When buying property, understanding exactly how much you can borrow is important. Known as your borrowing power, this amount is determined by each lender after considering a number of factors including your income, living costs and any other existing debts.
When buying in a competitive market, a small change to your borrowing power could be the difference between having enough funds to buy the property of your dreams and missing out completely. By understanding the factors that impact your borrowing power, you can better prepare before approaching your lender for finance.
One of the most important factors in determining borrowing power is your net income. While a salaried or wage earning employee has limited opportunity to increase income levels beyond a pay rise, they do have much more control over their spending habits.
Basic living expenses, such as clothing, food, and other weekly expenses are automatically factored into most lenders’ serviceability calculations. These are typically standardised expenses determined by whether you are a single applicant or share expenses with a partner, and if you have any dependants.
Any additional discretionary living expenses such as gym memberships, child-care fees or school fees, will also be factored into each lenders’ serviceability calculations. This will further reduce any loan amount that may be offered to you.
Keeping your ongoing living expenses to a minimum is helpful in protecting your borrowing power.
Any existing home, car or personal loan can impact considerably how much you can borrow. This is because the repayments for each additional loan reduces your disposable income, and with it your borrowing power. As a rule of thumb, a $350/month car loan would reduce the amount you can borrow by around $50,000.
Also, in cases when the applicant has an interest only investment loan, which generally costs less to service than a principal and interest loan, a lender is required to deduct the cost of principal and interest repayments from disposable income when calculating borrowing power, to assess true borrowing power once the interest only term has finished..
Credit Cards can also affect your borrowing power. When anyone applies for a home loan it’s not the outstanding balance of the credit card that is taken into consideration, but the total credit limit because lenders have to assume the applicant can max out their credit card at any time.
For example, say the applicant has a $30,000 credit card limit, but they only have a balance of $2,000 owing - the lender looks at the $30,000, calculates what repayments would be based on this amount and includes this amount in your ongoing expenses. In this example, having a credit card limit of $30,000 would reduce the borrowing power by around $100,000.
Interest rate buffers
When you apply for a loan, lenders will apply an additional buffer to your rate to assess your ongoing ability to make repayments should interest rates rise in the future. For example, your interest rate may only be 3.79% but the buffer can increase this to as high as 7.50% for servicing calculations. Buffers may differ from lender to lender and can also be applied not only on the loan you are applying for but for your other existing loans.
How can an adviser help?
LNS advisers understand the market well. There are so many factors that influence borrowing power, so they can guide you towards the lender that suits your circumstances. If you want to learn more about these lenders, talk to a Liberty Adviser.