#54 Borrow Smart Series – Calculating Your Borrowing Power: Know How Much You Can Afford

Understanding Your Borrowing Power: A Comprehensive Guide.

When embarking on the journey to purchase a property, one of the most crucial questions to answer is: “How much can I borrow?” Your borrowing power, also known as borrowing capacity, is a key factor that lenders use to determine how much they’re willing to lend you. Understanding how borrowing power is calculated can help you set realistic expectations and make informed decisions about your property purchase. Let’s dive into the key factors that influence your borrowing power and how you can calculate it.

Key Factors Influencing Borrowing Power

1. Income

Your income is the foundation of your borrowing power. Lenders consider:

• Salary: Your base salary is the primary component.
• Bonuses and Commissions: These are often included, but lenders may only consider a portion of variable income.
• Rental Income: If you have investment properties, typically 80% of the rental income is considered.
• Government Benefits: Some lenders include certain government payments in their calculations.
• Investment Income: Dividends and interest from investments may be considered.

Remember, lenders typically look at your gross income (before tax) when assessing your borrowing capacity.

2. Expenses

Your expenses play a crucial role in determining how much you can afford to repay. Lenders consider:

• Living Expenses: This includes food, utilities, transportation, and other regular costs.
• Existing Debts: Personal loans, car loans, and credit card limits are factored in.
• Dependents: The number of dependents you have can affect your estimated living expenses.

Lenders use either your declared expenses or a benchmark figure (like the Household Expenditure Measure), whichever is higher, to ensure they’re not underestimating your costs.

3. Interest Rates

The current interest rate environment significantly impacts your borrowing power:

• Assessment Rate: Lenders use a higher rate than the current interest rate to assess your ability to repay. This buffer ensures you can manage repayments if rates increase.
• Fixed vs. Variable: Your choice between fixed and variable rates can affect your borrowing power.

4. Loan Term

The length of your loan term affects your borrowing power:

• Longer terms (e.g., 30 years) generally increase borrowing power as they result in lower monthly repayments.
• Shorter terms mean higher repayments, which can reduce borrowing capacity.

5. Credit Score

While not directly used in borrowing power calculations, your credit score influences:

• Whether you’ll be approved for a loan
• The interest rate you might be offered, which in turn affects borrowing power

Steps to Calculate Your Borrowing Power

While a precise calculation is complex and best done by professionals or specialised calculators, here’s a simplified approach:

1. Calculate Total Income: Sum up all your sources of income.
2. Estimate Monthly Expenses: Include all living costs and debt repayments.
3. Determine Disposable Income: Subtract expenses from income.
4. Apply Lender’s Criteria: Typically, lenders allow 30-35% of your gross income for loan repayments.
5. Consider Interest Rates: Use current rates plus a buffer (usually about 2-3%) to estimate repayments.
6. Factor in Loan Term: Usually 25-30 years for standard mortgages.

Using Online Calculators

Many lenders and financial websites offer borrowing power calculators. These tools can provide a quick estimate based on:

• Your income
• Your expenses
• Current interest rates
• Loan terms

While these calculators are useful for getting a general idea, they may not account for all the nuances that lenders consider.

The Role of Your Mortgage Broker

For a more accurate assessment of your borrowing power, consulting with a mortgage broker is invaluable. A broker can:

1. Provide a comprehensive assessment considering all relevant factors.
2. Offer insights into different lenders’ criteria, as borrowing power can vary between lenders.
3. Help you understand how changes in your financial situation could affect your borrowing power.
4. Advise on strategies to potentially increase your borrowing capacity.
5. Pre-assess your application with multiple lenders to find the best fit.

Strategies to Increase Your Borrowing Power

If you’re looking to boost your borrowing capacity, consider:

1. Reducing Existing Debts: Paying down personal loans or credit cards can significantly increase borrowing power.
2. Lowering Credit Card Limits: Even unused limits are considered potential debt.
3. Increasing Your Savings: A larger deposit can sometimes lead to increased borrowing capacity.
4. Reviewing Your Expenses: Look for areas where you can reduce spending.
5. Considering a Guarantor: In some cases, a family guarantee can boost your borrowing power.

Conclusion

Understanding your borrowing power is a crucial step in the home buying process. It helps you set realistic expectations, focus your property search, and make informed decisions about your financial future.Remember, while borrowing power calculations give you an idea of what you might be able to borrow, it’s equally important to consider what you’re comfortable repaying. Just because you can borrow a certain amount doesn’t necessarily mean you should.

By working closely with a mortgage broker, you can gain a clear understanding of your borrowing capacity across different lenders and explore strategies to optimise your position. This knowledge, combined with a solid understanding of your financial goals and comfort level, will put you in the best position to make confident decisions on your path to property ownership.

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