have to put towards your home loan repayments. This is especially true of frivolous spending that may be categorised into your entertainment budget, such as dinners out, subscriptions, buy now, pay later habits and takeaway food.
Lenders may look at three months’ worth of your bank statements to determine how you spend your money. The money you put towards entertainment may be considered an ongoing expense and not counted towards what you can afford to repay to your mortgage. If you can reduce these expenses, or even pay in cash for a few months, this may help bolster your application.
Pay off your debts
Lenders will also look towards your debts to determine how much you may be able to afford to borrow for a mortgage. So, if you’ve got a car loan debt hanging overhead, for example, it may be worth budgeting to pay this off before you apply. There are also reports that lenders will look at your HECS/HELP debt as an ongoing expense, so some brokers may recommend you pay this before making a home loan application to boost your borrowing power.
Further, credit card limits can come into play when it comes to your borrowing power. It’s common for a lender to take your credit card limit and base your serviceability as if your card was permanently maxxed-out, even if you always pay your balance in full. But it can also be averse to your credit score to close a credit card account, so this may not be the answer. Instead, it may be worth considering asking for a reduced credit card limit in the lead up to your loan application.
Floor rates and loan affordability
With all that in mind, it’s worth noting that when you apply for a home loan, a lender will need to test your serviceability of the loan at a higher interest rate than the ones they advertise. This is regardless of if you are considering refinancing or are a new borrower.
This is because it’s safe to assume that over a 25-30-year loan term, interest rates will fluctuate. And if your interest rates rise, the lender needs to know you can still comfortably service the loan and afford your fortnightly or monthly repayments.
One measurement home loan lenders can use to test your borrowing power is the ‘floor rate’. This is an interest rate that is internally set, and typically sits somewhere around 5%. Some very strict lenders may set theirs much higher at 7-8%.
But it is designed to be a few percentage points higher than a lenders base rates to assess your likelihood of financial stress when interest rates rise.
Put simply, if you apply for a $400,000 home loan, a lender will test that you can afford loan repayments that are higher than advertised. If their base variable rate is, say, 2.25%, the lender’s floor rate may be 5.25%. The applicant would be tested on their ability to afford a $400,000 home loan with an interest rate of 5.25%, as opposed to one of the lower rates promoted online.
While this may seem frustrating, it’s designed with the protection of the borrower in mind to prevent everyday Aussies borrowing more money than they can afford. Regulator body, APRA, has encouraged this testing so that you will not fall into mortgage stress or default on your home loan if interest rates rise in the future.
This is why it can be so essential to consider a lower-rate lender when you start your home loan journey. The impact of an interest rate rise on your mortgage repayments and financial health is significant. You may be able to better manage your expenses with a more affordable mortgage.
Reduce Home Loans offers some of the cheapest interest rates in Australia, so borrowers don’t have to break the budget with what they can afford to borrow with a mortgage for their dream homes. With loans as low as 1.77%p.a. (1.86%*p.a. comparison), why not compare Reduce Home Loans mortgages today.
If you want to speak to an expert for more specialised advice, please don’t hesitate to call us on 1300 733 823.
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