If you’re going to buy your home, one of the first things you’ll need to figure out is, “How much can I actually borrow?” Lenders call this your borrowing capacity or borrowing power, and this is more than just a number. This is the limit beyond which you cannot borrow any amount of funds.
What is Borrowing Capacity?
In general terms, your borrowing capacity is the amount a lender is willing to offer you based on your income, expenses, debts, and overall financial position. In other words, it’s your financial boundary. That means if you cross it, your loan may be declined. And if you stay within it, you will get an effective foundation to buy your investment property or your first home confidently.
Then there is another term called borrowing power, which has a similar meaning. Lenders, brokers, and banks in Australia often use both terms interchangeably. It’s all about one thing, how much you can borrow based on your financial health and ability to repay the loan over time.
Why is Knowing Your Borrowing Capacity Important?
There are various reasons why knowing your borrowing capacity is important, such as
Helps Set a Realistic Property Budget
Imagine browsing homes for months, only to realise later they were way out of reach financially. But if you know your borrowing limit early, it can help you focus only on homes that actually fit within your budget.
At the same time, you’ll avoid wasting time, reduce stress, and keep your expectations grounded. It will also help you negotiate and talk to agents, as you know your budget and can act quickly.
Prevents Loan Rejection
Lenders check your borrowing capacity to make sure you’re not taking on more than you can comfortably afford. If you apply for a loan that exceeds your capacity, chances are it will get rejected, and that can leave a mark on your credit score. Repeated rejections can make lenders even more cautious in the future.
However, if you know how lenders assess borrowing capacity, it can prevent you from repeated loan rejections. It will also help you improve your chances of home loan approval the first time around without leaving a mark on your credit score.
Helps Compare Loan Options
When you know your borrowing limit, it’s easier to match it with the right type of loan, like fixed, variable or interest-only. You can also find the right lender, as per your preferences. As a result, you can choose the one that fits your financial style and future desires without any concerns.
That’s because there are various types of home loans, including refinancing home loans, low-doc home loans and others. And choosing the right one can be difficult if you don’t know your borrowing capacity and the details of each loan type.
Identifies Potential Issues Early
Sometimes, your borrowing capacity reveals more than a number. It can reveal things like high spending habits, credit score issues, or gaps in your savings. Knowing this early gives you time to fix it before applying.
Otherwise, it may lead to straightforward loan rejections and negatively affect your credit file.
Strengthens Your Financial Plan
Your borrowing capacity is more than the limit. It can help you plan for the overall financial journey, including your deposit, upfront costs like stamp duty, and monthly repayments.
It can even offer great help to manage your finances as per the changes in your lifestyle.
How Do Lenders Calculate Borrowing Capacity in Australia
Lenders don’t rely on assumptions. They follow a detailed procedure to assess your borrowing capacity in Australia. They will look at
Your Income
This includes your regular salary, rental income, bonuses, or even government benefits, basically, any money consistently coming in. And the higher and more stable your income is, the better your borrowing capacity will be in front of lenders.
Your Living Expenses
Lenders also ask how much you spend each month on essentials like groceries, transport, bills, subscriptions, and even childcare. They may also use benchmarks like HEM (Household Expenditure Measure) to cross-check your declared expenses.
That’s because by this, they confirm whether you can repay the loan on time or not.
Your Existing Debts
Lenders check all existing debts, including credit cards, car loans, student loans, and personal loans. Even unused credit card limits are considered because they represent potential debt.
So, if your debt-to-income ratio is high, it can reduce how much you’re allowed to borrow.
Your Deposit and Savings
The more genuine savings you have, the more confident a lender will be in your ability to handle a loan. A bigger deposit can also reduce your LVR (Loan to Value Ratio), which means lower risk for lenders and possibly better interest rates for you.
Number of Dependents
If you have kids or financially dependent family members, lenders will assume you have higher ongoing expenses. This can also slightly reduce your borrowing capacity.
Type of Loan
Different loans come with different requirements. For example, a low-doc loan may require more equity, while an interest-only loan may temporarily increase your borrowing power but come with long-term repayment risks.
In addition to these factors, lenders also conduct a “stress test” on your loan application. This is to assess whether you can still repay the loan if interest rates increase by 2–3% or not. It is called the buffer rate. Currently, as per APRA, the buffer rate is 3%, which is the minimum interest rate at which your home loan application will be assessed.
