The DEFINITIVE GUIDE to understanding and INCREASING your borrowing power
How do I increase my borrowing power?
Increasing your borrowing power gives you the advantage of choice. It can mean the difference between a three or four bedroom house, or living in an apartment or a townhouse. Web calculators on bank websites give you an estimate (albeit not as accurate as broker calculators), they do not really teach you how to increase your borrowing power or what factors that can affect it.
Our in-depth guide will breakdown the main key factors you as a borrower will need to be aware of when it comes to understanding and improving your borrowing power.
The key factors that affect your borrowing power are:
- Purpose of the loan
- Your Income
- Your Expenses (including other loans)
- Type of employment
- Credit Score
- The person (or entity) that is borrowing
- The lender you borrow from
- Other Factors
When reading through this list, the big thing to remember is that the banks are ultimately assessing how risky you are as a borrower if they let you borrow $X from them. As at the end of the day, the lenders (including banks) seek profit through lending out money. (no matter what their marketing says in how much they want to help you).
The other item to consider is that each lender will weigh and view each of these factors differently. This is because they target different customer segments and offer different deals to them. A customer that is avoided by a lender might be welcomed with open arms for another.
There is no lender that is one size fits all and it is important to know the ins and outs of lender credit assessment policies. Alternatively, you can work with a mortgage broker like us as we have already done the research and can help you choose a loan that is best suited to your personal circumstances and goals.
Purpose of the loan
Are you borrowing to live at the home you are purchasing or is it for investment purposes? The purpose of the loan will affect how much lenders are willing to lend you. For example, if you own your own house and are looking to rebuild the house yourself, lenders such as NAB do not even consider owner builder construction loans as it is too much of a risk for them. Unfortunately there isn’t much you can do to increase your borrowing capacity in this factor.
There are also other factors that you may need to take into consideration. For example, if you are living with your parents for now and want to buy your first property, your borrowing capacity might be limited if you want to live in it straightaway.
However, owning it as an investment property may enable you to buy it as it has the benefits of future rental income plus potential negative gearing making your serviceability (how you are able to pay off the loan) much more attractive. As a result your borrowing capacity may be substantially increased by having a different purpose for the property.
Note that there are tax implications and it is best to speak with your accountant on this too.
To borrow money, you must demonstrate the ability to repay your loans. One way a bank or lender assesses the borrowing power is your income. In general, the higher the income is better, however there are certain types of income which are generally looked more favourably upon than others.
A lender’s borrowing capacity calculator will combine all your sources of income to form one number. However depending on the type of income, they might only account (for example) half of a certain type of income into this one number. This is to reflect the risk and stability of that income.
To improve your borrowing power, it might actually mean selecting lenders who are more favourable to the type of income you predominantly earn in order to receive a better borrowing capacity.
The main types of income we see are as follows:
PAYG or Salary Income
The most favourable type of income is a PAYG or salaried income, especially if you are full time permanent. If you can demonstrate 2 years of consistent employment history or industry experience, nearly all lenders will look upon this favourably and factor 100% of the base income into their borrowing assessment calculators. Non-base income, including overtime, allowances, and commissions, is normally calculated at 80% by most lenders when the consistency can be verified. Even if you do not earn much, as long as you are salaried, it is possible to borrow to buy a property if you are willing to make some sacrifices in property type and location.
Self employed or business income
Many Australians are self employed and earn income from their own businesses. Most lenders require at least 2 years worth of income and they will take the average monthly income across 2 years to be the income amount they use for serviceability.
For example, in year 1 if your business was just starting up and you only paid yourself $1000/month but in year 2 you business was booming and you paid yourself $6000/month, lenders will treat your self-employed income as $3500/month due to averaging over the 2 years.
There are some lenders, such as Bankwest, who may use the most recent numbers in their serviceability calculations under certain circumstances.
Your Expenses and Debts
In order to calculate your serviceability (ability to pay), the lenders also need to look at your expenses and debts. The easiest way to improve your borrowing power is to reduce your expenses and, in particular debts. Consolidating debts, or paying off existing debts (such as credit cards and car loans) are the most actionable things you can do to improve borrowing power. At the end of the day, banks are looking to see whether or not you can pay and how much “buffer” there is in your finances if there are adverse events such as interest rate rises, job losses or no rental income.
Your expenses include anything and everything that you have to pay. Childcare fees, groceries, phone bills, internet, shopping, alcohol and gambling. Lenders will generally ask borrowers to split this into certain categories. With the notable (or notorious) law case between regulator ASIC and lender Westpac, the lenders are forced to look into a dozen categories of a customer’s living expenses.
A side note here, while ASIC is emphasising the importance of responsible lending, we argue (and both Federal Court and Full Federal Court agree) that it doesn’t make sense to assume a customer’s spending behavior won’t be changed when taking a new loan. This famous “shiraz and wagyu” case highlighted overregulation and a lack of common sense from the regulator.
As for Reservoir Finance, though we acknowledge the importance of responsible lending, we want all our clients to make sure that they are borrowing responsibly. We are certainly not on the side of irresponsible borrowers blaming lenders offering them a loan or a credit that they at the end abuse the money and manage their finance irresponsibly.
