There is a long journey to owning a home and as with any other journey, the joy of completing it is based on successfully crossing all obstacles. Before you can jump into the market and set your heart on a property, knowing how much you can borrow is vital. Here’s a guide on understanding borrowing power, how it’s calculated and how you can increase yours.
The amount you will be able to borrow depends on a lot of factors to do with your current financial situation. These include how much you earn, how much you’ve saved, as well as your expected future financial power, your credit history and a number of other factors. How much you are likely to be able to borrow can boil down to an evaluation of the following factors:
If you’re looking for an estimate in terms of your home loan borrowing power, use our borrowing power calculator. This calculator provides an estimate of how much you might be able to borrow. Additionally, our calculator can give you a preview of what your potential monthly repayments might look like:
Your borrowing power is essentially the amount of funds a lender is likely to approve for you to borrow from them. Lenders base this on their evaluation of your ability to make the upfront payments and your ability to make continuous repayments (your cash flow).
Lenders conduct their evaluations by reviewing your credit history, credit score and banking statements, amongst other documents.
If you have little to no existing debt, a large deposit saved and sufficient assets, you’re more likely to have a higher borrowing power than someone with a lot more debt and no assets. Similarly, if your expected lifestyle expenses are high, compared to your income and you are already liable to make large monthly repayments, you’re less likely to have a high borrowing power.
The best ways to increase your borrowing power and chances of credit approval involve indicating to the lenders that you are financially sound and can meet your financial obligations.
Get rid of unnecessary debt and credit cards: How much debt you currently have will greatly influence your borrowing power. Having unnecessary debt and credit cards deters lenders from lending you larger amounts as they are wary of your repayment obligations. Most lenders will count the limits of any credit cards you may have as existing debt and it therefore becomes important to get rid of any unnecessary debt.
Consolidate your debt: This can increase your borrowing power and also potentially save you a lot of money on interest payments. Consolidating prior debts can reduce your repayments by offering you a single lower interest rate with lower fees. Having fewer obligations is a positive signal to lenders and can improve your chances of approval with a lower interest rate. Try our debt consolidation calculator to find out how much you could save.
Save … A LOT!: Having a good saving history signals to the lenders that you will have a buffer for repayments in case your circumstances change in the future. At the same time, having a larger deposit saved will reduce the amount you need to borrow. Lenders usually require you to have around 20% of the value of your home saved up as deposit.
Related: Lenders Mortgage Insurance
Claim all your income: Not doing so has positive tax implications for you but when assessing your borrowing power, lenders focus a great deal on your income and ability to meet repayments on time. Prior to applying for a home loan, make sure to claim as much income as possible and also look for lenders that may factor in your rental income here.
Be aware of and try to improve your credit score: Your credit report is a reflection of your credit history and it shows all the defaults you have had on past payments. So, having a bad credit score will likely reduce your borrowing power as you will be seen as a higher risk. Changes to the Privacy Act in 2014 made it possible for lenders to access up to 24 months of your repayment history. Due to this, it is important for you to make sure all your payments are up to date. The best way of doing so is by checking your report in advance and making sure the information in it is accurate.
Loan to Value Ratio, or more commonly known as LVR, is essentially your loan amount divided by the value of the property, expressed as a percentage. The LVR is always the inverse of the percentage of the home loan deposit you have saved up so if you have a deposit of say 15% then the LVR will be 85%.
(Loan Amount / Value of property) x 100 = LVR
Because of its relationship with your savings deposit, having a high LVR will mean having a low deposit, which in turn will affect your borrowing power. The intuition behind this is that having a high LVR means that you are borrowing a larger proportion of the price of your home than you are saving yourself and this increases the amount of risk you pose for the lender. Consequently, the lender will be willing to lend you a lower amount or offer a higher interest rate.
Lenders Mortgage Insurance (LMI) is a fee charged by lenders to safeguard themselves from incurring losses if a borrower fails to meet their repayment obligations. It works in a similar way to most general insurances but in this case, the borrower is required to cover the premium payments for the insurance scheme. Commonly it is utilised if the borrower wants to borrow more than 80% of the purchase price, and therefore does not have the full 20% deposit. LMI is calculated as a percentage of the amount borrowed.
See how much you might need to pay if you're low on a deposit.
To avoid paying LMI, borrowers have a few options. One of which is having the 20% deposit saved, which will greatly enhance your chances of approval and can indicate to your lender that you are not a very risky borrower. Another option is getting a guarantor for your loan, which is a person that co-signs the loan agreement with you and ensures your credit worthiness by agreeing to be liable to repay on your behalf. Read more about guarantor home loans here.
Borrowing power is calculated differently between lenders, however, there are some basic criteria that most follow, which include:
Income: This is the most important factor when calculating borrowing power, as your earnings can provide solid information on your repayment ability and cash flow.
Savings / equity: Your savings are an indicator of your potential deposit and shows your ability to handle money and expenses. If you own enough assets or have sufficient equity in your home currently, your borrowing power increases as you can use these as security/collateral.
Deposit: Your deposit is critical to your borrowing power, as if you don’t have 20% of the purchase price of the property you may be required to pay Lenders Mortgage Insurance (LMI).
