For many people, owning a home means realizing the “Australian dream”.
The good news is that house prices in Australia have fallen by an average rate of 2%, partly due to higher interest rates, according to the latest data from the Australian Bureau of Statistics (ABS).
However, higher interest rates also mean that borrowing money is comparatively more expensive than before, leading some households to experience mortgage difficulties.
Understanding the many factors that make up an individual’s borrowing power is an essential first step in finding a forever home at the right rate for you.
You can read more about home loans in our comprehensive guide, but here’s a general guide to help you estimate your borrowing capacity.
How Lenders Assess Your Borrowing Power
Most lenders use a similar formula to calculate borrowing power. They assume that around 30% of gross income can be used to repay loans.
There are some variations in how expenses are assessed, with some lenders allowing for a larger buffer which reduces the overall amount that can be borrowed.
“Lenders look at income as a way to calculate a borrower’s ability to repay a loan,” says Justin Brand, director at Brand Financial.
“They first look at after-tax net income and then do an analysis of lifestyle expenses and other commitments such as loan repayments. They are looking for a surplus that allows the borrower to repay the loan and withstand some interest rate increases.
Non-taxable income from Family Tax Benefits A and B is generally treated as income if your children are under 11 years old. Other non-taxable income is assessed on a case-by-case basis.
Simply by their nature, bonuses are not guaranteed to be paid out, which is why lenders usually ask for a two-year bonus history. Some will completely exclude bonuses.
Rental income from investment properties is considered a form of income, although lenders deduct 20% from the total to account for the cost of repairs and council rates.
A mortgage applicant with an excellent credit rating is more likely to be approved for a home loan than someone with a poor credit history. The interest rate should also be lower.
Lenders want to see proof of stable earned income, so most require an applicant to have been in their current job for at least three months and complete any probationary period. A stable period of full-time work with a single employer will be viewed favorably.
Being independent is not an obstacle to obtaining a mortgage.
“Lenders will generally require two years of self-employed income history – they must have been in business for two full years. A small number of lenders will consider less time,” says Brand.
The size of your deposit
A typical house down payment is 20% of the total property price, but many lenders will accept a down payment as low as 5%. The Family Home Guarantee provides a down payment of just 2% for eligible applicants and is designed to help first-time home buyers enter the market.
The loan to value ratio is known as the “LVR” and it is an acknowledgment by the lender of the risk of the home’s value decreasing.
“Most lenders are comfortable lending up to 80% of the home’s value,” says Brand. “Beyond that, you’ll likely have to pay lenders mortgage insurance, which is a one-time cost that protects the lender from the risk that you don’t repay the loan. You are also likely to pay a higher interest rate as your loan increases in proportion to the value of the property.
A smaller deposit means borrowing more money and therefore paying more interest in the long run. That said, it puts you on the right track to owning your home sooner than if you were waiting to save a bigger deposit. This is an advantage to consider.
Estimate your expenses
A lender will look at all of the expenses a mortgage applicant needs to cover to determine how much surplus is left to pay off the home loan.
An existing car loan or other mortgage is considered a current liability and a form of debt.
“If you have a loan, a lender will look at your current repayments and deduct them from your total net income before assessing your ability to repay the new loan,” says Brand.
Credit cards or BNPL
Even if credit card limits have a zero balance, some lenders will add the total that could potentially be owed and treat it as a debt. Buy Now Pay Later (BNPL) transactions may negatively impact borrowing capacity if payments have been missed in the past.
Planned lifestyle changes
The ability to repay a mortgage will be influenced by lifestyle changes. This could include time off to start a family, start a new business and the financial risk it may entail, or a plan to reduce part-time working hours.
Consider other home loan costs
There are a range of additional costs to consider:
Stamp duty must be paid in addition to the deposit. The amount varies from state to state, but as a general rule, the higher the value of the property, the higher the stamp duty. Use an online calculator to determine what the requirements are in your state.
Other costs associated with a new mortgage
In addition to stamp duty and deposit, there are initial charges, ongoing charges and exit charges. Initial fees include ownership transfer fees and legal fees. Be sure to take them into account to avoid stress at the time of purchase.
Rising interest rates
Higher interest rates don’t just affect monthly repayments: they reduce borrowing power. In terms of repayments, it all depends on whether the loan is variable or fixed (or a combination of both).
“If you have a variable loan and interest rates go up, your repayments go up too. If your loan has a fixed interest rate, interest rates don’t impact you until you exit the fixed rate period,” says Brand.
How to know for sure
Of course, this is a rough guide to get you started on the road to home ownership. Use the government’s mortgage calculator for more accurate information and talk to a qualified bank or mortgage broker.
How much can I borrow when refinancing?
Generally, during refinancing, lenders won’t let a homeowner withdraw more than 80% of their home’s value, but this can vary from lender to lender, so it’s best to discuss this with a broker. or a qualified lender.
How much should I borrow for a mortgage loan?
What is the average mortgage loan?
How much can I borrow on a salary of 80,000?