How Much Can I Borrow?
Calculating how much you can borrow is not as simple as you may think. Different banks might come to different decisions on how much to lend you. Here are some things they look at before deciding.
Lending Is Case By Case
Finance Manager for Zinger Finance, Graham Turnbull, says lending is a case by case scenario that depends on the borrower’s serviceability and credit history.
[Serviceability is a word that banks use to describe the borrower’s financial ability to pay back a loan.]
A number of different income and expense considerations are taken into account before deciding how much an individual can afford to borrow.
How Do Banks Assess Borrowing Capacity?
Before a bank lends you money, they need to find out if you can afford to make the monthly repayments on this amount.
They may do this by using a variety of different calculations such as Net Income Surplus (NIS).
The NIS shows the lender how much money the borrower will have left each month after paying for expenses and making mortgage repayments.
To calculate NIS, lenders will aggregate all sources of income before subtracting living expenses, and debt obligations. This includes monthly repayments on the new debt and monthly repayments on any existing debt.
Each bank is different. While most banks calculate NIS in this way, the way each financial institution treats income and expenses can vary.
Not All Income Is Treated Equally
Most banks will distinguish between different types of income.
For instance, income from a self-employed person is usually seen as less secure than that of a permanent, full-time employee.
The amount of time an individual has worked in their role can also affect serviceability. If a person has only just started at a new job, their income will be seen as less secure than that of a person who has worked 12 months in their role.
Uncertain income sources, such as rental income, investment income, Centrelink payments, bonuses and commissions, will usually be given a “haircut”.
This trimming strategy is used to reduce risk to the bank – and the borrower.
When it comes to assessing a borrower’s level of expense, lenders apply a minimum benchmark that is based on the Household Expenditure Measure (HEM).
To the banks, it is almost irrelevant having a level of expense that is lower than this benchmark – even if you actually do. This is a safeguard to ensure that if your expenses do increase, you will still be able to make repayments.
If you have dependants, you will have a greater level of expenditure than if you are single and without children.
Lenders may load up your repayments on existing debt in order to reduce risk. While you may be paying interest only at a low interest rate, lenders will calculate this expense as though you were paying both principal and interest at a slightly higher rate.
Mortgage Repayment Buffers
Banks will also apply the above mentioned strategy to the repayments on the new loan. Even if you will be paying interest only for the first five years, the lender will use an “assessment rate” at higher interest on both interest and principal repayments.
The limits on your credit cards are also taken into account when calculating expenses. The banks want to know that you will be able to pay your mortgage even if you max out each month.
Banks may be reluctant to lend you money if you have a bad credit file. Missed payments and multiple loan applications may mean lenders will see you as a high risk customer, affecting how much you can borrow.
Put Your Best Foot Forward
Graham says, speaking with a finance strategist is the best way to find out how much you can borrow. He says, in order to present your best self to the banks, it is helpful to do the following:
- Stay in control of paperwork and have all income and expense statements in easy reach.
- Demonstrate a good savings history and manage statements to demonstrate consistency and financial control.
- Check your credit file and clear up any black marks.