How much can you borrow for a home loan with your salary?

What’s my borrowing power?

Borrowing power, or borrowing capacity, refers to the estimated amount you may be able to borrow for a home loan. Generally speaking, your borrowing power is based on your net income, minus your expenses. 

Expenses can be affected by factors such as the number of dependents you have and the amount of secured and unsecured debts you have. This is pretty much what most borrowing calculators do for you.

How does a Borrowing Power calculator work?

Generally speaking, your borrowing power is calculated as your net income minus your expenses. The more accurate the details you enter into the calculator, the more realistic your estimated borrowing capacity will be.

The borrowing power calculator estimates how much you may be able to borrow based on the information you provide and certain assumptions. Once you have a ballpark figure for your borrowing power, you’ll be able to house hunt with a price range in mind. That said, different lenders can give you wildly differing borrowing capacities.

Note that a calculator is designed to give you an idea of how much you might be able to borrow but shouldn’t be taken as a guarantee. It doesn’t consider your complete financial position or whether you meet any home loan eligibility criteria. For a more detailed conversation and to discuss the next steps, you’re better off speaking with your mortgage broker.

Why can't I borrow more?

Having a reliable source of income is important when estimating your borrowing power, but it’s not as simple as the more you earn, the greater your borrowing capacity. When looking at what you can afford to borrow, lenders don’t just look at your salary. They will consider your:

• other sources of income, such as shares or rental yield, 

• current expenses, 

• broader financial circumstances, 

• spending and saving behaviours, and 

• ongoing financial commitments. 

These factors can significantly impact your borrowing power as much as your salary. Additionally, lenders have to assess your ability to make loan repayments by considering future interest rate rises and your ability to cope with that. This is known as the Buffer Rate, or the Serviceability Rate.

The Buffer Rate:

Under Australia’s responsible lending obligations, lenders must consider every loan application carefully. The Australian Securities and Investment Commission (ASIC) also has rules around responsible lending. Before your lender agrees to risk their money on you, their assessment team looks at the Four Cs of Credit and applies this lens to your financial records:

1. Capacity: Can you actually repay your loan? Do you have a stable job and steady income? Do you have other debts?

2. Character: Have you had any loans before and paid your bills on time?

3. Collateral: Do you have assets the bank can sell if you don’t repay the loan?

4. Capital: Do you have savings, a car, or other assets that can cover the debt if necessary?

Banks have to legally prove that every home loan they approve, can afford the repayments now, and into the future. In fact, they must also be sure you can afford an interest rate up to 3% more than what they offer you on your loan. The buffer rate is regulated by the Australian Prudential and Regulation Authority (APRA). 

Here’s an example:

Let's say you need a home loan of $500,000 to purchase your new home. 

If your lender approves this amount, you still need to consider whether you could comfortably afford your monthly home loan repayments. As a rough estimate, assume about $2,550 based on an interest rate of 4.5% on a 30-year loan term with principal and interest repayments.

Additionally, consider how you would cope if your interest rate went up (say to 6.5%). This would mean your repayments would increase by over $600 a month.

How does your lender calculate your borrowing capacity?

Lenders take a prudent approach to their calculations. For instance, when it comes to credit cards, they look at the total limits across all of your cards - even if you don’t currently owe anything on them. If you have a credit card with a $20,000 limit for example, they see that $20,000 as potential debt and count the potential credit card repayments as an expense.

Every lender’s formula for calculating borrowing power may be slightly different. Usually, they’ll consider the following:

• Income: Your income affects how much you can borrow, and this varies by lender. Regular salary is the best type of income, and you’ll be asked to prove this with recent payslips. Bonuses, overtime, and other extra pay also help, but are assessed differently by each bank. If commissions form a major part of your income, you may need to prove several years’ worth of consistent income from this.

• Employment History: A consistent employment history is important, especially if you’ve been in the same or similar roles for a long period. Avoid changing jobs 3-6 months before applying for your loan.

• Savings: A history of savings shows that you can manage your money. Important Note: Sudden lump sum deposits (e.g. a tax refund) are not usually considered ‘savings’ because there’s no proof that you’ve built this up yourself.

• Deposit: When it comes to home loans, each lender has a limit on how much of your property’s value they will lend. This is known as the Loan to Value Ratio (LVR). Lower interest rates are often available if you’re borrowing less than 70% of your property’s value. The higher your deposit, the lower your LVR will be.

• Spending habits: Lenders examine your savings account and credit card statements to understand your spending habits. Regular transfers or payments indicating debts may not work in your favour.

• Credit score: Lenders also review your credit history and your credit score. Red flags include court judgments, bankruptcies, and defaults. Multiple credit inquiries can also be problematic.

• Assets and Liabilities: Your assets include any cars, superannuation, cash accounts, belongings, and any other properties. Your liabilities include credit card debts, loans, and any Buy-Now-Pay-Later arrangements.

• Debt to Income Ratio: This is the final part of your loan application calculation. The income amount your lender uses is less than your ‘real’ income because of the shaving for all forms of income other than your salary. Your total debt amount will be rounded up for all forms of debt you hold.

Lenders’ preferences change quite often. A good broker can help you understand what specific money matters for your situation. Using a broker doesn’t cost more than going directly to a bank and can be much more convenient. They offer specialised knowledge that can help place your loan with lenders that are likely to favour your specific circumstances.

Sources:

https://www.investopedia.com/terms/n/networth.asp

https://moneysmart.gov.au/managing-debt/net-worth-calculator

https://compareclub.com.au/expert-analysis/loans-and-credit/what-does-a-lender-look-at-in-a-basic-home-loan-application

https://www.afca.org.au/ 

https://moneysmart.gov.au/home-loans/mortgage-calculator

https://moneysmart.gov.au/home-loans/mortgage-calculator#borrow

https://www.strattonrealty.com.au/borrowing-capacity-calculator

https://williambuck.com/our-clients/your-business/how-does-a-lender-assess-a-loan-application/

https://www.apra.gov.au/housing-lending-standards-reinforcing-guidance-on-exceptions

https://www.investopedia.com/terms/m/mortgage-rate.asp

Anthony Stevenson, is the head of home loans at Compare Club. With over a decade of experience under his belt, Anthony is dedicated to helping individuals make informed decisions when choosing a home loan. Whether it's finding a great deal on your home loan or refinancing, Anthony has a wealth of knowledge in the space.

Meet our home loans expert, Anthony Stevenson

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