How to Calculate How Much You Can Borrow for a Home Loan
Purchasing a home is an exciting milestone, but the process can be overwhelming. Before you start house hunting and fall in love with a property, it’s essential to first understand how much you can borrow. Knowing your borrowing power is a crucial step in the home-buying journey, as it gives you a clear idea of your financial limits and helps you avoid disappointment.
In this guide, we’ll walk you through what borrowing power is, how lenders calculate it, and practical tips on how you can increase your borrowing capacity to secure your dream home. Whether you’re a first-time homebuyer or looking to refinance, knowing your borrowing power is key to making informed decisions in today’s competitive property market.
What is borrowing power?
Your borrowing power refers to the amount of money a lender is willing to approve for you to borrow, based on their evaluation of several key factors. Lenders assess these factors to determine whether you can comfortably manage regular mortgage repayments over the long term. Here are the key elements they consider when calculating your borrowing power:
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Income and assets: Your earnings and the value of your assets play a significant role in determining your borrowing capacity.
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Credit history: Lenders will assess your credit report to check for any history of late payments, defaults, or other financial risks.
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Savings history: Consistent savings and a solid history of managing money show lenders you're financially responsible.
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Debts: Your existing debts, including credit cards and personal loans, will be factored in to evaluate your current financial commitments.
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Typical monthly spending: Lenders will look at your monthly living expenses to ensure you can handle additional mortgage repayments.
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Loan type, term, and interest rate: The specific type of loan you’re applying for, as well as the loan term and interest rate, impact the total amount you can borrow.
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Deposit size: The larger your deposit, the less you need to borrow, which can increase your borrowing power.
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Property market value: The value of the property you’re interested in buying will also influence your borrowing power.
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Personal characteristics: Lenders also take into account factors like your age, job stability, and the number of applicants on the loan.
In general, lenders want to ensure that you will be able to make your repayments without financial strain. If you have a large deposit, minimal debt, and substantial assets, you're more likely to be approved for a higher loan amount. However, it’s important to note that a high income alone doesn’t guarantee high borrowing power if your expenses are high or if you have a poor debt-to-income ratio.
How much can I borrow?
When taking out a home loan, it's generally recommended not to borrow more than 80% of the property's value. Borrowing above 80% means you’ll have a higher Loan to Value Ratio (LVR), which indicates a smaller deposit and a greater level of risk for the lender. As a result, if your deposit is below 20%, you’ll most likely be required to pay for Lenders Mortgage Insurance (LMI).
It’s important to be cautious when purchasing a property to ensure you're not paying an inflated price. Overpaying for a property can lead to difficulties securing a home loan or, worse, finding yourself in negative equity—where the value of your home is less than the amount you owe.
Ultimately, the amount you can borrow is determined by several factors related to your financial situation, and these will influence your borrowing power. If you’d like an estimate of how much you could potentially borrow, you can use our Borrowing Power Calculator. By answering a few simple questions about your income, expenses, and personal circumstances, we can give you a more accurate estimate of your borrowing capacity.
How can I increase my borrowing power?
If you're not happy with your current borrowing capacity, there are several ways you can increase it and improve your chances of securing a home loan. Lenders primarily want to see that you are financially responsible and capable of meeting your financial obligations. Here are some strategies to boost your borrowing power:
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Pay off existing debt: The amount of debt you currently have plays a significant role in your borrowing capacity. Lenders may hesitate to approve a loan if you have high levels of existing debt. Pay down as much debt as possible before applying for a mortgage. If paying off all your debt isn't feasible, consider consolidating it under your home loan once you’ve secured one. This allows you to make a single, more manageable repayment.
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Reduce or eliminate unnecessary credit cards: Many lenders view credit cards as potential liabilities. For example, if you have a credit limit of $4,000, lenders may consider that as a $4,000 monthly debt. If you don't need the cards, consider cancelling them or reducing the credit limits to improve your borrowing power.
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Build up your savings: A strong savings history shows lenders that you have a financial buffer, making you less risky to lend to. The more savings you can demonstrate, the better your position will be for getting approved. Additionally, a larger deposit means you'll need to borrow less, which can positively impact your borrowing capacity. Lenders typically want a 20% deposit, and anything below that may require you to pay Lenders Mortgage Insurance (LMI).
