How Much Can I Borrow?
Maximizing Your Borrowing Potential
Making Informed Decisions:
Key Factors to Consider When Borrowing.
How to Determine How Much You Can Afford to Borrow for a Home Loan?
Determining how much you can afford to borrow is a crucial step when looking for a home loan or investment property. It’s important to know what your borrowing capacity would be to borrow the proposed amount is just the first step – you must also ensure that you can afford to make the loan repayments for the duration of the loan. To help with this, you can use our Home Loan Repayment Calculator, which breaks down loan amounts into weekly, fortnightly, or monthly repayments.
The amount you can afford to borrow will depend on a variety of factors. Here are some things to consider:
- Your income: This is one of the most important factors in determining how much you can borrow. Lenders will typically want to see proof of your income, such as current payslips, Notice of Assessments or last tax return. They’ll use this information to calculate your income and liabilities, or debt to income ratio, which is the percentage of your income that goes towards debt repayment each month. In general, the lower your debt-to-income ratio, the more you can afford to borrow.
- Your deposit: The more money you have saved for a deposit to contribute towards your home purchase, the less you’ll need to borrow. Lenders typically require a deposit of at least 20% of the purchase price, however, you may be able to borrow with a smaller deposit if you’re willing to pay Lender’s Mortgage Insurance Premium.
- Your partner’s income: If you’re buying with a partner, their income will also be taken into account. Lenders will look at your combined income when determining how much you can borrow.
- Your assets and liabilities: Lenders will also look at your current assets and liabilities, including any other loans or credit card debt you have. They’ll want to ensure that you have enough income to cover all of your current debt repayments, however, if your liabilities are affecting your borrowing power you may need to reduce the limits of your credit card or close them to increase your borrowing capacity.
- Joint tenancy: If you’re buying with someone else as joint tenants, their income will be factored into the equation as well. This can increase the amount you’re able to borrow.
- Your monthly living expenses: Finally, lenders will look at your monthly living expenses to ensure that you have enough income left over after paying your expenses to make your loan repayments. This includes everything from, groceries, transport, insurance, entertainment and credit card bills plus additional expenses.
How Can I Increase My Borrowing Power?
Excess Credit Card Reduction
If you’re looking to increase your borrowing power, one simple way is to reduce the credit limits on all of your credit cards. In addition, if you have any credit cards with a zero balance that you’re not using, it’s a good idea to close them completely. This can help show lenders that you’re responsible with your credit and may improve your borrowing capacity of being approved for a higher loan limit.
When you close a credit card account, it’s important to ask the credit provider to send you a letter or statement showing a zero balance and confirming that the credit card account is closed. This is important because you’ll need to provide this documentation to verify that you’ve closed the account as the credit limit may still appear on your credit file as an open active account.
It’s worth noting that when lenders assess your creditworthiness, they look at the credit limits on your cards rather than the outstanding balances. For example, if you have three credit cards with limits of $10,000 each, the lender will factor in a monthly credit card repayment of $1,140 (which is 3.8% of the combined limit of $30,000) regardless of whether you actually have any outstanding balances on your cards.
Lenders believe that credit cards are often the first type of credit to become unmanageable when borrowers face financial hardship, so they take this into account when assessing your ability to make loan repayments.
By reducing your credit card limits and closing any unused cards, you can improve your borrowing power and increase your chances of being approved for the loan required to purchase your new property. Additionally, the credit cards you have sitting in a draw for a rainy day will not help your borrowing power so you need to calculate if they are to remain open or to be closed since we expressed above why they are working against your borrowing power.
Consolidate Secured and Unsecured debt into a mortgage
If you’re carrying a lot of high-interest debt or liabilities in the form of personal loans, lines of credit, or credit cards, it can be challenging to manage your finances and make all your monthly repayments on time. In addition, these types of debt often carry higher interest rates than mortgages, which can make them even harder to pay off.
