Are you a first home buyer starting to look at properties but not quite sure what price range you can afford? This is where your borrowing capacity comes into play. While some borrowers like to go a step further and get pre-approval from their lender, simply having an idea of what you can afford is often enough to get the ball rolling.
Most banks and lenders consider several factors when determining your borrowing power. Here’s a breakdown of how they calculate your borrowing capacity as a first home buyer.
What Does Borrowing Capacity Mean?
Borrowing capacity, or borrowing power, refers to the estimated amount of money a lender is willing to offer you for a home loan. However, just because a lender is willing to approve a certain amount doesn’t mean you should max out your borrowing capacity. It’s crucial to review your financial situation and figure out what you can comfortably afford.
How Banks Calculate Your Borrowing Capacity
Most lenders have unique criteria for calculating borrowing power, so your borrowing capacity may vary between lenders. Here’s a basic formula some banks might use:
Gross income – (tax + existing expenses + new expenses + living expenses + buffer) = monthly surplus
For example, if your monthly figures are:
Your monthly surplus would be: $8,000 - ($1,500 + $300 + $2,200 + $1,600 + $500) = $1,900.
Key Elements in the Borrowing Capacity Formula
Lenders calculate your borrowing capacity by subtracting total expenses from your gross income. Beyond your salary, they may also consider other income sources such as:
Most lenders require tax returns from the past two years to assess your income. They may also adjust for certain tax deductions, such as depreciation and one-off business purchases, to better reflect your income.
Banks will closely examine your existing financial commitments to ensure you can manage a new loan. These commitments can include:
Lenders factor in potential new expenses, such as mortgage repayments, council rates, and utilities, to determine how much you can repay.
Your bank will ask for a detailed account of your monthly living expenses, including:
What is a Borrowing Capacity Buffer?
Lenders often apply a buffer, typically 2-3%, to account for future increases in interest rates or living expenses. This helps ensure that first home buyers can afford repayments even if costs rise.
How Is Serviceability Calculated?
To calculate serviceability, lenders subtract your debts and living expenses from your monthly income. The formula looks like this: Monthly income – Monthly household expenditure (debts, expenses, repayments) = Serviceability.
What Counts as Income?
Regular and ongoing payments count as income, including:
Lenders verify income through payslips, tax returns, and bank statements.
Debts and Expenses
Debt refers to money owed, including existing mortgages, credit cards, and personal loans. Expenses are ongoing costs related to living, such as utilities, groceries, and medical costs. Lenders assess these to calculate your ability to repay the loan.
Conclusion: Start Your Journey as a First Home Buyer
Knowing your borrowing capacity as a first home buyer is crucial for understanding what property you can afford. Lenders consider various factors, including income, expenses, and buffers, to determine your borrowing power. Be proactive in gathering and assessing this information to ensure a smooth home-buying journey.
By understanding these calculations and preparing yourself, you'll be in a much better position to secure the home of your dreams.
How First Home Buyers Can Increase Their Borrowing Capacity
As a first home buyer, understanding your borrowing capacity is crucial when looking to purchase your first home or an investment property. It determines how much you can spend on a property and can vary from lender to lender. However, it’s possible to improve your borrowing capacity and broaden your property options. Here are 10 smart ways first home buyers can increase their borrowing capacity:
Your credit score is one of the first things lenders check when you apply for a home loan. As a first home buyer, knowing your credit score can help you assess your financial health. If your score needs improvement, there are services available that allow you to check your credit score for free at least once a year, giving you the opportunity to take steps to improve it.
Unsecured debts such as credit cards and personal loans can significantly reduce your borrowing capacity. By paying off high-interest debts, first home buyers can increase their capacity to borrow. Lenders assess your ability to manage debts, so reducing these obligations boosts your financial profile.
Having high credit card limits, even if you don't use them, can impact your borrowing power. Lenders assume the worst-case scenario, meaning they treat your cards as if they’re maxed out. Reducing or canceling unused credit cards can significantly improve your borrowing capacity as a first home buyer.
As a first home buyer, it’s important to choose a loan product that suits your financial situation. Loan features, such as offset accounts or packaged products, can affect how much you can borrow. Doing research and selecting the right loan option is crucial for maximizing your borrowing capacity.
Organizing your financial records and making sure your tax returns and income information are up to date will streamline the mortgage application process. Lenders appreciate when first home buyers present accurate and complete financial information.
A larger deposit not only shows a consistent saving record, but also reduces the overall loan amount. For first home buyers, saving more money for a deposit can boost borrowing capacity while lowering interest payments and monthly mortgage repayments.
Your expenses play a significant role in determining your borrowing capacity. By reducing unnecessary expenses, first home buyers can increase their borrowing power. Consider trimming down utility bills, reassessing subscriptions, and reducing lifestyle costs to boost savings.
If you're buying a home with a partner, splitting liabilities can improve your borrowing capacity. For first home buyerswith partners, proving that one partner can financially provide for dependents may reduce the burden of dependents in the borrowing calculation.
Raising your income can greatly enhance your borrowing capacity. First home buyers can explore options like taking on extra work, negotiating a pay rise, or saving tax returns to increase their income and boost their borrowing potential.
Extending your loan term from 25 to 30 years can reduce your monthly repayments, allowing first home buyers to borrow more. While this means you’ll pay more interest over the life of the loan, it can significantly increase your borrowing capacity in the short term.
What is Borrowing Capacity and Why Does it Matter?
Borrowing capacity is the maximum amount a lender is willing to offer you based on your income, debts, expenses, and lifestyle. For first home buyers, this figure is crucial, as it determines the price range you can consider when purchasing a property.
Lenders use a variety of factors, including your age, job status, and whether you have dependents. First home buyersshould understand that borrowing capacity is also influenced by the Household Expenditure Measure (HEM), which calculates living expenses based on your location and lifestyle.
Responsible Lending for First Home Buyers
Recent discussions about responsible lending laws have put the onus more on borrowers than lenders. As a first home buyer, it’s important to thoroughly assess your financial situation and make sure you can comfortably manage mortgage repayments.
Conclusion
Increasing your borrowing capacity as a first home buyer is all about understanding your financial position and making smart decisions. Whether it's reducing debts, saving more, or selecting the right loan product, there are plenty of ways to improve your borrowing power and secure the home of your dreams.
By following these strategies, first home buyers can maximize their borrowing capacity, making it easier to enter the property market with confidence.