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How does rising inflation affect your borrowing power?

By ,| 4 min read

As the economy makes a speedy recovery from the COVID-19 pandemic, the rate of inflation in Australia has been rising more rapidly than expected.

To help curb rising inflation, the Reserve Bank of Australia (RBA) has begun hiking the cash rate. This, in turn, has upped interest rates on products like home loans, credit cards and savings accounts.

But what is inflation and why does it affect interest rates? And what do rising rates mean for your borrowing power?

In this article, we explain what inflation is and why it matters for interest rates. We also explain how rising inflation impacts your borrowing power and what you can do to help boost your borrowing capacity.

What is inflation and why is it important?

Inflation is an increase in the prices of goods and services. The inflation rate is the rate of growth at which this increase occurs.

In Australia, it’s the RBA’s job to manage the inflation target. The RBA is Australia’s central bank and is responsible for maintaining the country’s economic health and prosperity.

The inflation target is the rate of inflation the RBA wants to maintain on average over time – this target sits at 2 to 3%. The inflation target is decided using the Consumer Price Index (CPI), which is independently calculated by the Australian Bureau of Statistics (ABS) once per quarter.

The CPI measures the percentage change in the price of a basket of goods and services, which includes categories such as food and beverages, housing and transport.

Keeping the inflation rate on target contributes to sustainable economic growth. Earlier this year, Australia recorded an annual inflation rate of 5.1%, which signified that the growth in the economy needed to be reined in.

One way the RBA can slow economic growth is by raising the cash rate.

What is the cash rate and how is it related to inflation?

The cash rate is determined by the RBA and is the interest rate charged on overnight loans between lenders. Lenders borrow money from each other to help fund the loans they provide to consumers and businesses.

The cash rate is closely related to the inflation rate. If inflation creeps higher than the target rate, the RBA tends to raise the cash rate to restrain economic growth.

This is because the cash rate is essentially the cost of borrowing money and affects interest rates on products like home loans, car loans and credit cards.

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How does inflation affect interest rates?

The recent high inflation rate has sent alarm bells ringing for the RBA. High inflation has put pressure on the cost of living, so the RBA has started hiking the cash rate in an attempt to bring inflation down to its target level.

This year’s cash rate hikes have, in turn, raised interest rates.

Rate rises increase the cost of borrowing money, which helps to reduce demand for goods and services. For example, you might hold off purchasing a car if you’ll have to pay a higher interest rate on a car loan. As a result of the reduced demand, the inflation rate slows.

So, rising inflation also typically means rising interest rates. But what does this mean for your borrowing power?

How does rising inflation impact my borrowing power?

In short, when rising inflation causes interest rates to increase, it’s likely you’ll see your borrowing power decrease. This is because repaying a loan will become more expensive.

Your borrowing power is an estimation of how much money a lender is likely to let you borrow for a home loan.

Lenders calculate your borrowing power by taking into account your income, assets, liabilities, household expenses and home loan deposit size.

Lenders will also ‘stress test’ a home loan to see whether a borrower could keep up with repayments if interest rates increased by 3%.

For example, if the loan you apply for has an interest rate of 2.5%, the lender will check to see that you’ll likely be able to repay the loan if the interest rate were to rise to 5.5%.

Aspiring home buyers may find that as interest rates rise, the amount they are able to borrow falls.

However, house price growth is slowing in some areas across the country like Sydney and Melbourne. This means property prices could become more affordable even as interest rates rise. So, your borrowing power may be less affected if you’re buying in an area where property price growth is easing.

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How can I increase my borrowing power?

You now have an idea of what your borrowing power is and how it might be impacted by rising inflation and interest rates.

If you’ve calculated your borrowing power and you would like to increase it, here are some tips for boosting the amount you could borrow for a home loan.

1. Claim all of your income

When you apply for a home loan, declaring all of your income on your application can help increase your borrowing power.

While you might think of the obvious income streams like employment income, don’t forget to include details of your superannuation or any government payments you receive.

