Expenses that affect your borrowing power for a home loan
Want to know how much you can borrow? While income and deposit size are crucial factors in any home loan application, there are also a range of 'liabilities' that lenders take into account when assessing how much they will lend to you.
COSTS THAT DRAIN YOUR BUCKET
Mortgage broker and founder of Two Red Shoes Rebecca Jarrett-Dalton says it's helpful to think of it like 'a big bucket of money.'
Not only do banks deduct tax as well as regular living expenses, generally using the HEM index, they also consider a whole range of other additional expenses, or liabilities, depending on your lifestyle and financial situation.
These include credit card limits, any kind of repayment, including car loans and personal loans, HECS debts, private health and life insurance costs, private school fees, and in some cases, Strata fees.
'Whatever is left is broken down into a monthly figure,' she says. 'Everything that is not an average living expense has an impact.'
And the impact can be quite substantial.
'Every $10,000 of credit card limit is about a $50,000 reduction in your borrowing capacity,' she says, explaining that any type of repayment could shrivel your borrowing power.
'If we think about every kind of repayment, a credit card they take 3.8 per cent, so $10,000 is $380.'
'Every $380 worth of repayments, whether they be loan repayments, whether they be HECS repayments, whatever they are, is a $50,000 additional reduction.
'So if you think of an average car loan sitting close to $1000, that's three times – that's $150,000.'
Novated leases are even more costly, she says.
'The banks can't separate out what is the finance component and what are the general running costs so they have a huge impact on your borrowing capacity,' she says. 'Essentially in your average living expenses they take out an average running cost of the vehicle as well as it coming out in the actual repayment.'
If Strata costs aren't included in the HEM index used by the bank, they are generally assessed using the $380 worth of repayments method, meaning 'if your Strata is $1000 a month it's about a $120,000-$130,000 reduction.'
WAYS TO HELP YOUR APPLICATION
You may not be able to compromise on costs like health insurance, Strata or private school fees, but you can improve your borrowing capacity by paying down existing debts.
Canstar's data insights director Sally Tindall says reducing credit card limits also goes a long way since banks 'have to assume the worst – that you've maxed out your card' when they assess your expenses.
'Credit cards have the capacity to burn a giant hole in your maximum borrowing capacity, even if you don't owe a single cent on the card,' she says.
Tindall says aiming for a lower rate can also help since lenders add a three per cent buffer during the assessment process.
'For example, someone applying for a mortgage, on the average wage as a single borrower on a rate of 5.50 per cent instead of 6 per cent, could see their maximum borrowing capacity rise by around $24,000,' she says.
But she says it's important to leave some financial breathing room when taking on a mortgage.
'Just because your bank says it's OK to borrow up to a certain amount, this doesn't automatically mean you should,' she says. 'A home loan can be for up to 30 years – that's a long time to be saddled with debt that you have trouble managing day-to-day.'
APPLICATION TIPS
The best way to improve your borrowing capacity is to increase your income and pay down your debts – just remember that a mortgage is a big commitment and borrowing to your maximum limit is never recommended. Canstar's data insights director Sally Tindall shares some ways to strengthen your home loan application.
1. Increase your income – even a $5000 pay rise on the average wage could improve a single person's borrowing capacity by more than $30,000
2. Shop for a lower rate – a single person applying with an average wage on a rate of 5.50 per cent instead of 6 per cent could see their maximum borrowing capacity rise by about $24,000
3. Save more – a larger deposit could mean you'll need to borrow less and potentially avoid LMI
4. Cut up credit cards – cancel excess credit cards and reduce excessive limits remembering that a $10,000 limit will reduce your borrowing power by about $50,000
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