Home loan borrowing capacity.
If you’re looking to buy a home, it’s important to understand your home loan borrowing capacity. It’s a smart idea to get a loan pre-approval before you start looking for a home for two reasons:
1) it will let type of home and location that you can afford, and
2) it will put you in a strong bargaining position when you want to make an offer on a home that you like. Your offer will be much more likely to be accepted than an offer that is subject to finance approval.
What factors affect your home loan borrowing capacity?
The primary concern of any lender when assessing your borrowing capacity will be your ability to make your loan repayments. Lenders in Australia are legally required to lend responsibly. This means that they must do three things when assessing your home loan application:
1) make reasonable enquiries about your financial situation, requirements and objectives,
2) take reasonable steps to verify your financial situation, and
3) make an assessment about whether a home loan contract is not ‘unsuitable’ for you.
Key factors that will influence a lender’s assessment of your borrowing capacity are all of the following:
- whether you (and/or your partner) have a stable employment history.
- whether you (and/or your partner) have a good credit history.
- you and/or your partner’s current regular income level/s.
- you and/or your partner’s current debt level/s.
- you and/or your partner’s current spending habits.
- you and/or your partner’s age.
- the maximum loan-to-value ratio (LVR) that the lender is prepared to accept.
- whether you have any assets that can be used as collateral security.
- whether you can provide a guarantor.
Having all of these factors in your favour will be a good indication to a lender that you’ll be able to afford your repayments, especially if you’re a first home buyer. They’ll be more likely to approve your loan accordingly.
We’ll now look at each of these influences on borrowing capacity in some more detail.
Your employment history
Having a stable employment history helps to demonstrate to a lender that you have a secure job or career and that you’re a low risk of becoming unemployed and struggling to meet your loan repayments. Ideally, you should be able to demonstrate that you (and/or your partner) have been with your current employer for at least two years.
Lenders tend to view self-employed people as being higher risk. However, if you are self-employed, you can demonstrate the stability of your business by providing financial statements or tax returns from your accountant for the past few years to demonstrate its profitability and ongoing viability.
Your credit history
Lenders will be much more likely to lend you a larger amount if you have a good credit history. You can develop a good credit history by paying all your debts and bills on time (including utility bills like phone and electricity services).
The income level/s off you and/or your partner will obviously affect your ability to make your repayments. The higher your income, the more you’ll generally be able to afford to borrow and vice versa.
Your current debt level
You and your partner’s current level of debt also influences your ability to make home loan repayments. Any debts you have will be considered by a lender when assessing your loan application. If you currently have high-interest credit card or personal loan debts, this will reduce the amount of disposable income that you’ll have available for your home loan repayments.
Your current spending habits
It’s important to eliminate or reduce any non-essential expenses that you have so that you maximise your borrowing capacity. Lenders calculate a ‘loan serviceability ratio’ as part of assessing your application. This ratio indicates your ability to make your loan repayments. It’s calculated by taking your income, expense and debt levels into consideration.
Different lenders will have different maximum loan serviceability ratios that they are prepared to accept, which will affect how much they are prepared to lend you.
The more you want to borrow, the more time you’ll generally need to pay off your loan (and vice versa). Standard home loan terms today are 25 or 30 years, though you can get shorter terms if you can demonstrate to the lender that you’ll be able to afford your repayments. So your age when you apply can be a factor that affects your borrowing capacity, especially if you’re older.
The loan-to-value ratio (LVR)
A loan-to-value ratio is the value of a loan expressed as a percentage of the value of the home it’s intended to buy. For example, if you’re applying for a loan of $720,000 on a home valued at $800,000, the LVR would be 90% ($720,000 divided by $800,000).
Different lenders will have different maximum LVRs that they are prepared to accept, which again will affect how much they will be prepared to lend you. Most lenders in Australia will also require you to take out lenders’ mortgage insurance (LMI) if the LVR is over 80%.
Collateral security includes any assets that you own that you can put up as security for your home loan. Providing collateral security reduces the lender’s risk, and they may be prepared let you borrow more accordingly.
The preferred collateral security of most lenders is property. If you already have significant equity in your home (or you own it), you may be able to use it as collateral security for one or more investment properties.
It’s important to understand though that if you put an asset like your residential home up as collateral security for an investment property loan, that your lender will be able to repossess your home if you fail to make on your repayments (just like they would have if you failed to make your residential home loan repayments before you owned your home).
A guarantor is a suitable person who agrees to become legally responsible for your debt if you fail to make your repayments. A guarantor therefore lowers a lenders risk. If you can find a suitable guarantor that a lender will accept, it can increase your borrowing capacity accordingly.
However, it’s important to be careful with guarantor arrangements. In a worst-case scenario (if you fail to make your repayments for whatever reason), personal relationships can be irreparably damaged. You should always consider that possibility before asking someone to become a guarantor to increase your borrowing capacity.
How Our Melton Mortgage Brokers Can Help You
At PAT Finance & Mortgage Broking, we can help you to find the right home loan. We’re based in Melton in Melbourne and service nearby areas including Bacchus Marsh, Caroline Springs, Plumpton, Rockbank, Gisborne and Sunbury. We’ll take the time to understand your individual home loan needs and goals. We work for our clients, not for lenders and we’ll provide you with the best possible mortgage broking advice in Melton.
Finance your dreams, secure your future. Contact us today to book your free home loan assessment to find out how we can help you.