In the current property market, where interest rates are relatively high and borrowing capacity is reduced across the board, the last thing you want to do is shave any more off of your borrowing power.
After all, even as an investor, the last thing you want to hold you back from securing an additional asset for your portfolio is more restriction on your borrowing power.
While lenders do have a legal obligation to ensure borrowers can meet their repayment responsibilities, the problem is different lenders have different benchmarks for determining an individual’s ability to repay their debt.
And they take so many factors into account that the results may vary.
So here, to help, here’s a guide for how to improve your borrowing power and give yourself the best chance of securing your next, or even your first, property.
What is borrowing power?
Your borrowing power – also referred to as borrowing capacity – is how much a bank or lender is willing to lend you to buy a property based on your current financial situation.
It’s important because it directly dictates what you can afford to buy.
How do lenders calculate borrowing power?
To assess your borrowing power and ultimately decide whether or not you can pay your home loan, banks and lenders will look at a number of things in combination.
Whether you opt for a principal and interest loan or an interest-only loan, or whether you borrow on variable or fixed interest rates will obviously affect your repayments and your serviceability.
When assessing your ability to afford your serviceability, most lenders will also add an extra buffer known as a benchmark assessment rate or floor rate. This will typically be 3% above the bank's Standard Variable Rate.
But that’s not all that is taken into account.
To come to these figures, a bank or lender will look at:
- How many people are applying for the home loan. Borrowing jointly with your partner can significantly boost your borrowing power versus if you were a single person.
- The size of your deposit (below 20%, minus stamp duty, means you’re liable to pay lenders mortgage insurance, which is another expense lenders will want to factor into your overall loan amount).
- Your income, including your base salary, overtime income, bonuses, commission payments, any tax-free income, rental income, savings interest, or any other income.
- Your assets, including other properties.
- Your living expenses, including utilities, insurance, groceries, or school fees.
- The number of financial dependents (children) you have. The more dependents you have the less a bank may be willing to lend and therefore the lower your borrowing power.
- Your credit score.
- Any outstanding loans, like car loans, student debt, and your repayments.
- Your combined credit card limits, the outstanding balance and your minimum repayments. Most lenders will assess your credit cards as being fully drawn, whether they are or not,
- Any other financial commitments.
Combined, all these factors help paint a picture of your financial situation and whether you are able, or willing, to make repayments.
How do I find out what my borrowing power is?
Every bank and lender has its own assessment rate for estimating borrowing power, so it can be difficult to determine exactly what yours is.
The rate usually varies because it is based on the risk appetite and lending criteria of each individual lender.
However, it is possible to get a rough idea of how much your borrowing power could be.
The easiest way to work out your borrowing power is to input your details into an online calculator, but remember these are only an indication of your possible borrowing capacity, and in general are not very accurate.
But if it’s lower than you’d like it to be, the good news is that there are some things you can do about it.
How can I improve my borrowing power?
Because so many factors influence your borrowing power, there are several things you can try to improve.
Here are 10 ways you can do it:
1. Keep on top of your credit score
This is a great place to start because it’s where so many people fall short.
Sadly, it’s not uncommon for borrowers to overlook their credit score until right at the last minute when they’re going to secure a loan.
So to avoid letting it affect the amount you can borrow, regularly check in on your credit score and how it is tracking.
After all, poor credit performance can wreak havoc on your borrowing potential.
If you find there is some wiggle room for improvement here, it’ll also certainly improve your capacity too.
To keep your credit score in tip-top shape, ensure you always pay your bills on time (because regularly meeting your financial obligations demonstrates creditworthiness), and avoid making too many credit inquiries (too many loans or credit applications can negatively impact your credit score).
You can check your credit score for free every three months through Illion, Experian or Equifax.
2. Increase your income
An important option to increase your borrowing power is to increase your income if possible.
Your income is one of the first things lenders look at when deciding how much you can borrow, so the higher your income, the higher your borrowing capacity.