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Work on improving your credit score: Lenders closely examine your credit report and score when deciding whether to approve your loan application. A strong credit score indicates that you are a responsible borrower. Regularly check your credit report for any inaccuracies and ensure that all personal details are correct. Consistently making timely payments on loans and credit cards can help boost your credit rating.
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Include additional income sources: When applying for a home loan, don’t forget to include any extra income you might have, such as rental income. This can help improve your borrowing capacity and increase the amount you can borrow.
By focusing on these strategies, you can increase your chances of borrowing more and improving your overall financial position when applying for a home loan.
What is LVR?
The Loan to Value Ratio (LVR) is a key indicator of how much of the property's value you're borrowing from the lender. It's calculated by dividing the loan amount by the property's value and expressing it as a percentage. The LVR is essentially the inverse of the percentage of your deposit. For instance, if you have a 15% deposit, your LVR will be 85%.
LVR Formula: LVR = (Loan Amount / Property Value) x 100
A higher LVR means you’re borrowing a larger portion of the property’s value, and consequently, your deposit is smaller. This can significantly affect your borrowing power. The higher the LVR, the greater the risk for the lender, as you are contributing less of your own money towards the purchase. As a result, lenders may be less willing to approve your loan, or they may offer a smaller loan amount or higher interest rates to compensate for the increased risk.
Lenders typically prefer a lower LVR, ideally under 80%, as it demonstrates that you have a significant deposit and are less of a risk.
What is LMI and how can I avoid paying it?
Lenders Mortgage Insurance (LMI) is a one-off fee that lenders charge to protect themselves in case a borrower is unable to repay their home loan. It is typically required when the borrower has a deposit of less than 20%, meaning they are borrowing more than 80% of the property’s purchase price. LMI is calculated as a percentage of the loan amount and is usually added to the total loan balance.
To avoid paying LMI, there are a few options available:
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Save a 20% Deposit: Having at least a 20% deposit saved will not only help you avoid LMI but also improve your chances of loan approval. A larger deposit signals to the lender that you are financially responsible and a lower risk.
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Get a Guarantor: Another option is securing a guarantor for your loan. A guarantor is someone—often a family member—who co-signs the loan and offers their property equity as additional security. In the event that you cannot meet your repayments, the guarantor becomes responsible for the loan repayment. This option can help you avoid LMI while increasing your borrowing capacity.
These strategies can save you from paying the additional cost of LMI and potentially strengthen your application for a home loan.
How is borrowing power calculated?
Borrowing power is assessed differently by various lenders, but there are several key factors that most commonly influence the calculation:
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Income: Your income is the most significant factor, as it directly impacts your ability to meet loan repayments. Lenders will assess your salary, wages, and any additional income streams to determine your capacity to repay the loan.
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Savings and Equity: Savings demonstrate your ability to manage money and expenses, and having sufficient equity in an existing property can increase your borrowing power. The more assets or equity you can offer as collateral, the higher the amount you can borrow.
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Deposit: A larger deposit reduces the amount you need to borrow, which strengthens your position when applying for a home loan. If your deposit is less than 20% of the property's purchase price, you may need to pay Lenders Mortgage Insurance (LMI) to mitigate the lender's risk.
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Dependents (Children): Lenders will also factor in the financial impact of any dependents, as this can reduce the amount of disposable income available for loan repayments.
To calculate your borrowing power, lenders typically subtract your monthly expenses from your net income. They also take into account your ability to manage repayments if interest rates rise, as the Australian Prudential Regulation Authority (APRA) requires lenders to apply a minimum interest rate buffer of 3%. For instance, if the advertised interest rate is 4%, lenders will assess your ability to repay the loan as though the rate is 7%.
In addition to these main factors, don’t forget to consider other costs involved in purchasing a property, such as stamp duty, legal fees, and other upfront costs that may impact your overall borrowing capacity.
To get a better idea of how much you could borrow, try our Borrowing Power Calculator.
What other factors should I consider to work out my borrowing power?