For example, if you go for a home loan with a 6% variable rate, the lenders will assess you at 8%. Therefore, you must understand your borrowing capacity before applying for any type of home loan.
Borrowing Capacity Calculation Formula
While different lenders have different procedures to assess your borrowing capacity, there is a basic approach that you must prepare for. They will use the following formula:
Your Net Income – Your Monthly Expenses = Your Repayment Capacity
From there, lenders use this repayment capacity to estimate the maximum loan amount you can afford. They also consider your preferred loan term, interest rate, and ongoing financial commitments while doing so.
For example,
Say you’re a couple earning a combined income of $100,000 annually (around $6,250/month after tax) and you have the following commitments:
- Rent: $2,000
- Credit card repayments: $300
- Utilities, food, transport, etc.: $1,700
- Total expenses: $4,000/month
Then, you will have $2250 available for your monthly repayment capacity. Based on that, a lender may estimate you can afford a home loan of around $370,000 to $420,000, depending on:
- The loan term (say 30 years)
- The interest rate (say 6%)
- And your deposit size
Documents You Need to Prove Borrowing Power
Lenders don’t just take your word for it. To assess your borrowing capacity, they’ll verify everything from your income to your spending habits. So, you need to be prepared with
Income Documents
- The latest 3–6 months of payslips
- Tax returns, usually of the last 2 years, if you’re self-employed
- Group certificates or PAYG summaries
- Proof of bonuses, commissions, or secondary income
Expense and Spending Proofs
- Recent bank statements showing both incomes and expenses
- Credit card statements for all active cards.
- Details of personal loans, car loans, or any ongoing repayments
- Buy Now Pay Later statements, if applicable
Asset and Liability Evidence
- Superannuation balance, because some lenders also factor this in
- Rental income evidence, like a lease agreement or rental statements
- Existing property and investment statements
- Details of any savings or term deposits
Identity and Legal Documents
- A photo ID, like a passport or a driving license
- Medicare card
- Visa, if you’re on a temporary residency
Although these are the basic documents, some lenders can ask for more documents depending on your employment type, visa status, or if you’re using a guarantor.
How to Increase Your Borrowing Capacity Before Applying
Since borrowing capacity is the first stepping stone while applying for a home loan, you should know about increasing it before applying. So, here are a few ways to improve your borrowing power.
Pay Off or Reduce Credit Card Limits
Even if you don’t owe anything, a high credit card limit can still impact your loan approval chances. That’s because lenders assess your borrowing capacity, as if your full limit is used. So, to address this issue, you can take the following steps:
- Lower your credit card limit to what you actually need
- Pay off outstanding balances
- Avoid taking on any new “Buy Now, Pay Later” debt before applying
This will help you reduce your liabilities and show the lender you’re in control of your finances.
Improve Your Credit Score
A healthy credit score isn’t just about approval, it can also directly impact how much a lender is willing to offer. Therefore, to improve this
- Always pay bills and debts on time
- Don’t apply for multiple loans or credit cards in a short time
- Check your credit file for errors
- Avoid late payments or defaults on your current commitments
By utilising all of these methods, you can improve your credit score. Even a small improvement in your score can widen your borrowing potential and put you in a better position with multiple lenders.
Reduce Living Expenses Where Possible
Your monthly spending has a major impact on how lenders assess your borrowing capacity. That’s because lenders look at your every expense. This can include subscriptions, takeaways, discretionary expenses, childcare, school fees, and entertainment. Therefore, it is beneficial to reduce your living expenses whenever possible. To achieve this, you can take the following actions:
- Cut back on non-essentials for a few months before applying
- Track and plan your expenses using a budget app
- Be honest about your spending because lenders often benchmark it against averages (like HEM)
By doing all these things, you can show that you’re financially disciplined to your lender, which, as a result, will improve your borrowing capacity.
Build a Consistent Savings Pattern
Lenders like stability, and regular savings can be a clear sign that you’re financially responsible. This can help you in several ways, like
- Shows genuine savings history
- Helps improve your deposit
- Strengthens your overall financial profile
Even if a little change happens, depositing a consistent amount each month into a separate savings account can help you increase your borrowing capacity. Additionally, it will show your effective spending habits, which in turn will strengthen your negotiation power with lenders.
Apply Jointly
Two incomes are stronger than one. If you’re buying with a partner or family member, applying jointly can increase your borrowing power. That’s because, by this, you can have
- Shared expenses
- Combined incomes
- And lower individual debt-to-income ratios
But remember, both applicants are equally responsible for the loan. So, you cannot avoid any of your responsibilities during the loan period.