One option to consider is consolidating your debts into a mortgage with a lower interest rate. By doing this, you can take advantage of the lower interest rates that come with a mortgage and potentially reduce your monthly repayments, which can have a positive impact on your overall weekly, fortnightly or monthly cash flow.
When you consolidate your debts into a mortgage, you essentially take out a new mortgage that includes the amount of your existing debts. This means that you’ll have a larger mortgage balance, but you’ll also have the ability to pay off all your other debts at once. This can simplify your finances and help you save money on interest over time.
It’s worth noting that consolidating your debts into a mortgage can help to increase your borrowing capacity for a new purchase or an investment property.
Provide current financial documents
When applying for a home loan or an investment home loan, it’s important to provide accurate and up-to-date financial documents to the lender. This includes recent payslips and tax returns that accurately reflect your current income.
Providing older financial documents can significantly reduce your borrowing capacity, particularly if you’ve had a recent pay rise or your business turnover has increased. For example, if you’re a self-employed borrower and you provide outdated tax returns that don’t reflect your current business earnings, this can hinder your ability to borrow the amount you need.
To avoid this, it’s essential to provide current financial documents that reflect your current financial situation. This includes up-to-date payslips that show any recent pay rises, as well as any bonuses or overtime and recent tax returns that accurately reflect your current business earnings if you’re self-employed.
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What do Banks or Lenders Look For When You Apply For a Loan?
When applying for a loan, lenders need to assess your borrowing power or borrowing capacity to determine how much they are willing to lend to you. This requires you to provide certain details and documentation that can affect your ability to secure a loan. Some examples of what lenders look for include:
- Your gross and net incomes as provided to the Australian Taxation Office.
- The type of income you receive, such as whether you are self-employed or PAYG, full-time, part-time, permanent part-time, casual, or contractual.
- Your housing situation and living arrangements, including whether you own a home, rent, board, or live with parents, as well as whether you are single, married, defacto, and have children and their ages.
- Your living expenses.
- Your liabilities, such as credit card limits, personal loans, motor leases, and other lenders’ loans.
- The value of your assets, including money in the bank, other properties you own, or your current wealth.
- The size of the loan you require against the property value you wish to purchase, which is known as Loan to Value Ratio (LVR).
Once you have worked out what you can afford to borrow, the next step is to obtain In-Principle or Preliminary Loan Approval (Pre-Approval). This involves submitting up-to-date documentation to a proposed lender to verify your borrowing power.
Whether you’re looking for a new home, an investment property, or your second place to purchase, Neomoney can provide you with the knowledge, comfort, and tools you need to make an informed decision as soon as you find the right property.
For more information on Pre-Approvals, follow this link.
What is Joint Tenancy and How does it Affect Your Borrowing Capacity?
Joint Tenancy refers to a legal arrangement where two or more people come together to purchase a property as co-owners. There are two types of Joint Tenancy – Joint Tenants and Tenants in Common. In Joint Tenancy, each person has an equal share in the property while in Tenants in Common, each person has a different share percentage in the property. It is important to understand the implications of each type of ownership before entering into a purchase contract with others.
When it comes to borrowing, lenders will consider the assets and liabilities of all parties involved in the joint tenancy. This means that if one of the joint tenants has a high level of debt, it could negatively impact the borrowing capacity of the other tenants. Therefore, it is essential to have a clear understanding of the financial position of all parties involved before entering into a joint tenancy.
When assessing your borrowing capacity, lenders will also consider your assets, including any other properties or investments you may own or what the other co-owner may own and the liabilities on those assets. Therefore, if you are a joint tenant with other property investments, this could positively impact your borrowing capacity for the current property purchase.
If you’re considering entering into a joint tenancy with a friend or a business arrangement, it is important to seek professional legal advice to understand how it may impact your borrowing capacity and overall financial situation when it comes time to sell or have the other party buy out your share.
By understanding the potential risks and benefits of joint tenancy, you can make an informed decision that is right for you.
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