Buying a house is a big investment and a decision that you must plan wisely for. Part of that decision is working out your mortgage options and how much you can borrow. Lenders assess your borrowing power to know the amount you can borrow, and this is based on several factors, such as your income, expenses, existing debts, and other financial obligations. In this article, we will explore how lenders generally calculate borrowing power, the factors that affect it, and how you can increase your borrowing power to maximise your chances of securing a home loan in Australia.

How do lenders calculate how much I can borrow?

When applying for a home loan in Australia, one of the most critical aspects to consider is your borrowing power. Your borrowing power refers to the maximum amount of money a lender will lend you based on several factors. To determine your borrowing power, lenders use a borrowing power calculator that considers various factors such as income, expenses, and credit history. This calculator computes the amount that you can borrow and gives you an estimate of your monthly repayments. For Expats, this can vary greatly between each lender due to the different ways they consider overseas income.

What is borrowing power?

Borrowing power is the maximum amount of money a lender is willing to lend you to purchase a property. This amount is determined based on your financial situation, income, expenses, credit history, and other factors that lenders consider. Your borrowing power determines how much you can borrow from a lender to purchase a property.

What factors impact my borrowing power?

Several factors impact your borrowing power, and lenders take these into account when assessing your loan application. These include:

• Interest rate and loan term
• Income and expenses
• Existing credit card and overdraft limit
• Dependents

As an Expat, your borrowing power will vary greatly between lenders. This is because every lender has a different way they assess and account for overseas income. Many lenders will look at your foreign income, shade it 10%-40% and then often apply Australian tax rates. Some other lenders will still shade your income, but instead consider your net income overseas. This can obviously have a big impact in your borrowing power with each lender.

• Interest rate and loan term

The interest rate and loan term are two essential factors that impact your borrowing power. A higher interest rate means higher repayments, which could reduce your borrowing power. Similarly, a shorter loan term may result in higher repayments, reducing your borrowing power.

• Income and expenses

Your income and expenses are also critical factors that determine your borrowing power. Lenders will look at your income to ensure you can afford the repayments. Your expenses, including living expenses and other debts like personal loan debts, will also be assessed to determine how much you can repay each month. Expenses such as rent and school fees play a big part in the assessment of expat borrowing power.

• Existing credit card and overdraft limit

Your existing credit card and overdraft limit could also impact your borrowing power. Lenders will assess your credit history and current debt levels to determine how much you can repay each month.

• Dependents

If you have dependents, such as children or elderly relatives, this could impact your borrowing power. When assessing your loan application, lenders will consider the additional costs associated with caring for dependents.

Is it possible to increase my borrowing power?

Yes, it is possible to increase your borrowing power. Here are some tips on how to do so:

• Having a suitable deposit

Saving for a sufficient deposit is a prudent step towards enhancing your borrowing capacity. A greater deposit reduces the loan-to-value ratio, which is a critical factor that lenders evaluate when determining loan amounts. Essentially, the more you save for a down payment, the less you have to borrow, leading to lower monthly repayments. This decrease in financial commitment can make you a more attractive prospect to lenders, as it implies a lower risk of default. Additionally, with a larger deposit, you may gain access to a wider range of loan options, some of which may offer more favourable interest rates, further reducing your long-term financial burden.

For Expats, the minimum deposit you need will generally be 20% plus an amount for paying stamp duty. But many lenders require even more, often 25%-30% as a down payment. The larger your deposit, the greater the amount of lender options will be available to you as an Expat.

• Pay off debt

Addressing your existing debts is a strategic move to boost your borrowing power. When you pay off debts like credit cards and personal loans, you reduce your debt-to-income ratio—a measure lenders use to assess your ability to manage monthly payments. A lower ratio signifies that a larger portion of your income is available for future repayments, thus potentially qualifying you for larger loan amounts. Moreover, clearing debts often improves your credit score, which is instrumental in securing loans with better terms and lower interest rates.

Credit card limits have a big impact on borrowing power, as even if they are not being used, the lenders in Australia still apply a repayment against the limit. The higher your credit card limits, the lower your borrowing power. So when considering applying for a loan in Australia, it is very beneficial to reduce or close unnecessary credit card limits.

• Reduce spending

Reducing non-essential expenditures can substantially bolster your borrowing power. By streamlining your budget and eliminating extra costs, you can accumulate more savings, which can help show your ability to afford higher loan repayments. This fiscal discipline demonstrates to lenders that you have a surplus of income that can comfortably cover increased borrowing costs, potentially leading to an enhanced loan amount. A track record of prudent spending can give lenders confidence in your financial management skills, thereby improving the terms of credit they may offer you.