Extend Your Loan Term
A longer loan term means lower monthly repayments, which can make your application more serviceable in a lender’s eyes. For example, switching from a 25-year loan to a 30-year term might give you the extra capacity you need, but it does mean more interest over time.
This will even help you while managing your cost of living without impacting your monthly loan repayments.
Explore Government Grants and Schemes
There are various government grants and schemes that you can refer to to reduce your upfront costs, like stamp duty. You can consider schemes and grants, like
- Home Guarantee Scheme
- First Home Buyer Guarantee
- Help to Buy Scheme
- First Home Super Saver Scheme
- First Home Owner Grant
- Stamp Duty Exemptions
- Shared Equity Schemes
Additionally, you can check your state and federal programs to reduce the upfront costs. It can also help you buy your first home with a 2-5% deposit.
Common Mistakes That Reduce Borrowing Power
Even with a stable income, simple financial missteps can reduce your borrowing capacity. Here are some common mistakes to watch out for before applying for a loan:
Keeping High Credit Card Limits
Even unused credit limits count as debt. Say, a $15,000–$20,000 limit could reduce your borrowing power significantly, even if you never touch it.
Overspending Before Applying
Big purchases, unnecessary spending or rising expenses in the months before applying can alarm lenders who review your bank statements. So, make sure you don’t overspend for a couple of months.
Missing or Late Repayments
Whether it’s a credit card, car loan, or BNPL, missed payments can impact your credit score and lender confidence in your profile. Even missing once can have a great impact.
Relying on Online Calculators
Online calculators give a rough figure, but they don’t factor in your full financial picture. Many people overestimate what they can borrow. Therefore, always consult a trustworthy mortgage broker to determine your actual borrowing capacity.
Ignoring Future Rate Rises
Lenders now stress test your loan at higher interest rates because of APRA buffer rules. This means that if you only plan based on the current low rates, you may encounter troublesome situations later.
Lifestyle Changes Not Considered
Planning a baby, switching to part-time work, or any other life change can affect your borrowing power. And lenders? They often factor in when assessing your future affordability. Always consider this before applying for a home loan.
Not Disclosing All Debts
Leaving out a HECS debt, Afterpay, or even a car loan in the loan profile is also a major mistake. This is because, during an assessment, not disclosing these debts can make your application seem misleading.
Applying Jointly Without Strategy
Going in with a partner or friend who has poor credit or unstable income could drag your application down, even if you’re financially sound. For this, plan your credit score early before applying.
Submitting Too Many Loan Applications
Every application leaves a mark. Multiple enquiries in a short time can signal desperation or instability to lenders. Thus, avoid submitting too many loan applications to strengthen your credit score in front of lenders.
Summary
Your borrowing capacity is more than just a starting point. It is the overall foundation of your financial journey, which keeps your financial decisions within limits. It also helps you stay within safe limits, avoid loan rejections, and protect your credit score. But every lender assesses it differently. They’ll consider your income, expenses, existing debts, dependents, and more.
So, if you’re looking to strengthen your position, focus on reducing credit limits, improving your credit score, and cutting back on unnecessary expenses. Additionally, remember that relying on online calculators or ignoring future interest rate changes can lead to costly mistakes.
To know more about your borrowing capacity, call us at 1300 GET LOAN or 0456 456 267 or book your time at Nfinity Financials.
Frequently Asked Questions
Here are the answers to the most commonly asked questions about borrowing capacity:
Q1. How is borrowing capacity calculated by banks?
Usually banks use a simple formula to calculate your borrowing capacity in which they deduct your expenses from your net income.
Q2. Can I increase my borrowing capacity quickly?
Yes, you can improve your borrowing power fairly quickly by paying off debts, lowering credit limits, and cutting unnecessary spending.
Q3. How does a credit card affect my borrowing power?
Your credit card limits can have a major impact on your borrowing power. It can reduce it, since lenders assume you might use them, which increases your potential debt.
Q4. Does refinancing change my borrowing capacity
Yes, refinancing can improve borrowing capacity if it reduces repayments, interest rates or clears out other existing liabilities and debts.
Q5. Are online borrowing calculators accurate?
No, they provide rough estimates but are not fully accurate, as they don’t consider detailed personal factors lenders use during assessment.
