Your borrowing power is, essentially, your ability to borrow more funds. A person with a great deal in assets and very little debts will have a greater borrowing power than a person in the opposite situation.
Nearly every bank, finance lender or mortgage broker works off the same formula to determine an individual’s (or couple’s) borrowing power.
Gross income – tax – existing commitments – new commitments – living expenses – buffer = monthly surplus
Even though the formula to work out your borrowing power is the same, there are differences in how some lenders will assess your financial situation.
There are a number of income sources your bank will assess, including:
Banks take a number of financial commitments into consideration when assessing your borrowing power, including:
This refers to your new mortgage. Lenders will calculate your mortgage repayments at a higher assessment rate — usually 1 to 3 percent above the actual interest rate — to allow for interest rate rises.
If you’re an investor, the assessment rate is even higher, due to a tightening of rules by the Australian Prudential Regulation Authority (APRA).
Where interest rates are 4.5 percent per annum, for example, it’s not uncommon for a lender to assess your mortgage rate at 7.5 percent per annum or higher.
Even if you can produce records to show your living expenses are relatively low, banks and lenders still refer to the Household Expenditure Measure (HEM), determined by the Australian Bureau of Statistics to calculate your living expenses.
Under the HEM, a high expense is used for the first adult and child in the household, with a lower expense assigned to each additional adult and child.
If you’re applying for a mortgage without your spouse, the lender will include your spouse’s living expenses in their assessment to ensure you can still support your family and service the loan.
This is an indiscriminate amount that lenders will add in to your assessment to ensure you can service your loan, even despite assessing you at a higher than usual interest rate. The amount varies lender to lender.
Sometimes your surplus, which is the figure that determines your borrowing power, is expressed in a monthly or annual dollar figure, and other times it’s expressed as a ratio. In most cases, your surplus will be display in one of two ways:
Your borrowing power goes a long way toward getting a loan approved, however lenders will still look at other factors before approving your loan, such as your credit score, savings and your loan value ratio (LVR), which is the amount of money you’re borrowing represented as a percentage of the value of the property. The LVR is used to determine the risk of the loan, and whether you will need to have lenders mortgage insurance.
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