Understanding your borrowing power means that you’ll know what kind of properties you can afford to buy. It’s easy for prospective homeowners and investors to waste time looking at properties outside of their budget because they simply don’t know how much money they’ll be able to borrow for a home loan.
In this article we’ll explain what borrowing power is and how to increase your borrowing capacity in 2021.
To put it simply, borrowing power is a term used to describe the loan amount a lender is likely to approve you for, based on your financial situation. Having a higher borrowing power means that lenders trust you to pay back a larger home loan.
Your borrowing power is likely to be greater if you have low debt, reasonable lifestyle expenses, a large deposit and sufficient assets. In contrast, someone with a lot of debt, poor financial management skills, bad credit and a low deposit will have lower borrowing power.
By knowing your borrowing capacity, you can:
Search an address for price estimates and sales history.
Lenders want to know that you have the financial means to repay your home loan each month, so your income is one of the most critical factors to your loan application. Taking into consideration any debt and your standard living expenses, lenders will weigh up whether you’ll be able to comfortably meet your home loan obligations on your current salary.
If you have existing debt, lenders want to examine your capacity to take on more, which is what you are doing by getting a mortgage. Having some debt is normal, but there is such a thing as good and bad debt. An existing home loan and university HELP debt are examples of good debt as they don’t usually indicate poor financial choices. Large amounts of credit card debt, personal loans and sometimes even a car loan can be viewed less favourably. However, if you are making on-time repayments on these debts, they won’t necessarily be an issue.
In the months leading up to your mortgage application, it’s a good idea to reduce your credit card limits and work on paying off your debt. Even if you never reach your credit card limit and pay it off on time each month, lenders still sometimes view credit cards as a potential debt. So, if you have a $4,000 monthly limit, lenders may see that as a $4,000 of possible debt. If you don’t need a higher credit limit, consider reducing it.
Once the lender has established that you have a stable income and can manage existing debts, they’ll want to know what your everyday expenses look like. This is how much you spend on things like food, entertainment, travel, transport, clothing, childcare, among others. When applying for a specific loan amount, you need to figure out whether you’ll be able to make repayments alongside your day-to-day expenses.
In the 3-6 months leading up to your home loan application, it’s smart to review your spending and see where you can make changes. If you remove certain expenses from your budget, you could increase your borrowing power. For example, if you’re paying for a gym membership that you aren’t using, consider cancelling it for now. Lenders will look over your bank statements and may flag applicants whose statements include a lot of unnecessary spending.
Making sure you have a clean credit history can improve your borrowing power. You can check your credit by accessing a free credit report. When reviewing your credit history, check for any inaccuracies that could negatively affect future credit applications. While unlikely, credit reporting agencies can sometimes make mistakes - especially if you have a common name.
Don’t fear if you have a poor credit rating. This can be improved by paying bills, loans and rent on time. It may take a little while, but lenders will note if you have established a good repayment history.
When assessing your home loan application, lenders will look at what assets you have. These can include savings, stocks, property and other investments. Looking at your assets gives them an idea of your saving habits and overall finances.
There are a number of steps you can take to increase your borrowing capacity. Take into account the factors listed above that influence your borrowing power, but also consider the following tips:
If a bank thinks that you won't be able to repay the loan amount you've requested, two things can happen. The first is that your application may just be declined and you now have a negative credit inquiry in your credit history. The second is that you do get approved for the requested loan amount, but this debt becomes unmanageable leading to future repercussions.
This is where a good mortgage broker can be a lifesaver. You need to take time to analyse different home loans carefully. Your borrowing power can vary between banks, and a mortgage broker could help you find a lender that can provide you with your desired loan amount. For example, if you have a poor credit score but want a home loan, your borrowing power might be low with a traditional bank. However, there are lenders who specialise in lending to unconventional borrowers (e.g. those with bad credit or self-employed).
So, make sure the home loan product you are looking at matches your needs and financial circumstances.
Knowing your credit score means that you have the power to change it. If it’s not looking too healthy, dedicate a few months towards making regular, on-time debt and bill repayments. Don’t forget to look for errors in your credit report, as these can appear from time to time.
Make sure you have all your recent tax returns ready to go and work on establishing good savings habits in the months leading up to your home loan application. If you have any credit cards, consider paying them off in full or reducing credit limits.
Look carefully at your bank statements and see where you could be saving. Could you cut down on certain subscriptions, memberships and online purchases?
A $400,000 mortgage over 30 years will be seen as a lot less risky than a $400,000 mortgage repaid over 25 years. If it suits your financial situation, consider going with a longer loan term to increase your borrowing power. If your income and repayment capacity improves in the future, you can refinance to a shorter loan term or make extra repayments as desired. If you are on a fixed rate mortgage, you may be limited in your ability to make extra repayments, so factor this into your planning.
A larger deposit indicates good savings habits which leads lenders to view you as a low risk borrower. The larger your deposit, the lower your Loan to Value Ratio (LVR). Plus, if having a higher deposit pushes you over the 20% threshold, you can avoid paying Lenders Mortgage Insurance (LMI).
Consolidating your debt can indicate that you have fewer financial obligations and can reduce your monthly expenses. Plus, debt consolidation under your home loan will usually result in paying less interest on these unsecured debts.
Roll your credit card, car or personal loans into your home loan.
Yes, you can often increase your home loan further down the track. This is usually known as a home loan top up and will require you to have sufficient equity in your property before you can qualify. Equity is primarily increased by making repayments on the home loan principal amount, but if your property’s value has increased since you purchased it, your equity will likely have increased too.
Read more about top up home loans here.
A guide to deposits, pre-approval, & choosing the right property.
Before you go out and find your dream property and apply for a home loan, it’s smart to seek out home loan pre-approval. Pre-approval is a formal indication from a lender that they will approve you for a specified home loan amount. Pre-approval can give insight into your borrowing power. It also signals to a vendor that you are ready to buy their property and can settle the process sooner than someone without pre-approval.
Pre-approvals aren’t set in stone, so a lender can change their mind. This is because a borrower’s circumstances could change, meaning that they may no longer be able to afford the previously agreed-upon loan amount. Therefore, pre-approvals usually only last for 3-6 months.
For an informal look into how much you might be able to borrow, check out Lendi’s Approval Confidence™ tool. Unlike formal pre-approval, Approval Confidence™ provides borrowers with a realistic view of their home loan options - no credit check involved!
Your borrowing power isn’t fixed forever - with these tips, you may be able to increase it to get closer to owning your next property.
We're here to help. Get free expert advice at a time that suits you. Choose a time to chat with a Home Loan Specialist here
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.
Enter a few details about your home loan and see how much you could save on your repayments