How do you calculate borrowing power?

Working out your borrowing power is an important part of applying for a loan – but there are many factors involved.

25 Jun 2021 | Personal finance | Share:

Most people will take out a loan at some point in their lives, either for a home, a car, a business or for personal expenses – and more borrowing power means more options. But how do you know how much you can borrow?

Borrowing power is something lenders and creditors calculate when assessing applications, and knowing what increases or decreases your borrowing power can help you put your best financial foot forward. Here’s what you need to know.

What is borrowing power?

Borrowing power, sometimes known as ‘borrower power’, is the term used to describe how much you can borrow based on your financial situation. The more borrowing power you have, the higher credit limit or loan amount you can get.

Your borrowing power is based on several factors. Generally, a person has more borrowing power if they have a strong credit history, a healthy deposit either in cash or in equity from property and a low debt-to-income ratio. Other factors such as interest rates and loan terms can also impact your borrowing power.

Good credit and high borrowing power often go hand in hand, but it’s important to get credit to build credit. Young adults often start building their credit when they take on the responsibility of their mobile phone bills or start paying for their own utilities. Paying on time and in full on regular monthly bills helps establish good credit.

It may seem counterintuitive, but having no debt can actually decrease your borrowing power. Lenders like to have a reference point to assess their risk level and it can be helpful to see that you’ve had financial obligations before and have met them on time.

While you may decide to take on some debt to evidence a solid financial track record, it’s important not to take on more than you can afford. While some lenders offer loans to borrowers with a history of credit issues, it may reduce your borrowing power.

How do you calculate borrowing power?

Different lenders have their own formulas for calculating your borrowing power, but there are many useful online calculators which can provide an estimate of how much you might be able to borrow.

However, there are some other factors to consider. Many people make a substantial portion of their income from bonuses, commissions or seasonal work – but not all lenders will factor that into your total income for borrowing power purposes.

Some lenders will only use the income listed on regular payslips. So, if you’re self-employed, seasonally employed or paid in cash, it’s important to find a lender who offers flexible assessments and is willing to take extra time to verify your income.

Other factors besides your credit history or hard financial numbers can impact your borrowing power as well. Your lender may look at things like your number of dependents, the length of time you’ve been at your job and any resale risks associated with the type of purchase you may want to make.

General market conditions also impact borrowing power, and borrowers have more power when interest rates are low and borrowing rules are more liberal. For a more in-depth estimate, a mortgage or finance broker who is familiar with the policies of many different lenders can help.

Does equity increase borrowing power?

If you have equity in your home or investments, it may be possible to harness it in place of a cash deposit, to increase your borrowing power.

Equity can increase borrowing power when it is put towards the deposit on a new purchase. For home ownership purposes, equity is the figure between the current market value of your property, and what you still owe on your mortgage. Equity can be leveraged to access borrowing power without actually selling the property.

Many people take out loans against their home equity, using the underlying property as security or collateral. The proceeds from a home equity loan can go towards whatever you need the money for.

Some people take out a home equity loan to make improvements or repairs to the property. This can increase the home’s market value, which can help to restore some of the equity accessed.

What percent of the property value can you borrow?

The percent of the property value that you can borrow will depend on a number of factors. If your credit and income are strong and you’re not overextended financially, you may be able to borrow up to 95% of the property purchase price. However it is important to note that different lenders will set different criteria for what is an acceptable percentage based on loan purpose, the property type and location.

A trusted mortgage broker can advise you on the percent of a property value you can borrow and which lenders are best equipped to help facilitate this process.

How can I increase my borrowing power?

You can increase your borrowing power by:

  • Paying all your bills on time
  • Lowering the limit on your credit cards
  • Increasing your income or reducing your monthly expenditures
  • Getting a loan with a longer term
  • Saving for a larger deposit
  • Keeping your credit history in good shape
  • Showing consistency of employment or income levels
  • Consolidating debt into one easy to manage repayment

Does your deposit amount affect your borrowing power?

When you’re talking about a home loan, the amount of your deposit can impact your borrowing power. All other things being equal, the higher your deposit, the more borrowing power you have.

Some lenders may want to see somewhere between a 10-20% deposit for a 30-year mortgage with a low interest rate. However, there are other lenders that offer home loans requiring as little as a 5% deposit. This may mean a slightly higher interest rate, but it could help you get into your new home sooner.

Do I need a loan broker?

If you’re looking to get a home, car or business loan, it’s usually best to consult a broker first. They can compare lots of different lenders for you, so you don’t have to do it on your own and potentially miss out on a better deal.

They can also help calculate your current borrowing power and give your tips on what you can do to help maximise how much a lender will approve you for.

If you have a low deposit, unusual income sources, credit history issues or are simply wanting to refinance your home equity, then getting in touch with a trusted broker is a great first step.