house loan

Borrowing Capacity and Borrowing Power

When any possible home buyer reaches out to us for a house loan, we at Loan Junction offer them one of the most crucial services required to aid in any new loan, that is, discovering their Borrowing Capacity or the Borrowing Power.

What is Borrowing Capacity for a House Loan

Borrowing capacity or borrowing power is essentially the maximum loanable amount a lender is willing to provide, based on the financial profile of the borrower.

The lenders measure this borrowing capacity with the help of several factors, including:

  • Income
  • Credit score or rating of the borrower
  • Financial history
  • Debt (the most important factor)

In fact, your current debt can significantly reduce your borrowing power for a house loan. But why does debt have such an impact, and how does it affect your loan eligibility? More importantly, if you have debt, what steps can be taken to improve your borrowing capacity? Let’s explore answers to these main questions.

Debt-to-Income Ratio (DTI)

The amount of debt plays a vital role in deciding your borrowing capacity or borrowing power. The more debt you have to service each month, the less money available for the repayment of your home loan.

The debt-to-income ratio is one of the key metrics lenders use while calculating your borrowing power. It can be calculated using a simple formula:

Divide the sum of all monthly debt payments by gross monthly income.

This ratio is a key measure in the lender’s assessment of your financial health.

A lower DTI is more favorable, as lenders will be more likely to offer you a loan. A commonly acceptable DTI in Australia is 7. Though non-bank lenders are not regulated by the Australian Prudential Regulation Authority and may not have strict DTI limits, they still use DTI ratios while evaluating loans.

A lower DTI increases the chances of securing a home loan and can lead to better conditions, such as lower interest rates. With a higher DTI, you may encounter less favorable loan conditions.

Types of Debt & Their Impact on Borrowing Capacity for House Loans in Australia

There are different debt types, and their impacts on borrowing capacity vary, especially regarding home loans. Some common debt types, along with their impacts on your credit score and borrowing capacity, are:

  • Credit Card Debt: High-interest rates combined with default risks make credit card debt one of the most damaging to your credit report, thus reducing your borrowing capacity.
  • Personal Loans: Unsecured personal loans are risky due to default threats impacting your credit. Secured personal loans carry fewer risks but still contribute to the DTI ratio, reducing borrowing power.
  • Buy Now, Pay Later (BNPL): These loans involve minimal credit checks. Multiple BNPL debts increase default risks, reducing borrowing capacity.
  • Auto Loans: While auto loans are part of the debt calculation, they carry lower risks since they are secured by your car. However, they still increase your DTI, reducing borrowing capacity.

House Loan: Debt Management Strategies

  • Pay Down High-Interest Debt: Reducing high-interest debts can improve your credit score and financial credibility with lenders.
  • Consolidate Debt: Consolidation simplifies payments, potentially lowers interest rates, though it may temporarily lower your credit score.
  • Avoid New Debt: Taking on new debt before applying for a home loan can significantly reduce your borrowing power.
  • Create a Budget: Practical budgeting helps control finances and make debt payments faster, thereby improving borrowing capacity.

The house loan amount you can borrow is a critical first step in obtaining a home loan. For an idea of how much you may be able to borrow, you can use our ‘How much can I borrow?’ calculator, based on income, debts, and other financial criteria.

If the result doesn’t fit within your expectations or if you are concerned about how your existing debt will affect your ability to borrow, please contact our team. At Loan Junction, we have a team of experts who can guide you through the process and help find solutions, ensuring you’re in a financial position to secure the best possible home loan!

Disclaimer: The content of this article is general in nature and is presented for informative purposes. It is not intended to constitute tax or financial advice, whether general or personal nor is it intended to imply any recommendation or opinion about a financial product. It does not take into consideration your personal situation and may not be relevant to circumstances. Before taking any action, consider your own particular circumstances and seek professional advice. This content is protected by copyright laws and various other intellectual property laws. It is not to be modified, reproduced or republished without prior written consent.