There are so many reasons you might consider refinancing your home. Whether you’re looking to take advantage of a lower interest rate, access the equity in your home, or consolidate your debts, refinancing can be a fantastic choice.
If you’re thinking of refinancing your home loan, one of the key factors to consider is your borrowing power, as it does impact your ability to refinance. Knowing and understanding these factors and their impact can help you make better, more informed decisions.
What is Your Borrowing Capacity?
Borrowing power, also commonly called ‘borrower power’, ‘serviceability’ or ‘borrowing capacity’, refers to the amount of money a lender is willing to let you borrow.
Lenders assess your borrowing power to help them determine the risk associated with lending you money and ensure you can comfortably manage the loan repayments, as well as any additional monthly service fees.
If you have high borrowing power, you’re typically more likely to be approved for loans, and given better terms with those loans too, such as lower interest rates or increased loan amounts.
Calculating Your Borrowing Power
Understanding how your borrower power is calculated can help you improve it and increase your chances of securing a loan that suits your needs – whether it’s a refinance or an initial home loan.
When you apply for a refinance or loan, lenders will first aim to determine your borrowing capacity by reviewing several factors that will help them assess your ability to make the loan repayments.
Key Factor #1: Income
Your income is one of the most important factors in determining your borrowing power. Lenders consider your annual income, rental income from an investment property, or any other regular payments you receive.
Having a higher and more stable income generally leads to higher serviceability, as it indicates a greater ability to repay the loan.
Key Factor #2: Credit History
Another critical aspect considered by lenders is your credit history. Your credit card limits, credit score, payment history, defaults, and any existing debts are assessed.
Your potential to refinance will be more likely if your credit history demonstrates responsible borrowing behaviour, as that shows a lower risk for the lender. If you’ve had credit issues in the past, you can improve your borrowing capacity by paying your bills on time, minimising debt, and achieving a healthy credit score. This can increase your chances for approval.
Your monthly living expenses and financial commitments are also key factors potential lenders will examine. This examination includes your daily living costs, such as groceries, utilities, and transport, as well as any existing loans or financial obligations, like investments or other personal loans.
An online borrowing power calculator can help you determine how much you can borrow for refinancing, but you can always chat to a finance professional to find out your options.
How Much Can I Borrow to Refinance My Home Loan?
The process to refinance your home loan works a bit differently from obtaining your initial loan. The most significant difference is the value of the property at the time and your borrowing power. Equity is an important aspect as it is a variable to determine the risk rating of a client, the more equity you have the more likelihood of a good rating.
Equity is the difference between the amount you owe to your lender and the current value of your home. Lenders consider this to be an essential factor when they’re evaluating an application to refinance.
Looking at your available equity is a good way for lenders to determine the risk they run if they choose to refinance your loan. More equity means less risk, at least for the lender.
Additionally, the more equity you have, the better loan periods and interest rates you can access.
How Much Equity Do You Need To Refinance
So, if you have decent borrowing power, you’re probably wondering how much equity you need to refinance.
This can change depending on your lender, but you’ll likely need at least 20% equity in your home in order to refinance. Without that, you may be able to refinance by paying Lenders Mortgage Insurance (LMI).
The risk would be if you purchased your property at the peak of the market, and while the property prices has moved backwards a little, your LVR may not be 80% and thus LMI may incur if you want to refinance – which at times defeats the purpose.
Understanding your available equity and improving your borrowing power is crucial in the refinancing process, as it plays a significant role in loan approval, loan amount, interest rates, and loan features.
Tips for Improving How Much You Could Borrow
There are various things you can do if you’re looking to refinance your home loan but aren’t feeling overly confident about your borrowing power or amount of equity. These include:
- Reducing your debt: Pay down any debts you may have, like a personal or car loan. This improves your debt-to-income ratio, increases your borrower power and lifts your credit score.
- Trying to boost your income: A higher income can help you reach a higher borrowing capacity. Consider looking at salary increases, additional employment, or passive income sources as potential options.
- Improving your credit score: Maintain good credit by paying your bills on time, restricting credit card usage and credit applications, and keeping credit card balances low. Having unpaid amounts on a credit card limits your borrowing power, as it can show you’ve overextended on financial commitments.
- Saving up a larger deposit: Having a larger deposit can reduce the loan-to-value ratio (LVR) of your home loan. A lower LVR can encourage lenders to be more willing to offer you a better loan term.
- Shopping around: Different lenders have different criteria for assessing how much you can borrow. By comparing multiple lenders, you may find one more favourable to your financial situation and willing to offer you a better refinancing option.
Knowing your borrowing power is crucial to your success, if you want to refinance your home loan.
Understanding how it affects your refinancing options and taking steps to improve it can increase your chances of securing better loan terms, making healthier financial commitments, and saving money in the long run.
Check out our online borrowing power calculator to start exploring your serviceability, or contact us today to speak to one of our expert mortgage brokers. We can help you determine the smartest way to refinance.