2. Pay down other debts

Do you have credit card debt, a car loan or a personal loan? It could be a good idea to work on paying any of these debts off before you apply for a home loan if you want to up your borrowing power.

From a lender's point of view, the less debt you’re in, the more money you’ll have to repay a home loan.

3. Trim down your expenses

Taking stock of your monthly expenses and finding areas to cut back can not only save you money but boost your borrowing capacity too.

You might rein in your online shopping in the months leading up to your home loan application, for example. Or, you could compare your health insurance policy to see if you might find a more competitive deal elsewhere.

4. Focus on your saving habits

Providing a lender with evidence of genuine savings is typically a requirement for your home loan application.

Implementing consistent saving habits in the lead up to applying for a mortgage can help increase your borrowing power.

You might want to set up an automatic direct debit to your savings account on payday to help you save. This can take away the temptation to spend the money otherwise destined for your savings.

5. Reduce your credit card limit

If it isn’t feasible for you to get rid of your credit card entirely, you might consider reducing your limit before you apply for a home loan.

In the eyes of a lender, a borrower with a lower credit card limit has less potential debt than a borrower with a higher limit, boosting their borrowing capacity.

6. Save a sizeable deposit

While this may seem like an obvious tip, saving up a deposit of at least 20% can boost your borrowing power.

Not only will saving a 20% deposit mean you can avoid paying Lenders Mortgage Insurance (LMI), it means you won’t have to borrow as much money for a home loan.

If you’re concerned about how rising interest rates might affect your borrowing power, a Lendi Home Loan Specialist can help. Book an appointment at a time that works for you.

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The information in this post is general in nature and should not be considered personal or financial advice. You should always seek professional advice or assistance before making any financial decisions.

Tags: home loan, interest rate, borrowing power, deposit, official cash rate, cash rate, rba cash rate, first home buyer, new purchase

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# Quoted rate applies only to PAYG loans with LVR of 80% or less with security in non-remote areas. All applications are subject to assessment and lender approval.

Lendi is a privately owned and operated Australian business. Our mission is to change the way Australians get home loans by providing a faster, smarter and more secure home loan experience designed around the customer’s convenience and needs. Although Lendi compares over 1600 products (2,500+ products including feature and pricing variations) from more than 25 lenders, we don't cover the whole market or compare all features and there may be other features or options available to you. Lendi Group Pty Ltd, which is the ultimate holding company of the Aussie and Lendi businesses is owned by numerous shareholders including; banks such as CBA, 1835i (ANZ’s external venture capital partner) and Macquarie Bank, the Lendi founders and employees, and a number of Australian institutional investors and sophisticated investors including UniSuper.

*WARNING: This comparison rate is true only for the example given and may not include all fees and charges. Different terms, fees or other loan amounts might result in a different comparison rate. The comparison rates are based on a loan amount of $150,000 over a loan term of 25 years. Fees and charges apply. All applications are subject to assessment and lender approval. Quoted rate applies only to PAYG loans with LVR of 80% or less with security in non-remote areas. All applications are subject to assessment and lender approval.

IMPORTANT INFORMATION: Loan terms of between 1 Year and 40 Years are available subject to lender and credit criteria. Maximum comparison rate will not exceed 14.99% (see comparison rate warning above). Any calculations or estimated savings do not constitute an offer of credit or a credit quote and are only an estimate of what you may be able to achieve based on the accuracy of the information provided. It doesn't take into account any product features or any applicable fees. Our lending criteria and the basis upon which we assess what you can afford may change at any time without notice. Savings shown are based on user inputted data and a loan term of 30 years. All applications for credit are subject to lender credit approval criteria. Top rates include lenders who are on our panel and are then defined by the circumstances provided by the borrower.

The Lendi Group Pty Ltd, which is the ultimate holding company of the Aussie and Lendi businesses is owned by numerous shareholders including; banks such as CBA, 1835i (ANZ’s external venture capital partner) and Macquarie Bank, the Lendi founders and employees, and a number of Australian institutional investors and sophisticated investors including UniSuper.

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