Buying a home or investment property is of course a significant milestone and financial commitment for anyone. Understanding your borrowing capacity and being comfortable with the amount of debt you are taking on is key to achieving your long term goals for property, financial stability and lifestyle.
Borrowing capacity can actually vary significantly from lender to lender depending on their approach to assessing your circumstances. Online borrowing capacity calculators are often handy for a rough guide but the reality is that these aren’t particularly accurate for most people’s circumstances. We often have people approach us that are keen to buy a property but are unsure about their ability to borrow in order to achieve this, especially with the increase in interest rates and cost of living pressures.
So, what are the 2 major factors that will affect your borrowing capacity?
#1 Do you have enough disposable income to meet your loan and other expenses?
Income: This includes not only your salary but also any additional sources such as overtime, bonus, rental income, government payments and investments etc. Some lenders may not count all of this income or may look upon certain employment types differently such as contractors, casual or self-employed borrowers.
Living Expenses: Your spending habits and anticipated living expenses (groceries, bills, transport, recreation etc) play a role in determining how much you can borrow, and you may want to consider whether you’re comfortable with potentially trimming some discretionary expenses in order to increase your borrowing capacity.
New & Ongoing Loan Commitments: Lenders also evaluate your financial commitments including any new or existing debts. Most lenders will also be conservative by factoring in interest rate buffers (e.g. an additional 3% on your home loan, or treating your credit cards as if you pay 45% interest on your full limits!), or assuming debts will be ongoing for the next 30 years (e.g. your HECS/HELP debt or car loan even if these are close to being paid off). If required and when it makes sense to do so, your borrowing capacity can often be substantially improved by restructuring/consolidating debts, reducing unused credit limits or even paying off certain debts.
#2: What ‘contribution’ do the banks want from a borrower?
Deposit or contribution: Ideally, banks will want a contribution of minimum 15-20% of the property's value + stamp duty in order to lend at a comfortable risk level. This is often required using your savings &/or a gift, however you may instead contribute by providing additional property as security (yours or family members). Alternatively, a lesser contribution may be possible by utilising government schemes, Lenders Mortgage Insurance (LMI), recognition of professional qualifications or other approaches.
So how do you know what might be possible and when you may be in a position to buy? Everyone’s circumstances are different, and the best place to start is by having a conversation with an advisor to assess your financial situation and preferences, discuss what changes could be made to improve your borrowing capacity, select the most suitable lenders and determine a strategy/budget for your purchase.
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