When considering your borrowing power, many borrowers focus primarily on having a large enough deposit, but it's equally important to account for other upfront costs associated with purchasing a property. These include:
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Stamp Duty: A one-off government tax applied when transferring property ownership, calculated based on the property's value and location. Stamp duty is often the largest expense after your deposit, unless you qualify for an exemption or concession.
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Legal and Conveyancing Fees: Costs for legal services to ensure that the property transaction is handled correctly, including contract reviews and the transfer of ownership.
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Loan Establishment Fees: Fees charged by lenders for setting up the loan, which can include application and processing fees.
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Property Inspections: Costs for conducting thorough property inspections to check for structural issues, pest problems, or other potential concerns.
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Property Valuation: An independent property appraisal to determine its market value, which the lender may require before approving your loan.
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Lenders Mortgage Insurance (LMI): If your deposit is less than 20% of the property's value, you'll need to pay LMI, which protects the lender in case you default on the loan.
It’s wise to budget an extra 5-10% of the property's value on top of your deposit to cover these property-related fees. By planning ahead, you’ll avoid any financial surprises and ensure a smoother path to homeownership.
How can I qualify for a home loan?
When applying for a home loan, lenders commonly evaluate several key factors to determine your eligibility. Some basic guidelines they typically consider include:
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Deposit Amount: Lenders generally require a minimum deposit of 20% of the property’s purchase price. However, there are home loan options that allow you to provide a lower deposit, though this may come with additional costs such as Lenders Mortgage Insurance (LMI).
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Credit History: A clean credit history is crucial for loan approval. Lenders prefer borrowers with a strong credit report and minimal debt. Make sure your credit history is up-to-date and accurate, as it directly impacts your chances of being approved for a home loan.
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Income and Financial Stability: Lenders want to ensure you have a reliable and steady income to comfortably manage loan repayments. Be prepared to provide the necessary documentation, such as payslips or tax returns, to demonstrate your financial stability and declare all admissible income.
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Age: While age is not a primary criterion, it can affect your loan terms. Home loan options are available for borrowers of all ages, but if you’re older, your repayment period might be limited. By law, you must be at least 18 years of age to qualify for a home loan in Australia.
Understanding these guidelines can help you prepare for the home loan application process and increase your chances of securing approval.
What is pre-approval and how long can it last?
Knowing exactly what you can afford before you start house hunting can save you time and help streamline the buying process. This is where pre-approval comes in.
Getting pre-approved for a home loan means that the lender has reviewed your financial situation and indicates they are likely to approve you for a specific loan amount. While pre-approval is not a guarantee, it provides a solid indication of your borrowing capacity and can give you greater confidence when searching for properties, making offers, or bidding at auction.
For sellers, having a pre-approved borrower can be an attractive proposition. It shows that the buyer is financially ready and capable of quickly securing finance, which is particularly appealing for fast settlement deals.
Pre-approval typically lasts for 3 to 6 months, but it can be extended in certain circumstances. These time limits are in place to allow for potential changes in a borrower’s financial situation.
However, it’s important to note that pre-approval does not guarantee final approval. If there are significant changes in your personal or financial circumstances, or if the lender adjusts their policies, your home loan application could still be declined.
What is a loan term and how long do you have to pay off your loan?
A loan term refers to the length of time you have agreed upon with your lender to fully repay your home loan. It essentially defines the "life" of the loan and is chosen at the outset. However, the loan term can be adjusted through refinancing if needed.
Most home loans in Australia typically have repayment terms of up to 30 years, given that home loans are often large amounts. It's important to keep in mind that interest accrues over the life of the loan. The longer the repayment term, the more you will pay in interest overall.
While a longer loan term may result in higher interest costs, it can also lower your monthly repayments, which may increase your borrowing capacity. However, it’s essential to be realistic and responsible when applying for a home loan. Although lenders will only approve loans they believe you can manage, it’s best not to overextend yourself financially.
As a general rule of thumb, aim to keep your home loan repayments under 30% of your gross monthly income to avoid financial strain.
To get a better understanding of your borrowing power and repayment options, reach out to one of our experienced Home Loan Specialists today. We’re here to help you navigate your home loan journey.
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