How do lenders calculate your borrowing power?
Understanding how much you can borrow – your borrowing power – is the first step to finding the right home for you. It gives you guidance on your budget and confidence that you are spending your time looking at homes that fit in that budget.
It’s pretty easy to jump to Lending Loop’s borrowing power calculator and get a general idea. But with so much riding on your borrowing capacity, it’s important that you’re doing everything you can to improve your chances. That means getting approved for a home loan in the amount that you want. And the first step to improving your chances is understanding how lenders calculate your borrowing capacity.
How lenders calculate your borrowing power
Most lenders use the same basic formula in order to determine how much you can borrow. However, this is impacted by the lender’s own assessment rate and the varying factors that each considers.
Calculating your borrowing power
The basic borrowing formula is essentially:
Gross income – commitments and expenses = monthly surplus
In the simplest terms, this formula indicates how much money a lender might allow you to borrow. However, no borrowing power calculator is that simple. In practice, each lender also applies some additional factors in their decision making – including an assessment rate and borrowing factors.
Lender assessment rate
Each lender applies their own assessment rate when calculating your borrowing power. This assessment rate is determined by the lender based on their own appetite for risk.
In effect a lender will assess you at a higher variable rate (or ‘floor rate’) than the standard variable rate. This allows the lender to feel confident that you could still make your mortgage repayments if interest rates rise. And it gives them a buffer that lowers their risk.
Borrower factors
In addition to the assessment rate, lenders will also include other factors when applying their own borrowing power calculator. These factors are those that could impact your ability to make your repayments.
Often these factors include:
- Number of financial dependents
- Number of applicants applying for the mortgage
- Size of deposit
- Credit history
- Assets
- The type of loan you’re applying for
- The type of property you’re looking to buy
- Amount of your annual salary before tax
- If you receive any rental income, and how much
- Any other regular income
- Tax owed
- Your living expenses
- Combined limit of credit cards and overdrafts
- Other loan repayments
- Any other commitments
How to improve your borrowing power
If you’re preparing to get a home loan, there are ways to improve your borrowing power.
Lower your credit card limits
When lenders assess your home loan application they consider your combined credit card limits. So, if you have three credit cards (or even store cards), with a combined limit of $30,000, this could impact how much you can borrow.
To maximise your borrowing power, reduce the number of cards you have and lower the limits.
Avoid personal loans
Personal loans are generally used for depreciating assets (like TVs or cars) and often carry high interest rates. Avoid taking out personal loans. If you already have one or more, focus on repaying these as quickly as possible.
Give up on the gig economy
Changing jobs often might seem fun, but it’s not a great way to increase your borrowing power. Without job stability lenders might think you could struggle to pay your mortgage. Unfortunately, this is also often the case for those who are self-employed.
Luckily there are many lenders, and brokers like our Lending Loop experts, who are able to help out those who are self-employed or with potentially inconsistent employment.
Pay your bills consistently on time
Your credit history is one of the most important factors that lenders will consider when calculating your borrowing power. It’s vital that you pay your bills on time, consistently. This includes your utilities and phone bills as well as repayments on smaller items – like store cards. All of this will impact on your borrowing capacity.
Lending Loop Borrowing Power Calculator
If you want to get a clearer idea on how much you can borrow, check out our borrowing power calculator. It’s an easy tool to get some insights into how much you can borrow to buy a home.
And, if you’re looking for more information, our experts are on hand to help you determine exactly how much you can borrow. That way you can have the confidence you need to find the home of your dreams.
