Borrowing capacity refers to the maximum loan amount a lender will approve based on your financial position. This figure varies from lender to lender as each financial institution has its own assessment criteria and risk appetite.
Lenders determine borrowing capacity by evaluating factors such as income, expenses, existing debts, credit history, and loan type. While online calculators provide a general estimate, a detailed assessment by a mortgage broker or lender offers a more accurate picture.
Key Factors That Affect Your Borrowing Capacity
1. Income and Employment Stability
Lenders assess all sources of income, including:
- Salary or wages – Full-time, part-time, or casual employment
- Self-employed income – Tax returns and business financials
- Rental income – From investment properties
- Government benefits – Some lenders accept Centrelink payments as supplementary income
- Bonuses and commissions – If they are consistent over time
Employment stability plays a significant role. A full-time, long-term job is more favorable than casual or contract work. If you’re self-employed, lenders may require two years’ worth of financial statements to verify income.
2. Expenses and Lifestyle
Lenders scrutinise monthly expenses, including:
- Utility bills
- Grocery costs
- Transport and fuel
- Childcare and school fees
- Entertainment and subscriptions
- Insurance premiums
The Household Expenditure Measure (HEM) is commonly used as a benchmark, but actual spending habits can impact borrowing power. Keeping discretionary spending in check can improve your borrowing capacity.
3. Existing Debts and Financial Commitments
Your current liabilities significantly affect your ability to take on new debt. Lenders evaluate:
- Credit cards – Even if you don’t use them, lenders consider the full credit limit
- Personal loans and car loans
- Buy Now, Pay Later (BNPL) services – Afterpay, ZipPay, etc.
- HECS/HELP debt – Reduces net income available for repayments
4. Credit History and Score
A strong credit score increases borrowing power, while a poor credit history with defaults or late repayments can reduce it. Lenders access your credit file to assess past borrowing behavior. Ensuring timely bill payments and limiting multiple credit applications can help maintain a healthy credit score.
5. Loan Type and Interest Rates
The type of loan and its associated interest rate affect affordability. Higher interest rates mean higher repayments, reducing borrowing power. Factors include:
- Fixed vs. variable rates
- Principal & Interest vs. Interest-Only repayments
- Loan term – A longer term reduces repayments but increases overall interest costs
6. Deposit Size and Loan-to-Value Ratio (LVR)
The more you save for a deposit, the higher your borrowing potential. A lower LVR (Loan-to-Value Ratio)—which is the loan amount as a percentage of the property’s value—reduces lender risk. Borrowers with an LVR above 80% may need Lenders Mortgage Insurance (LMI), adding to costs.
How Lenders Calculate Borrowing Capacity
Lenders use serviceability calculators to determine how much you can borrow. These calculators factor in:
- Gross income (less tax and superannuation)
- Living expenses
- Debt repayments
- Buffer rates – Lenders add a safety margin (usually 3% above the actual interest rate) to test affordability
Example: If your mortgage interest rate is 5%, lenders may assess your ability to repay as if it were 8% to ensure you can handle future rate increases.
Ways to Increase Borrowing Capacity
If your borrowing capacity is lower than expected, consider these strategies:
1. Reduce Unnecessary Debts
Paying off credit cards, car loans, and BNPL balances can improve borrowing power. Even reducing your credit card limit can help.
2. Improve Your Credit Score
- Pay bills and loans on time
- Limit multiple loan applications in a short period
- Check your credit report for errors and rectify them
3. Increase Your Income
Boosting income through a promotion, side hustle, or rental property can enhance borrowing capacity. If you have a partner, applying for a joint loan may increase eligibility.
4. Cut Down on Living Expenses
Lenders assess your bank statements to verify spending habits. Reducing unnecessary expenses for 3-6 months before applying for a loan can improve serviceability.
5. Save a Larger Deposit
A bigger deposit reduces the LVR, minimising lender risk and potentially allowing access to better loan terms. Aim for at least 20% deposit to avoid LMI.
6. Choose the Right Loan Structure
Opting for a longer loan term (e.g., 30 years instead of 25 years) reduces repayments, increasing serviceability. However, it may result in paying more interest over time.
Why Work With a Mortgage Broker?
A mortgage broker assesses your financial situation and matches you with lenders that align with your borrowing capacity and financial goals. Brokers have access to multiple lenders and can often secure better interest rates or lending policies than what’s available directly to the public.
Final Thoughts
Understanding borrowing capacity is key to planning your home purchase or investment. By improving income, reducing debt, and managing expenses wisely, borrowers can enhance their borrowing power and secure a loan that fits their financial goals.
If you’re looking to assess your borrowing capacity and explore mortgage options, speak to a professional mortgage broker who can guide you through the process.
The Team at The Accountants and The Finance Brokers are here to help you navigate your cash flow requirements in your business. We offer complimentary cash flow reviews and assist you in understanding your finance needs.
