When considering purchasing a home, investment property, or any other major asset, one of the first questions you’ll likely ask yourself is: What is my borrowing power? Understanding your borrowing power is a crucial step in the property-buying process. It helps you gauge how much you can borrow from a lender and what kind of properties you can afford.
In this guide, we’ll explain what borrowing power is, the factors that influence it, and how you can calculate your borrowing capacity. By understanding how your borrowing power is calculated, you’ll be better prepared when applying for a loan.
What Is Borrowing Power?
Borrowing power refers to the amount of money that a lender is willing to lend you for a loan based on your financial situation. It is determined by assessing various factors, including your income, expenses, credit score, and any existing debts. Your borrowing power is essentially the maximum loan amount you can afford to repay based on these factors.
Lenders use your borrowing power to ensure you can repay the loan without financial strain. This assessment helps prevent borrowers from taking on more debt than they can handle, ensuring that lending is responsible and sustainable.
Key Components of Borrowing Power:
- Income: How much you earn and the stability of that income.
- Expenses: Your regular monthly costs, including rent, bills, groceries, and debt repayments.
- Credit history: Your credit score, which indicates how well you’ve managed debt in the past.
- Existing debts: Any current loans, such as personal loans, credit card balances, or student debt.
- Deposit size: The amount of money you can contribute as a deposit, which affects the size of the loan you need.
How Lenders Calculate Borrowing Power
Lenders take a holistic approach when calculating borrowing power. They look at your income, expenses, and credit profile to assess your ability to make regular loan repayments.
Here’s a breakdown of the main factors that impact your borrowing power:
1. Income
Your income is one of the most significant factors in determining your borrowing power. Lenders will assess your regular income sources, such as:
- Salary or wages: The amount you earn from employment.
- Self-employment income: If you’re self-employed, lenders will review your business’s financial records, tax returns, and profit/loss statements.
- Rental income: If you own other properties that generate rental income, this will also be factored in.
- Investment income: If you receive income from investments, such as dividends or interest, this will contribute to your total income.
Lenders typically use your gross income (before tax) rather than your net income (after tax) to calculate borrowing power.
2. Expenses
Lenders also assess your regular monthly expenses, which include:
- Living expenses: This includes things like groceries, utilities, and insurance.
- Existing loan repayments: Any loans you are already paying off, such as car loans, credit card payments, or personal loans.
- Dependents: The number of dependents you have and the financial support you provide.
- Other obligations: This can include child support, alimony, or any other recurring costs.
Your living expenses can be a crucial factor, as lenders will estimate your monthly outgoings based on your income. The more disposable income you have, the higher your borrowing power will likely be.
3. Credit Score
Your credit score is a numerical representation of your creditworthiness. It’s based on your past credit history, including your ability to manage debt, make timely repayments, and avoid defaulting on loans.
Lenders use your credit score to assess the risk of lending to you. A higher credit score indicates that you have a reliable history of managing debt, which increases your borrowing power. Conversely, a lower credit score might limit your ability to borrow and result in higher interest rates.
4. Existing Debts
Any current debts you have will impact your borrowing power. Lenders consider your debt-to-income ratio, which compares your monthly debt repayments to your income. The higher your existing debts, the less you can borrow.
For example, if you already have significant debt (such as credit card balances or personal loans), lenders may reduce your borrowing power to ensure you can manage both your existing and new loan repayments.
5. Deposit
The size of your deposit plays a significant role in determining how much you can borrow. A larger deposit reduces the loan amount needed, which in turn lowers the lender’s risk. It also increases your loan-to-value ratio (LVR), which is the ratio of your loan to the value of the property you want to buy.
- LVR Calculation: LVR is calculated by dividing the loan amount by the property’s value. For example, if you want to purchase a property worth $500,000 and you have a $100,000 deposit, your LVR is 80%. The higher the LVR, the higher the risk for the lender.
Lenders typically prefer a deposit of at least 20% of the property’s value to avoid requiring you to pay Lender’s Mortgage Insurance (LMI). A smaller deposit might limit your borrowing power or require LMI.
How to Calculate Your Borrowing Power
There are several ways to calculate your borrowing power:
1. Online Borrowing Power Calculators
One of the easiest ways to get an estimate of your borrowing power is by using an online borrowing power calculator. Many banks and financial institutions offer these tools on their websites. To use the calculator, you’ll need to input your income, expenses, existing debts, and other details. The calculator will then provide you with an estimate of how much you can borrow.
2. Speak with a Mortgage Broker
A mortgage broker can provide a more personalized assessment of your borrowing power. They’ll take into account your specific financial situation and help you navigate the different lending options available. Mortgage brokers can also provide access to multiple lenders and help you find the best loan deal for your needs.
3. Consult with Lenders
You can also speak directly to a bank or lender to get an accurate borrowing power assessment. Lenders will typically require more detailed information, such as your financial documents, before providing a specific borrowing amount.
4. Understand the Interest Rates
When calculating your borrowing power, it’s essential to consider the interest rates that apply to the loan. Lenders will calculate the monthly repayments based on the interest rate, which can impact the amount you’re able to borrow. If interest rates are high, your borrowing power may be reduced.
What Affects Your Borrowing Power?
Several factors can influence your borrowing power:
- Interest rates: High interest rates can reduce the amount you can borrow because they increase monthly repayments.
- Loan term: A longer loan term can reduce your monthly repayments, potentially increasing your borrowing power.
- Lender’s assessment: Different lenders have different criteria for assessing borrowing power, so your borrowing capacity may vary between financial institutions.
Conclusion
What is my borrowing power, and how can I calculate it? Your borrowing power is determined by your income, expenses, credit history, and existing debts. It is the maximum amount a lender is willing to lend you based on these factors.
Understanding your borrowing power is essential for making informed decisions when applying for a loan, whether you’re buying a home or investing in property. By knowing your borrowing capacity, you can set realistic expectations and avoid overcommitting financially.
If you’re ready to calculate your borrowing power and start your property journey, contact us today at Sydney Finance for expert advice and assistance with your loan application.
FAQs
- What factors determine my borrowing power?
Your borrowing power is influenced by your income, existing debts, living expenses, credit score, and deposit amount. - How can I calculate my borrowing power?
You can use online calculators, speak with a mortgage broker, or consult directly with a lender to get an estimate of your borrowing power. - How does my credit score impact my borrowing power?
A higher credit score can increase your borrowing power, as it indicates to lenders that you’re a reliable borrower. - Do I need a 20% deposit for an investment loan?
While a 20% deposit is typically preferred, it’s possible to borrow with a smaller deposit, although you may need to pay Lender’s Mortgage Insurance (LMI). - Can my borrowing power change over time?
Yes, your borrowing power can change based on fluctuations in your income, expenses, debt levels, and interest rates.