Your borrowing capacity is an important consideration when buying a home or an investment property. It will affect how much you can spend on a property.
Your borrowing capacity will vary from lender to lender and it is possible to improve your capacity so you can broaden your property options. Here are 10 smart ways you can increase your borrowing capacity:
Your lender will check your credit score when you apply for a home loan. Knowing your credit score will help you determine if you’re in a healthy financial situation and if there are any issues with your credit history. If you’re worried about a ‘thin file’, e.g. limited history, rest assured a lender generally prefers that to bad history of unpaid loans and so on. There are a few services out there that allow you to check your credit score for free at least once a year. This will allow you to start working to improve your score.
Unsecured debts like credit cards and personal loans are very expensive and reduce the amount you can repay on a mortgage. Note, you won’t accrue interest if you pay your credit card off in full every interest-free period, which can work favourably when looking at your credit score. If you work to reduce your high-interest-rate debts you can increase your borrowing capacity.
Do you have any unused credit cards? You might want to consider getting rid of them and cutting the limit on any cards you keep, because lenders will consider any credit cards to be drawn to their full limit. As an example, if you have two credit cards, one with a $5,000 limit and the other with $10,000, a lender will write down $15,000 in debt against you.
When shopping for a loan, take time to consider the features of the loan product so you know if it suits your situation. Loan features can impact how much your lender will offer you, and this includes things like packaged products, offset account, and so on.
Organising your financial records, including completing your tax returns and having up-to-date information on your income will save you time when applying for a mortgage.
Saving more money for a home deposit can increase your borrowing capacity because lenders look for a consistent saving record. This shows you can make regular mortgage repayments. Having a bigger deposit also reduces interest paid, and your monthly payment, too.
Other than your income, your lender will also consider your expenses such as your rent, utility bills, school fees and childcare costs if you have kids. Trimming your expenses will not only help you save money for a deposit but will increase your borrowing power. Most people generally prioritise paying off the mortgage above all else, but the main message is to shop around - reassess your expensive phone plan, internet plan, energy bills, and so on, which can all add to the budget.
Rather than buying a property in your own name, why not split the expenses on-paper with your partner? As an example, if you can prove that your partner can and will provide for your dependents financially, they may not be counted as your dependents in the application.
Increasing your income is a great way to increase your borrowing capacity. You may want to save your tax return, rent your spare room, or do some extra shifts. Consider, too, your ability to get promoted in your work place and negotiate for a pay rise.
A 25 or 30 year mortgage is generally the norm, but a longer term can reduce your repayments. For example, $400,000 borrowed over 25 years at a 1.99% p.a. advertised interest rate equates to a $1,693 per month mortgage repayment. Compare this to a 30-year term, which reduces this to $1,476. The trade-off is that the latter results in more than $23,000 extra in interest paid over the life of the loan.
Borrowing capacity is a calculation from your lender about how much you can borrow on a home loan. The lender uses factors like your age, your income, your expenses, your existing debts, your job status, whether you have kids or not, and a range of other factors.
Lenders typically use what’s called ‘HEM’, or household expenditure measure. The household expenditure measure accounts for a range of things such as the borrower’s location, number of dependents, and their lifestyle standard (student, basic, moderate or lavish).
On top of that, lenders also take a look at your debts, such as whether you have outstanding credit card debt, or a personal loan debt, as well as car loans and other loans. They will also assess your job status - full time, part time, contract and so on.
With all that in mind, your lender will then give you a figure. If you’re a dual income household, with stable jobs, limited debt and expenses, it might be surprising how much you can borrow in a low interest environment.
You’ve probably heard the term ‘responsible lending’ in the news quite a bit recently. In September 2020, Treasurer Josh Frydenberg announced the government will be reassessing responsible lending laws, and placing less of the onus on the lender, and more on the borrower, to assess their own financial circumstances and ability to repay a mortgage.
The main argument for tweaking these rules is, in the words of Mr Frydenberg: “[To] make it easier for the majority of Australians and small businesses to access credit, reduce red tape, improve competition, and ensure that the strongest consumer protections are targeted at the most vulnerable Australians.”
However, the main argument against the changes is that access to credit is already pretty decent anyway. Home loan commitments reached a new record in March 2021, according to the Australian Bureau of Statistics, with $30.2 billion worth of housing loans written. Investors accounted for most of the gains over February’s results, while first home buyers accounted for over a third of all home loans written in terms of number.
So, watch this space.
If you’re shopping around for a home loan, a borrowing power calculator is a great tool to help you determine how much you can borrow. Keep in mind that a borrowing power calculator will only give you an estimate.
If you’re ready to start your home buying journey, speak with one of our lending specialists today to find out how much you can borrow.