This common question for buyers and property investors has everything to do with your borrowing power and whether a lender believes you have the capacity to pay back a loan. First-home buyers and seasoned property investors all go through similar evaluations, although lending criteria may differ between the two. We’ll look at how these assessments take place, and what you can do to give yourself more borrowing power.
The term loan serviceability refers to how comfortably a person can make repayments on a loan. This assessment takes into account the principal and interest repayment amounts of the loan and weighs it against the borrower’s income and expenses to make sure they can afford the overall picture. Here’s how all the elements come together to formulate how much a lender is willing to lend, and in turn – what you can afford to buy.
The lender considers every source of income when it comes to determining your borrowing power. This will include salary or self-employed income, but also factors in income such as dividends, rental income, commissions and bonus. If there’s money coming in, the lender needs to know about it.
It should be noted that income can be calculated differently depending on the lender in question — especially in the case of rental income. If you have investment properties, some lenders will only accept 60% of the rent you collect. Lenders also calculate gearing differently, or how much money you spend a month on the properties compared to the amount you make from the rent.
‘Living expenses’ refers to expenditures required for daily living. These include things like transport, groceries, rent, medical care, bills and much more. Managing these expenses is crucial in improving your borrowing power, as lenders will always analyse these costs when calculating your borrowing power.
Before you start looking for a property, it is worthwhile cutting out or cutting down on as many expenses as possible permanently – both to ensure your cash and savings balances are strong, but also to present a sensible picture to the lender. Limiting how often you eat out, shopping around for better insurance policies, or eliminating unnecessary expenditures can all add up to major savings over time. If a lender determines that your living expenses are high compared to your income, you will see your borrowing power reduce.
All credit cards and debts are taken into account when calculating assessment rates – even undrawn cards or cards that are paid off every month. In particular, credit cards with high limits will affect your borrowing capacity. The rationale behind this is that you could at any time, or overtime max out these cards, and if you do, you are going to have to make a monthly repayment to the credit card company to pay back this debt and it’s going to dramatically affect your available income that could be spent on mortgage repayments. So the more credit cards you have, and the higher credit limit you have access to, the more likely your borrowing power is to be negatively impacted.
Lenders will also analyse other types of loans such as personal or car loans, and will also look at your loan history to see if you have previously defaulted or missed repayments. All of these factors affect the perceived risk of lending and ultimately contribute to the final amount you can borrow and at what rate.
Your savings play a heavy role in what you can buy. ‘Savings’ might mean your everyday savings account, but it can also refer to equity, inheritance, or any other major assets under your name.
If you can’t contribute at least 20% of the property purchase price as a deposit plus pay any stamp duty that might apply, you’re usually required to pay Lenders Mortgage Insurance (LMI). This cost is paid by you but benefits the lender in case you default on the loan. LMI is a serious expense that will bump up your monthly payments and loan amount so you need to be able to show you can afford the extra borrowings, but it’s also a necessary cost for buyers who don’t want to wait until they have a 20% downpayment.
A borrowing power calculator can go a long way toward helping you determine your position in the market.
As it happens, buyers who are at the top of their financial game will still need to make allowances for future events. While precise predictions are impossible, you should reasonably account for major events that might affect your finances and your ability to repay mortgage debts. This includes both personal, professional, industry and market events that might occur over the next 5 to 10 years. Think about the impact that COVID-19 had on people’s livelihoods and income, or what increasing interest rates would mean for your ongoing mortgage repayments.
In addition to reducing unnecessary spending and boosting your savings, now is a good time to close as many credit cards as possible, or at a minimum reduce your credit card limits. You should also seek to gain conditional approval on a loan from a lender, which is the only concrete way to find out the appropriate price bracket when looking for your next property purchase.
If you want to secure as much as possible for your property purchase though, you need to look for a mortgage brokerage who will find a lender that will agree to your terms. Mortgage brokers have established relationships with multiple lenders, meaning they have access to interest rates and loan products that may be difficult to find on your own. This could mean the difference between owning your dream property, or settling for something far less enticing (or foregoing your dreams altogether) — so it pays to have the right person in your corner.
Shore Financial works with property owners of every variety, and we know how important it is to optimise borrowing power. When one lender can give an entirely different assessment rate than another, we’re here to track down the lenders that will both work with you and for you. Contact us today to start getting customised mortgage advice that you can count on.