By saying that, fulfilling the requirements and compliance is a broker’s daily life. In terms of the category of living expenses, nowadays most lenders categorise them into four large groups:
- general or basic living expenses
- additional living expenses
- investment property expenses
- rental expenses
Additional Living Expenses
Investment Property Expenses
Debts, outstanding loans and similar items are one of the major items that will impact and severely reduce a person’s borrowing power. Ideally, paying down your car loans, credit cards, personal loans, will significantly help improve your borrowing power for a home loan.
Credit card limits (not debts) in the last couple of years have been treated more cautiously by banks. Whilst you may show a good history of only spending a small dollar amount of your credit card limits, many lenders will assume the maximum limit as a debt and thus impacts your borrowing capacity. For many of our clients we recommend to either reduce the credit limit or cancel unused cards to improve borrowing power. A side note, if you are using an American Express NO-LIMIT credit card, different lenders have very different ways of assessing the limit, with some treating it as a limit of $1. Yes, only $1. Reach out to us below to find out how we can help you take advantage of this to maximise your borrowing potential.
Type of Employment
Type of Job
If you are a part time worker on a casual basis, many lenders will shy away from lending you large sums of money due to the fact the job is not perceived as secure. Permanent employees are generally viewed much more favourably by lenders.
Again this depends between the lender you approach. Some lenders, like Westpac, have no issues with you being a part time employee, even if you just start your job on day one. It is best to work with a broker to help you identify the best lender for your personal circumstances.
A credit score is a number being used to determine the riskiness of you as a borrower based on your previous loans and credit history. If you have borrowed before, owned a credit card, have a postpaid internet or phone bill, etc, It is likely they contribute towards your credit score.
The higher the credit score, the more favourable banks will be in their willingness to lend to you. Borrowers with bad credit ratings are less favourable by most banks and those that are willing to lend charge higher interest rates. The minimum credit score to get a home loan will vary between lenders, so it is best to ensure you have good habits and work hard at increasing your credit score.
Most of the Big 4 banks prefer applicants with clean credit histories with no defaults. 2nd tier banks like Bankwest also generally prefer clean credit histories but have more leniency on minor credit defaults.
Getting an understanding of your credit score before you apply for the loan is important as it helps guide the broker’s recommendations of which lenders you can apply for a loan. If you want to have a thorough look into your credit report, contact our brokers and the report will be generated in a second after consent is given. Generating a comprehensive credit report by us only costs $16.50, and is refundable on settlement of a loan by us.
Entity that is borrowing
Entity that is borrowing refers to who or what will the loan be issued to. Is it an individual borrowing the money or something more complex such as a trust or company?
In general, companies and trusts may not be able to borrow as much initially and will generally attract a higher interest rate due to the increased risk and work that a lender needs to do if they default on a loan.
Borrowing as an individual will have advantages of lower rates for owner occupied homes and potentially some tax benefits with negative gearing, however we recommend speaking with an accountant (and we are happy to chat with them too) in working out the best structure to be buying your next home (whether to live in or investment).
The lender you are borrowing from
Earlier we have outlined how each lender will treat the same borrower differently. This is due to their credit assessment policies and their risk tolerance towards certain types of lenders.
A major bank (Big four or 2nd tier) will generally aim for consumers who have strong credit scores, good incomes and can manage their expenses. These are the “safe” type of customers for them. Though major banks may not offer you the best rate or maximum borrowing capacity, they are still so far the most popular ones due to the convenience and the belief of “too big to fail”.
2nd tier, 3rd tier and non bank lenders will aim for a mix of consumers. For example, Resimac is a lender who targets more companies, trust and bad credit borrowers with slightly higher interest rates (to reflect the risk), whilst others like Macquarie offer better rates for borrowers who have had at least 30% of their homes paid off (again lower risk for the bank).
Interest rates offered by the lenders will also have an effect on your borrowing power, this is because many lenders will take the interest rate they are offering you and add a 2.5% or more buffer to be the “repayment amount” in their calculators in assessing borrowing capacity and serviceability.
- Type of property – in general, regional and high density properties will require higher deposits
- Location of the property – suburbs with historically high vacancy rates are frowned upon by lenders for people looking to purchase investment properties in those locations
- Timing – the turnaround of assessment may differ due to a variety of reasons. Sometimes lenders might just not have the appetite to lend, sometimes lenders may have an excessive amount of applications due to their promotions.
Want free help improving your borrowing power?
Maximising your borrowing capacity is a common goal for many of our clients, but is it the best thing for them? At Reservoir Finance, we practice a philosophy of responsible borrowing and this means that whilst you might be eligible to apply for a large loan and the loan itself might not be unsuitable for you, sometimes, if we think it is not in your best interest, we will encourage you to think again especially in the current age of uncertainties.
We seek to be lifelong partners with you in your financial journey to achieve your goals and dreams. Learning the ins and outs of each lender’s policy is time consuming and they change almost every month! Let us do the heavy lifting and provide you with recommendations. Speak with us today for an obligation free chat using the form below or call us on (02) 9261 8994. We would love to help you out!