• Increase income

Boosting your income through additional jobs, securing a raise, or starting a side venture can significantly enhance your borrowing capacity. This increase in earnings raises your disposable income, allowing for larger loan repayments. Lenders assess this higher income when calculating your debt-to-income ratio, which can lead to approval for a larger loan. Demonstrating an increased and stable income can convince lenders of your solid financial foundation, potentially leading to better borrowing terms.

• Reduce your excess credit limits

Your borrowing power is a crucial factor when you're looking to borrow for a home. It's often an initial estimate provided by financial institutions, such as commonwealth banks, to help you gauge how much you could borrow. This estimate takes several variables into account, including your personal objectives, income before tax, other income like rental income, and living expenses.

By reducing the credit limit on your outstanding credit card, you can positively influence your borrowing power. Credit card limits form part of your financial commitments, which financial institutions examine alongside other loan amounts you may have, such as car loans or personal loans. A lower credit limit reduces your potential financial liability, making you a less risky borrower.

• Other factors

Always seek pre-approval before making any home purchase decisions. When you use tools like a borrowing power calculator, you'll often find that they request details such as how much deposit you have, annual income, and other financial commitments. This is to assess how much you can comfortably afford to borrow. However for Expat borrowers, these calculators are often not accurate and it is important you check with a specialist Expat mortgage broker to work out your true borrowing power.

What other factors should I consider to work out my borrowing power?

When securing a home loan, borrowers must consider several additional costs aside from the principal loan amount. One is stamp duty, a government tax that varies based on the property's value and location. The cost of stamp duty can be significant and is usually payable at settlement, or within 30 days of the property transaction. It is a large expense and is vital that it is accounted for in your initial calculations.

Legal fees are another consideration. These are charges for a solicitor or conveyancer who handles the legal aspects of buying a home, such as contract preparation and property searches. Additionally, property evaluation fees may be applicable. Lenders often require a professional appraisal of the property's value to determine its suitability as loan security, affecting both your borrowing power and interest rate. These costs are pivotal in shaping your financial commitments and should be factored into your overall budget and loan details.

How can I qualify for a home loan?

Lenders commonly evaluate a range of factors when approving home loans. Your age plays a role; younger applicants may have longer work histories ahead, but older applicants often have more financial stability. The deposit amount is also significant; a larger deposit generally increases your borrowing power and may enable you to secure a loan with more favourable terms.

Conclusion

In conclusion, assessing your current financial situation before applying for a home loan in Australia is essential. Consider your income, expenses, and credit history to determine your borrowing capacity. To increase your borrowing power, save for a big deposit, pay off debt, reduce spending, increase your income, and reduce your credit limit. It is also recommended that you consult a broker to guide you through the loan application process and help you find the right home loan for your needs.

Frequently Asked Questions

What does LVR mean, and how do I calculate it?

LVR, or Loan-to-Value Ratio, is calculated by dividing the loan amount by the property's value and then multiplying by 100 to get a percentage. This figure is crucial for banks and other financial institutions when they estimate how much you could borrow for a home. It factors into your interest rate, borrowing power based on income before tax, and other financial commitments like outstanding credit card limits.

A high LVR may limit how much you can afford, influencing fees and charges, loan amounts, and comparison rates. Conversely, a lower LVR can improve your borrowing terms, potentially offering you better interest rates and terms. It's advisable to seek pre-approval and consult home loan specialists to understand your financial situation. Always remember that these factors are subject to change.

What is LMI, and how can I avoid paying it?

LMI, or Lenders Mortgage Insurance, is a one-time fee paid by borrowers who have a Loan-to-Value Ratio (LVR) above 80%. To avoid paying LMI, you typically need to have a deposit of at least 20% of the property's value.

What is pre-approval, and how long can it last?

Pre-approval is a conditional approval from a financial institution that gives you an estimate of how much you could borrow for a home. It typically lasts for 3 to 6 months.

What is a loan term, and how long do you have to pay off your loan?

A loan term is the period you have to repay your loan, commonly ranging from 15 to 30 years for home loans. The term affects your monthly repayments and interest rate.

Does having a guarantor increase borrowing power?

Having a guarantor can help you avoid paying LMI, as the guarantee is typically used to help cover not having a full 20% deposit available.

How much can I borrow using the equity in my home?

The amount you can borrow using the equity in your home generally depends on the home's value and how much you still owe on your loan; lenders typically allow up to 80% of the home's value minus your outstanding loan.

What's the difference between principal and interest and interest-only repayments?

Principal and interest repayments cover both the loan amount and the interest accrued, reducing the loan balance over time. Interest-only repayments cover just the interest, leaving the principal loan amount unchanged.

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