When lenders determine your borrowing capacity, there’s a few factors they take into consideration. We take a closer look at each of the factors here. It’s helpful to understand what factors might be limiting your borrowing capacity, should you wish to maximise it.
Income
When performing servicing calculations, a lender is simply trying to determine that at the end of the month – after your income has come in to your account and living costs/monthly commitments have come out – there’ll be enough left over to cover the proposed repayment on a new loan. So, it makes perfect sense that a lender will take a very close look at your income and monthly outgoings.
This one seems pretty obvious, but nothing is straight forward when it comes to lending! Not only are lenders looking at the wages that hit your account each fortnight, they’re also looking at:
- whether you’re a casual/ contracted employee
- how much of your income comprises of allowances, overtime/ penalty rates – because often not all of this income can be used for servicing calculations
- how long you’ve been in your job – depending on how much you’re looking to borrow, some lenders have minimum employment periods that need to be satisfied too
Monthly commitments
Do you have any liabilities that require a regular payment? Credit cards/interest-free store-cards, car leases, personal loans or a HELP debt – each of these will need to have a monthly provision allocated to cover the repayment. The more liabilities you have, the more income you need to cover the debts you already have – which will typically leave less left over to cover the repayments on a new loan.
Even if you’re a full-balance payer on your credit card, servicing calculations factor in a monthly repayment commitment that equates to a certain % of the available limit. This is because you could technically go and max out your card tomorrow. If you have credit facilities you no longer use/need – with small balances owing – we suggest you pay them off and close the account before lodging an application. As this can be an easy way to boost borrowing capacity.
Living Expenses
Your living expenses are something else a lender will look at closely. You need to advise your monthly spend across a wide range of categories – and you’ll also need to provide statements to support this – but lenders will also take the Household Expenditure Measure (HEM) into consideration when determining your monthly living expenditure for servicing purposes.
The HEM is a standard benchmark used by lenders use to approximate living expenses. It uses the prices of more than 600 items the ABS has identified as absolute basics (i.e. food, transport costs, utilities) and discretionary basics (i.e. take-away food, restaurants, alcohol) to determine the approximate cost of living across different types of households/income levels. HEM doesn’t include all living expenses, so some need to be accounted for separately. Each time HEM is updated (it’s been increasing due to inflationary pressure), it can impact servicing.
HEM is not something that’s a clear precise figure. It works in the background of lender calculators and will vary in accordance with your level of household income and household type. For example, HEM will be higher for a couple with 2 children as opposed to a couple with no children.
The size of your deposit/ equity position
Servicing the new loan is the first part of the assessment, but we then need to look at how much of a deposit you have available because this will also affect your maximum purchase price.
Lenders want to see you’ve been able to save a deposit and/or have equity built up in another property.
Having cash demonstrates you have surplus income at the end of each month. Having equity shows you’ve used your cash over time, to help create wealth in an asset. Bringing cash or equity to a purchase reduces the lender’s risk associated with lending you money, so the more you can bring to the table the better.
There are also lending ratios to consider here too. Lenders will only allow you to borrow up to a certain % of a property’s value. And if you seek to borrow more than 80% of a property’s value, Lenders Mortgage Insurance (LMI) is typically added to your loan, which means we then need to be able to demonstrate ‘capacity to repay’ is evident for this higher (inclusive of LMI) loan amount.
Interest Rates
Once your income and outgoings and cash/ equity contribution are considered, your ‘capacity to repay’ a loan is based on the current rate of interest for the type of loan you’re applying for, with a buffer of 3% added to this rate. This is why we’ve seen borrowing capacity take such a massive hit in the last 12 months – because each time the RBA increases the cash rate, servicing gets harder to demonstrate.
It’s worth noting that whilst the above factors are all considered by each lender, each have different servicing calculators which are regularly updated. This means you can have a different maximum borrowing capacity across lenders at a given point in time, especially if one lender is a little slow to update their calculator to incorporate recent changes to the HEM.
If you’d like us to investigate your borrowing capacity, you can get started here.