Dependants (children): This can affect your borrowing power as the amount spent on dependants is taken into consideration.
Lenders will take all of this into account and evaluate your borrowing power based on various algorithms. Here is a calculator where you can input all your personal information and data that you likely already possess and find out exactly how much you can likely borrow:
Calculate your borrowing power based on your income.
There are some other factors that you should take into account before determining your borrowing power. You’ll need to set aside other funds, as well as the property deposit, to cover fees and taxes such as:
Stamp duty, for example, is government tax calculated based on the property’s location and sale price. Most states and territories offer first home buyers exemptions or concessions up to a certain price point usually around the $600,000 mark. Depending on the value of the property, stamp duty tax will likely be a significant payment.
Find out how much stamp duty you might need to pay.
Consider saving up an extra 5-10% on top of your deposit to account for these property and home loan related fees.
Your home loan repayments for a mortgage will primarily include two components of principal and interest that you will have to take into account when borrowing. The size of each of these components will affect how much you end up repaying over the term of your loan:
Principal: is the total amount borrowed from the lender. You can choose to repay the principal in different ways as well. Having an initial principal amount in excess of what you actually require can cost you a lot as you will be paying interest on these amounts for the entire loan term and interest is calculated daily. Make sure to borrow what you have to and not what you can because this will alter the amount you end up repaying to a great extent.
Interest: is the fee for borrowing which is charged by the lender. Since lenders undertake a risk of defaults on repayment when they lend you money, they charge you interest as compensation. The interest rate you get can greatly affect your repayments as you will be required to pay interest with every repayment. Compare lenders and find a low interest rate, combined with a flexible way of paying it that suits your circumstances. Most lenders offer interest only payments for an initial set period and variable and fixed interest rates for different periods.
Speak to a Lendi Home Loan Specialist for more information on repayment options.
As stated in the previous section, you can choose different ways to pay interest. If you choose to pay variable interest rates then your rate will fluctuate with market interest rates and the official cash rate (OCR) set by the RBA. It’s unlikely that the interest rate on your loan will stay stable throughout the duration so it’s important to make sure that you can continue making repayments, even if the interest increases significantly.
Lenders should also take this into account when assessing your application, but it’s an important thing for you to note as well. If you don’t think you can make repayments if the interest fee increases, then it might be best to wait until you can or choose a loan with a fixed interest rate.
Some basic guidelines that are commonly considered when approving home loans include:
Deposit amount: Generally, lenders require a minimum of 20% of the purchase price but there are home loan product options that allow you to provide a lower deposit.
Credit history: A clean credit history and little to no debt is the desired goal when being assessed for a loan. Ensure your credit history is favourable and up to date with all the correct information.
Income and financial stability: Maintaining a steady income and being able to prove your financial stability is critical. Ensure you have all the required documents to prove your financial power and declare all admissible income to qualify for your desired loan.
Age: This is not the most pressing criteria, as there are different types of home loans for people of different ages, however if you’re over a certain age then your repayment period can be limited. By law, in order to qualify for an Australian home loan product, you must be eighteen years of age or over.
Value of the property: The value of the property can influence the amount of money loaned. To qualify, ensure the value of your property is in line with your circumstances and other factors lenders consider. Play around with Lendi’s borrowing power calculators to find out what you might be able to afford.
Related: How to get a home loan
It can be a smart idea to understand and know exactly what you can afford before you go out and search for your dream home. Pre-approval does exactly that for you. Getting pre-approved for a loan means getting approved for a loan and sorting out the entire application process before you make an offer on a home.
Getting pre-approved signals to the seller that you are eligible to get a home loan and settle on the house quickly. This way, pre-approval can increase your chances of landing your preferred home for a cheaper price as well if the seller is focused on selling quickly.
Pre-approvals do not last forever as a borrower’s circumstances are subject to change with time. Lenders are aware of this and usually only pre-approve a borrower for short periods of 3-6 months typically.
Most lenders offer you the ability to make different repayments at different time periods. Such flexibility can be very helpful and also reduce the time you will be making repayments for, while also bringing down the overall cost of the loan.
A loan term is the amount of time it will take to pay off the loan if you make the minimum specified payments for every repayment cycle. In other words, it is the life of the loan. You are required to select the loan term at the start and this choice can affect things like the loan amount, the interest rate etc. Your financial power will be a big determinant of the loan term.
While different home loans can have different features and terms, and there is no exact ideal loan term, repaying your home loan faster will greatly reduce its cost. You can repay your loan faster by making lump sum payments during financially good times, changing the frequency of repayments if possible or even simply rounding your payments up everytime. In order to have this flexibility, you will usually need to have a loan with a variable interest rate.
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Your borrowing power greatly affects which home you can buy and how soon you can own the home outright. It is important to understand your borrowing power before searching for houses, but what’s most important is to borrow only what you require and can responsibly pay off in time. Borrowing in excess of what you require can negate all the efforts you make to reduce your cost. Make sure to read all terms and conditions in the product disclosure statement and talk to one of our Home Loan Specialists today to better understand your borrowing power.
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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.
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