Your borrowing capacity refers to the maximum amount of money a lender will lend you to buy a house. Knowing your borrowing capacity can help determine how much you can spend on a property, which is useful in narrowing down your property search. By looking at properties within your reach, you also reduce your risk of getting rejected for a home loan because you applied for an amount that’s more than you can afford to borrow.
How is your borrowing capacity calculated?
Even though each lender calculates borrowing capacity differently, some of the factors that go into the calculation are common. These common factors include your income details, living expenses, number of dependents, and your assets and debts. While it may not be possible to decode the exact formula used by each lender, you can find free borrowing capacity calculators online that can help you crunch the numbers. You’ll generally need the following details to check your borrowing capacity using an online calculator:
- Your deposit size
- Your annual income, including any investments, rental income, and bonuses
- Your average expenses
Why should you check your borrowing capacity?
When you’re looking to buy a new property, it helps to determine how much money you can borrow from a lender for the purchase. By calculating your borrowing power, you can start looking for properties in that range to avoid any disappointment at a later stage.
Knowing your borrowing capacity can also help you determine whether or not you can afford to purchase a house. If your borrowing capacity is low, it could mean you don’t have much left after paying for your living expenses, or you’re servicing a high amount of debt and might not be able to afford another repayment. Your borrowing capacity could also be low due to a poor credit score. A low borrowing capacity could thus be an indicator for you to analyse your financial health and improve on specific areas before you apply for a home loan.
Tips for increasing your borrowing capacity
Your borrowing capacity is an important figure when buying a home. It affects how much you can spend on purchasing a property. However, each lender calculates your borrowing power differently, and how much you can borrow may differ between lenders. While it’s important to limit the size of your borrowing to an amount you can afford to comfortably repay, it’s possible to increase your borrowing capacity in some cases if you need to.
Here are some tips to help you increase your borrowing capacity:
1. Reduce your expenses
Lenders consider both your income and expenses while calculating your borrowing capacity. Even if you earn a high income but you spend most of it each month, you’re unlikely to have spare cash in your budget to service a mortgage. Reviewing your budget and avoiding unnecessary expenses could help you borrow more by freeing up some of your income that could go towards servicing your home loan.
2. Pay off your debts
Getting on top of your debts can help you increase your borrowing capacity. It’s simple – the more outstanding debt you have, the less you can borrow. However, all debt is not equal. Paying off your debts with higher interest rates, such as any credit card debt or personal loans, can help free up your budget and also save you money in the long run.
You might also consider reducing the credit limit on your credit card to increase your borrowing capacity. Lenders don’t consider the actual spending on your card but use your entire credit limit while calculating your borrowing capacity. Closing unused cards is another option, but check the effect of closing a card on your credit rating before making the decision.
3. Grow your savings
Saving money regularly could help increase your borrowing capacity. If you are a saver, banks and lenders tend to look at you favourably because of your consistent saving record. Regular savers are also considered less likely to default on their mortgage because they are financially disciplined. If you save money, you’re also likely to have a larger deposit that could help you negotiate a lower interest rate or better loan terms.
4. Check your credit score
Your credit score impacts your borrowing power because lenders use it to determine how much of a risk you pose as a borrower. If your credit score is high, it indicates you are a responsible borrower, and you might be able to borrow more money. But if your credit score is low due to any missed payments in the past, you may find it difficult to borrow money or end up paying a higher interest rate.
5. Check with multiple lenders
Every lender calculates your borrowing capacity using a proprietary formula. Therefore, your borrowing capacity will likely differ with every lender you apply to.
You can check the borrowing capacity calculators offered by various lenders to estimate how much you might be able to borrow. But don’t make the mistake of making multiple loan applications at once, as this could hurt your credit score. You could seek help from a mortgage broker instead to find the most suitable home loan for your situation.
Borrowing capacity vs affordability
While your borrowing capacity is an important figure that can help you determine the amount you can spend on a property, it might differ from the maximum loan size you can comfortably service. For example, you may earn a high income, but there could be a default on your credit file, because of which your borrowing capacity might be low. On the other hand, you might qualify for an amount that’s more than what you can actually afford in monthly repayments.
Even though banks and lenders use all reasonable checks to make sure they only lend you an amount you can comfortably service, their estimate is based on the information you provide and your past financial history. If you’re planning to grow your family or take a sabbatical, your income might reduce temporarily. But the lender may not know of your plans. Calculating your monthly repayments for different loan sizes and running the numbers by your household budget can help you determine the amount you can realistically afford to borrow. You may also want to calculate your monthly repayments at a higher interest to prepare for any upcoming rate hikes.
