Calculating your home loan borrowing power is the first step on your journey to homeownership.
Taking your income and subtracting your expenses might seem simple enough, but unfortunately, it’s not that straightforward.
So, we’ve compiled the ultimate guide on how to calculate your home loan borrowing power and tips and tricks to make yourself more attractive to lenders when applying.
Note: the figures you come up with are not absolute but should be seen as a guideline. Instead, the conclusions to your calculations will give you a better idea of where you’re at and will assist you in your decision-making going forward.
How Do Banks Calculate Home Loan Borrowing Power?
Banks calculate home loan borrowing power to determine how much extra disposable income you generate every month. This is because your new monthly mortgage payments will end up coming out of that disposable income.
So, the point of calculating your borrowing power is to see if you can afford to borrow and have enough extra money to cover principal and interest repayments.
To calculate your borrowing power yourself, you’ll need to replicate what the bank will do.
Each lender has its own assessment rate based on its capacity for risk, so your borrowing power will vary between them. But, they all consider the same things – the specific weight of each criteria is subject to change among lenders.
9 Things A Bank Will Consider When Calculating Your Borrowing Power
Below are some of the things that the bank will consider when calculating borrowing power for home loans.
1) Number of Applicants
If you’re taking out a home loan with a partner, both of your incomes will be considered. A higher income doesn’t necessarily mean a larger loan, though, because both of your expenses will be taken into account.
For the sake of this article, we will discuss home loans within your personal capacity.
2) Number of Dependents
The more dependents you have, including children below the age of 18 the more commitments included in your calculation.
So, the more living expenses you have, the less disposable income.
When you calculate your living expenses below, be sure to include your dependents’ influence on your household expenditure.
3) Partner
If you’re taking out a home loan with a partner, both of your incomes will be considered. A higher income doesn’t necessarily mean a larger loan, though, because both of your expenses will be taken into account.
For the sake of this article, we will discuss home loans within your personal capacity.
4) Annual Income Before Tax (Salary)
This refers to your income amount before income tax is deducted.
5) Rental Income
If you have an investment property and receive monthly rental income, it can increase your total income.
6) Other Regular Income
Be sure to take any other streams of regular income into account. If you freelance or work a part-time job, any form of regular income can be added to determine your total income.
7) Monthly Living Expenses
When calculating your living costs, be sure to add:
- food;
- electricity;
- transport;
- education; and
- entertainment – including that which you pay for other people.
- Insurances – Health, Motor and property
You can calculate your living expenses using the Household Expenditure Measure (HEM).
It’s important not to downplay these as you will only be disadvantaging yourself later. Banks have set minimum household expenses according to the number of dependants, so if yours is below that, they will use their amount anyway.
8) Monthly Loan Repayments
This refers to loan repayments if you already have an existing home loan or have taken out a personal loan, a student loan or a car loan.
Each lender will have its own credit approval criteria based on your existing credit.
9) Other Commitments
If you have any other expenses that don’t fall into the above categories, it doesn’t mean that they don’t exist.
Remember, you want to make this as realistic as possible.
If you leave out some of your expenses and can’t afford to pay your home loan, you run the risk of it being repossessed by the bank.
10) Credit Cards, Store Cards, and Overdrafts
Lenders calculate your minimum repayments by considering your credit card limit.
This is true even if you have a high credit limit but don’t ever plan on reaching it. You might not plan on taking out that much credit – but if you wanted to, you could. This is why banks consider the whole amount.
How Much Can I Borrow – Borrowing Power Calculator
You can enter these income and expense figures into an online borrowing power calculator or calculate it yourself.
You can expect that most lenders will work on a 5% interest rates over the principle and interest term.
How To Increase Your Borrowing Power For Home Loans
Because the borrowing power calculator takes so many factors into account, your borrowing power might be lower than what you expected.
This is exactly why it is beneficial to engage with a broker to calculate what your borrowing capacity is before applying for a loan.
If you’re worried that your borrowing power is a bit too low, here are some things you can do to make yourself a more attractive borrower.
1) Maximise Your Credit Score
For at least six months before applying for a home loan, be sure to pay all of your loans, debts, and bills on time.
A high credit score rating shows the bank that you are a low-risk borrower.
2) Make Sure Your Financial Records Are Up to Date
This is particularly true if you are self-employed. Make sure you have submitted all your tax returns and have all the correct company documents at hand.
3) Reduce Your Credit Card Limits and Cancel Unnecessary Credit Cards
As mentioned above, lenders consider your maximum credit limit. Try and have only one credit card with the necessary credit limit, and close the ones you don’t need.
4) Cut Down on Expenses
Assess your everyday spending habits, and see what is unnecessary. Takeaway coffees, going out to eat, buying clothes and shoes – these are sacrifices worth making for your future home loan.
You can consider electricity, gas, internet, insurance policies, and other such expenses. Shop around and see if you can change providers and save money by getting a better deal.
5) Build Up a Good Savings History
Having a good savings history is a way to show lenders that you are disciplined. If you can put away savings every month, it can be in good faith that you will honour your home loan repayments every month.
It also indicates that you have money for emergencies should something go wrong.
6) Save Money for the Deposit
After using the borrowing power calculator, you’ll have an idea of how much you can borrow.
A reasonable deposit is anywhere between around 10% of the purchase price. Then you can work out how much that would be and start saving towards it.
An even better option would be to save 20% because then you won’t be required to pay lenders mortgage insurance (LMI).
Key Takeaways
It’s always an advantageous to be prepared when it comes to your home loan borrowing power.
Knowing what questions will be asked when lenders calculate how much you can borrow and knowing your answers will make the loan application process smooth and stress-free.
Calculating this amount before the time in your personal capacity can give you an idea of how much money you should aim to save as a deposit.
Don’t be hasty in your application. Take the necessary steps to increase your borrowing power.
If doing all these calculations yourself seems to be a daunting task, you may want to consider engaging a Mortgage Broker to assist you.
A Mortgage Broker is a go-between for you and the lender.
At The Mortgage Agency, our mission is to help you achieve your goals and guide you in every step of the property buying journey by implementing a solid home loan plan.
We can help by:
- comparing hundreds of home loan products on the market to find the best one suited to your circumstances with the best interest rates;
- working closely with your accountant, real estate agent and financial planner to ensure that you’re always getting the best outcome; and
- sweating the small stuff, so you don’t have to.
If you would like assistance in establishing your home loan borrowing power, book a consultation with one of our expert mortgage brokers today.
Disclaimer:
Please note that every effort has been made to ensure that the information provided in this guide is accurate. You should note, however, that the information is intended as a guide only, providing an overview of general information available to property buyers and investors. This guide is not intended to be an exhaustive source of information and should not be seen to constitute legal, tax or investment advice. You should, where necessary, seek your own advice for any legal, tax or investment issues raised in your affairs.