Negotiating for a raise or promotion at work may be an option for some, or taking on extra hours at work or even a second part-time job could help boost your earnings.
If you own an investment property, maximising your rental income can also improve your borrowing power.
3. Cut back on your expenses
Along with your income, lenders will also look closely at your living expenses when assessing your application so reducing unnecessary expenses can improve your chances.
To increase your borrowing power, it could help to look at how you can reduce your rent, utilities, petrol costs, and any other ongoing payments.
Carefully managing your spending and lowering discretionary costs can enhance your borrowing power.
4. Reduce your existing debt
When calculating your borrowing power, lenders will look at your debt-to-income ratio (DTI), which is the total amount of debt you have collected versus your overall income.
If you have a high DTI, you may be able to reduce it by paying off your debts, reducing your credit card limit, or refinancing any loans to a lower interest rate, which will improve your borrowing power.
This includes credit card balances, personal loans, car loans, buy-now-pay-later loans and any other financial obligations.
Try combining several debts into one with a lower interest rate, this can reduce your monthly repayments, which improves borrowing capacity.
5. Get rid of any excess credit
Debt is one thing, but it’s common for people to hold a credit card or two with a relatively large limit for an emergency.
But this can also damage your borrowing power.
Even if you have a credit card with little or no balance owing but a credit limit of $20,000, that amount will be factored into your lender’s loan calculations, because they know you can always borrow against it.
So, if you want to maximise your borrowing capacity, it’s a good idea to reduce any credit you don’t immediately need.
6. Increase your savings and deposit size
If you sit under the “preferred” 20% deposit, not including fees and stamp duty, then increasing the amount you save will positively influence what you can borrow.
A bigger deposit reduces the loan-to-value ratio (LVR), which is attractive to lenders, and it may also help avoid the cost of lender’s mortgage insurance (LMI).
It also helps by showing consistent savings over time, which indicates to lenders that you have financial discipline, possibly making them more likely to lend a larger amount.
7. Choose the right loan type
Different lenders have different ways of assessing borrowing capacity.
And there may even be different products available to suit your needs within the same lender, so always ensure that you’re looking at the right loan type to suit your financial situation and needs.
Similarly, choosing a loan with a longer term can reduce monthly repayments, thus increasing your borrowing capacity or some borrowers opt for interest-only loans to reduce upfront repayment costs, although this can carry higher long-term costs.
8. Consider joint borrowing
Combining incomes with a partner or trusted family member can significantly improve borrowing power.
However, it also comes with shared responsibilities so shouldn’t be taken lightly.
9. Get your papers in order
Lenders will want to review various documents throughout the home loan application process, so it’s important to ensure that everything is in order and that it presents a clear and up-to-date picture of your finances.
This includes having a copy of up-to-date tax returns.
10. Consult with a mortgage broker
A mortgage broker can help you navigate the lending market and provide tailored advice on how to improve your borrowing power.
They may also have access to lenders that offer more flexible terms.
Note for investors
Mortgage brokers help you find the best deal and the most essential features of a home loan.
But if you have a problematic credit history, even an experienced and qualified finance advisor may have to battle to get you across the line.
The key is to be responsible for your debt.
This is what banks want to see to be able to ensure they’re lending to a good candidate.
Pay your bills on time and in full, if you can.
Don’t miss repayments, don’t pay just the minimum amount, and never go over your credit limit - even one exceeded the limit and a single missed bill can derail your mortgage hopes.
Lower your credit limit as much and as low as possible because the higher your limit, the more your liability in the bank’s eyes.
Plus get rid of excess cards so you’re not seen as a risk.
Using your credit card will help build your good credit score, but don’t overuse it.
Banks look at something called a credit utilisation ratio, so the more you swipe, the worse it will be and the more nervous they might feel.
If you don’t pay your balance in full – a lot of credit card holders don’t – then start immediately focusing on whacking that debt as much as you can.
The important message here is that you should do anything you can to make yourself, your finances and your situation, as attractive as possible to ensure that you can borrow your full potential.
