The Australian financial landscape is changing rapidly. And we don’t just mean month-to- month. It’s day-to-day at the moment. That’s why it’s so important to understand current trends, while at the same time, anticipating new ones.
But what does this have to do with your borrowing capacity? With the increased regulation that is likely to follow recent investigations by the Royal Commission (read the recent findings in their entirety here), there will be changes to the lending environment with significant knock-on effects regarding the products and services banks can offer you. So, the pendulum has swung and perhaps the smarter question is: How much is the bank willing to lend me?
Just because you can, doesn’t mean you should…
The sweet spot for a great Home Loan is one that allows you to grow your professional or personal life, but that doesn’t eventually overwhelm you with repayments or interest accrued.
To that effect, banks are required to benchmark interest rates on your debts to help ensure that you can still repay, even if those rates increase. We’ve all heard those nightmare scenarios where a small loan at a high interest rate eventually snowballed and caused issues for the consumer. These benchmarks help to prevent this.
Loan amounts also need to be calculated for the future, not only the present. Just because you have the ability to borrow the full amount now, doesn’t mean that you should or that your financial situation won’t change.
For example, if an unforeseen expense comes up, such as a car repair or medical expense, will you still be able to make your loan repayment? If the answer is no, or even a maybe, it’s probably a good idea to decrease your loan amount or hold off entirely.
Further, if you’ve successfully applied for a loan in the past, the paperwork and processes you undertook may not be the same anymore, and your capacity to borrow – irrespective of your great credit score, significant asset base and consistent earnings – may be viewed in a different light by the lender.
Find the loan amount that’s right for you
To help you determine the right loan amount, you can use online calculators, but we also recommend professional consultation. That’s because there are a number of things you may not realise you’ll need to add into a calculator that a professional will take into consideration, and, online calculators can be unreliable (most are not regulated), giving you an inflated sense of your borrowing capacity.
Maximum borrowing capacity is often mistaken for affordability. It’s important that you calculate what you can afford to make in monthly repayments within your budget.
“Five times your annual income is a good place to start, but you must remember that existing savings or existing debt can change that figure accordingly. If you’re purchasing an investment property that is able to generate rental income and tax benefits, you may be able to stretch your borrowing capacity further based on the returns that will be gained from the investment.”
When banks and lending institutions examine your borrowing capacity, they review existing loans, credit card limits and additional risk factors as well. Additionally, any debt that exists overseas, or debt that is privately funded, needs to be disclosed to the loan provider and will likely be taken into account. The more transparency you provide, the more likely you’ll wind up with a loan agreement that’s appropriately tailored to your individual situation.
Additional factors to consider
It’s a complex combination of factors that ultimately determine your borrowing capacity. This has to do with both your risk tolerance, and the risk tolerance of the lending institution which you engage with.
Existing interest costs on current loans can decrease your borrowing capacity. For example, taking out 5 years of interest only repayments on a loan means that you have to demonstrate that you can repay the principal of that loan over a shorter 25 year term when otherwise it may have been a 30 year term.
Another important factor to understand, is that lenders have specific and highly regulated guidelines to determine which type of income they can accept. For instance, rental income, commission and bonus income are all treated separately to your annual salary or self-employed income.
There are also variations when it comes to living expenses and ongoing expenses (utilities etc.) as determined by the specific institution at hand.
We recommend partnering with a lending institution that has transparent policies and rates, as well as a great reputation among clients. A lender that is familiar with your industry is best placed to ensure you get the best possible loan outcome for your circumstances.
Asking the right questions
Determining your borrowing capacity can be a bit complicated but is truly a worthy endeavor. By factoring in specific things like current income, existing debts and the need for emergency funds, you can determine a figure that allows you to grow personally or professionally, but not bite off more than you can chew.
Asking, How much can I borrow? may not be the best question after all.
Instead try asking, How much can I comfortably pay back in monthly repayments? This is more likely to better answer the question of How much is the bank willing to lend me?
Asking the right questions may be a little less exciting for the imagination, but they will help you think methodically and practically about your needs, and ultimately help you to avoid any undue stress associated with your loan.