How Do Banks Determine Your Borrowing Capacity?

Australia’s banking regulator, APRA, has introduced new lending rules to reduce the maximum amount some people can borrow. This article explores how determining the serviceability of a loan or how much you can borrow is not as straightforward as you may expect. We also look at the difference this could make to you.

An online calculator to determine your repayments is an excellent resource for understanding how different rates and figures affect your payments. Still, it does not account for the other variables that go into assessing if you can repay a loan.

When applying for a mortgage, your capacity to repay a loan is determined by commonly known factors such as your loan-to-value ratio, income, debts, savings, and spending history.

Lenders must also assess your ability to repay the loan on the actual interest rate plus a buffer. Each lender will have their own formula around serviceability to mitigate their risks.

Putting in multiple applications to choose the best option is also not a recommended strategy. Other than being very time-intensive, multiple checks of your credit history can be a flag that is detrimental to getting a loan with certain lenders.

What do new lending regulations mean for you?

Previously, the buffer was a minimum of 2.50 percentage points; now, APRA has told lenders to increase it to 3.00 percentage points.

If you applied for a loan with an interest rate of 3%, lenders would have to assess whether you could repay the loan if the rate increased to at least 6%.

Simply put, the buffer provides a contingency for rises in interest rates over the life of the loan, as well as for any unforeseen changes in a borrower’s income or expenses. APRA expects this change will reduce the average person’s borrowing capacity by about 5%.

The intention is to test that a borrower will continue to repay a loan if interest rates change and would not be under onerous financial pressure. The impact of the change to the buffer is expected to affect investors more than owner-occupiers. On average, investors tend to borrow at higher levels.

However, each person’s situation is unique. Some borrowers may not experience any reduction in their borrowing capacity. Others might experience a more considerable impact.

CASE STUDY

Let’s have a quick look at how this is applied to the following property:

• Purchase Price: $500,000

• 80% LVR: $400,000

• Interest Rate: 3%

• 30 Year Loan Term

Your repayments at 3% interest would be $1,686.42. Which may seem entirely feasible.

• Serviceability calculated with a 3% interest rate with no buffer $1,686.42 per month

However, in determining your ability to repay the loan, the lender will need to assess if you can continue paying with a change of circumstance. Adding a buffer of 3%, making the serviceability assessed on at least 6%:

• Serviceability calculated with 3% + 3% buffer = 6% $2,398.20 per month

The difference is over $700 per month, which could push your budget and make your loan not serviceable.

In practice, this change has raised the minimal buffer lenders to work into their servicing, but some banks may have a higher buffer to reduce their risk.

How can I increase my borrowing power?

As brokers, we are across our various lenders’ policies, including their serviceability, interest rates and loan options. Talk to us when you start looking for your next property to make sure you have a clear understanding of your borrowing capacity.

In the meantime, some common factors that can help increase your borrowing capacity include:

Healthy Deposit

• The larger your deposit to the size of your loan can help you borrow more. Generally, you will likely need to pay Lenders Mortgage Insurance if your deposit is less than 20% of your loan amount

Reduce Your Credit Limits

• If you don’t use your total limit, consider reducing it. Lenders look at the maximum of your credit cards and other buy-now-pay-later accounts you could pay, not the amount you owe

Boost Your Savings

• Showing that a responsible savings history over the long term helps demonstrate that you will be able to manage your mortgage repayments

In this new home loan environment, it’s never been more important to get help from an expert broker who’s across the new rules. As your broker, I can:

• Maximise your borrowing capacity so you can buy your dream home

• Show you how your borrowing capacity can change from lender to lender

• Compare dozens of lenders and hundreds of loans for you

Disclaimer:

Terms are subject to approved persons only. This information is true and correct as of 25/11/2021. All of the content above is general in nature and may not suit your personal needs, situation objective & goals.