When it comes to securing a home loan, one of the most important factors to understand is your borrowing power. This term refers to how much a lender is willing to lend you based on your financial situation.
Each bank or lender has its own unique formula for determining borrowing power, but don’t worry – understanding the basics can help you plan ahead and make informed decisions that can get you on the path to homeownership.
At Bluestone Home Loans, we’re all about empowering borrowers with the most up-to-date information to support their home buying journey.
In this guide, we’ll break down what borrowing power is, how banks calculate it, and how you can manually estimate your own borrowing power before you apply for a loan. Let’s dive in!
What is Borrowing Power?
Your borrowing power is essentially the maximum amount of money a lender will be willing to lend you based on a range of factors. These factors include your income, expenses, existing debts, and the overall risk you represent to the lender.
Remember: borrowing power isn’t just about how much money you make. It’s also about how much of your income can be directed towards repaying a loan after covering your living expenses and other financial commitments.
What Lenders Consider When Determining Borrowing Power
Lenders assess borrowing power through a combination of criteria, and while each lender may have its own specific policies, here are the key factors they typically consider:
Income: Your monthly or annual income is a primary factor in determining your borrowing capacity. Lenders will typically use gross income (before tax) to calculate your potential loan amount.
Expenses: Banks also take into account your regular living expenses, such as rent, utilities, food, and insurance premiums. They may also factor in other personal expenses like school fees, car loans, or credit card repayments.
Existing Debts: Any current debts you have, including credit cards, personal loans, or other mortgages, will impact your borrowing power. For instance, how much does a car loan affect borrowing power? Lenders want to ensure that you can comfortably manage new debt alongside existing obligations.
Credit History: Your credit score or credit history often plays a role in your borrowing power. A higher credit score typically leads to better loan terms and higher borrowing power, while a low score can limit the amount you’re eligible to borrow. At Bluestone, we consider more than just your score, looking at your full history—even if you have imperfect credit!
Loan-to-Value Ratio (LVR): Lenders will also assess how much of the property’s value you are borrowing. A lower LVR (for example, borrowing 80% of the property value) is considered less risky for the lender, which could improve your borrowing power.
Interest Rates: The current interest rates will impact your monthly repayments, which in turn affects your borrowing capacity. Lenders often assess your ability to repay the loan at a slightly higher rate than the current one, factoring in potential rate rises.
Deposit Size: A larger deposit can reduce the loan-to-value ratio (LVR) and improve your borrowing power, as it shows the lender that you have more equity in the property.
Employment Stability: Lenders want to see stable employment history and income. Job security is an important factor in determining your ability to repay a loan over time.
Other Financial Obligations: If you have dependents, child support payments, or other ongoing financial commitments, lenders will include these in their assessment to ensure you have sufficient disposable income to service your mortgage.
Role of a Guarantor: Having a guarantor can significantly boost your borrowing power! A guarantor provides additional security for the lender, which may allow you to borrow more than you could on your own.
Impact of HECS Debt: If you have HECS-HELP debt from your higher education it can affect your borrowing power. Lenders consider this debt when assessing your financial situation, as it represents a future repayment obligation.
Medical Records: While lenders typically focus on financial information, they may also request medical records if they believe it will impact your ability to repay the loan.
How to Calculate Your Borrowing Power
While many lenders will use complex algorithms and software to calculate borrowing power, you can get a rough estimate on your own by considering the following steps:
| Step 1: Calculate Your Monthly Income | Include all sources of income, such as your salary, rental income, or any other regular earnings. If you’re self-employed, lenders may average your income over the past two years to account for fluctuations. Example: If your gross monthly income is $6,000, that’s your starting point! |
| Step 2: Add Any Additional Income | If you have a second income, rental income, or dividends from investments, add those amounts as well. Example: Rental income from an investment property: $1,000 Total monthly income = $6,000 + $1,000 = $7,000 |
| Step 3: Subtract Your Monthly Expenses | Next, take the time to calculate your regular living expenses. These could include things like rent, utilities, food, health insurance, and any loan repayments you’re already making (such as car loans or personal loans). Lenders may ask for detailed breakdowns, but you can use a rough estimate here. Example: Living expenses: $3,000 Other debt repayments: $500 Total monthly expenses = $3,500 |
| Step 4: Calculate Your Serviceability Ratio | Lenders typically want your debt-to-income ratio to be below a certain threshold, which is usually around 30-40%. This means that no more than 30-40% of your gross income should be going towards debt repayments. For example, if your monthly income is $7,000, 40% of this is $2,800. If your mortgage repayments exceed this, it may impact your borrowing power. |
| Step 5: Speak with a Broker | Now that you’ve got a little more knowledge on your financial position, you’re ready to chat with an expert. |
To get a more accurate picture of your borrowing power, we always recommend you consult with a mortgage broker. Brokers will take into account additional factors such as interest rates, LVR, and other financial obligations that you may not have accounted for.
Why lenders use these criteria
The goal for lenders is to ensure that borrowers can comfortably repay the loan without undue financial strain.
By assessing factors like income, expenses, and debt, lenders want to make sure that you’re not overextending yourself and you’re able to meet your financial obligations throughout the life of the loan.
It’s also important to factor in the type of loan you’ll be applying for. Many current homeowners might be assessing their financial situation to organise refinancing. Mortgage refinancing can allow you to take advantage of lower interest rates, reduced monthly payments, or access equity for other financial goals.
If you’re also exploring building your dream home and trying to estimate borrowing power, then you may be looking at a new construction loan.
Unlike a traditional mortgage, construction loans are designed specifically for financing the building process. They typically cover the cost of land, materials, and labor, making them a great option for aspiring homeowners.
Understanding the various components of your loan type, borrowing power and how they are calculated can help you make smart strategic decisions about your home loan.
If you’re looking to borrow the maximum amount possible, increasing your income, lowering your expenses, paying off high-interest debt, and saving for a larger deposit are some of the most effective ways to improve your borrowing power.
By carefully understanding the various factors that influence your borrowing power and learning how to calculate it manually, you’ll be better prepared to make an informed decision when applying for a home loan.
If you don’t already have a broker, then contact us today to connect with a trusted mortgage broker who can help you navigate your borrowing power and secure the best home loan, no matter how unique your financial situation.
