How a lender decides how much you can borrow

WHEN you apply for a home loan, banks and lenders assess you on a host of different criteria to determine how much they’re prepared to let you borrow.

But which factors and information do they use in deciding the final figure?

Here’s a sneak peek at the analysis that lenders do when calculating your borrowing power.

Can you service a higher interest rate?

Forget about running calculations based on current interest rates when trying to gauge your own borrowing power.

When banks and lenders crunch the numbers, they do so on a significantly higher interest rate to ensure you can still afford the repayments if interest rates climb.

uno Home Loans founder and CEO Vincent Turner says many lenders will use a hypothetical interest rate that is as much as double the actual rate.

"They don’t do the calculations based on current interest rates, which are about 4%. Depending on the bank, they actually do it on about 7% or 8%," Turner says.

"That’s a trap a lot of people fall into, because they do the maths in their head and say, ‘OK, if I need to borrow $700,000, what’s 4% a year on that?’ And feel they can easily afford that. But lenders compute it on almost double that amount, so if interest rates did go up, they feel confident you could still service the loan."

The size of your deposit

Having money behind you is critical if you wish to increase the amount that banks will let you borrow.

Turner says a bigger deposit can be just as determinative as a huge salary.

"Even if you have a really, really high income and an impeccable credit score, if you don’t have much of a deposit, that’s going to limit you," he says.

All income is not created equal

That said, a higher income will weigh in your favour when it comes to determining the maximum amount you can borrow. But it’s important to note that varying standards are applied to different types of income.

For example, Turner says, people who are self-employed will have a more difficult time having income recognised compared to someone who earns the same amount as an employee.

"The other thing to keep in mind is that contracting or casual basis income is often penalised," he says.

"So even if you’re a contract worker and you’re making $80,000 a year, most lenders will see that as not as strong as a permanently employed full-time worker making $80,000 a year."

Credit cards

Just because you haven’t racked up any debt on your credit cards, it doesn’t mean they won’t significantly impact your borrowing power.

Turner advises that lenders will be cautious and assume that you may spend up to your cards’ limits at any moment.

"If you’ve got a $20,000 credit card limit, lenders will view that the same way as if you had a $20,000 credit card debt, because it’s basically a liability that you already have, and you could spend up to that amount of money," he says.

Expenses a major factor

Turner says banks and lenders are looking harder than ever at borrowers’ expenses.

"When you hear the horror stories of dodgy brokers being fraudulent in home loan applications on behalf of their client, it’s often because they’re understating their expenses," he says.

"We always say to people, really take the time to genuinely look at what your real expenses are, because you want to enter into a home loan that ultimately helps to put you in a better financial position – not a stressful one."