As a first home buyer, knowing your borrowing capacity should be the first step in your home buying journey. It gives you a realistic idea of what size home loan you might be eligible for so that you can search for properties accordingly.

What Is Borrowing Capacity and How Is It Calculated?

Your borrowing capacity or borrowing power is an estimate of the maximum amount a lender will lend you for purchasing a home. Lenders rely on a range of factors to calculate your borrowing capacity, and some of these factors might be different. This also explains why some lenders might agree to lend you a little more than the others because they use different parameters to determine your mortgage borrowing capacity. That being said, some common factors are key to determining your borrowing capacity, such as:

  • Your gross income, including your basic salary, bonus payments, any regular overtime payments, income from investments like rental properties and shares, etc. 
  • Your expenses, including everything from your average grocery shopping, utility bills, gym membership and school fees for kids.
  • Your debt-to-income ratio, calculated by dividing your total debts by your income to measure your home loan serviceability without putting you in financial hardship. 
  • Your credit score, which is an indicator of your financial health and behaviour. Having a low credit score might reduce your borrowing capacity. You may even end up paying a higher mortgage rate if you still meet the lender’s eligibility criteria for a mortgage despite a low credit score.

Based on these factors and some others, lenders arrive at your borrowing capacity using some complicated calculations. However, you can always use an online borrowing capacity calculator to get a rough idea about how much you can borrow. 

Tips For Increasing Your Borrowing Capacity

While you should never borrow more than what you can comfortably afford to repay, if you think you can service a larger amount than what you are currently eligible for, there are a few ways in which you can boost your borrowing capacity:

1. Trim Your Expenditure

Reducing your expenses will automatically increase your disposable income, which can positively impact your borrowing capacity. However, living frugally for a month before putting up your home loan application will not help as lenders will consider your spending for at least the past six months.

Besides, every dollar saved is a dollar earned, and reducing your expenditure is also likely to boost your savings that you can apply towards your home loan. To get better control of your spending, start by drawing up a realistic budget and identify the expenses you can cut back on. For instance, many users of buy now pay later services are spending more than they would without the services, and one in six can’t make payments in time. If you think that’s happening with you, it’s perhaps better to steer clear of such services than spending more than you need to.

It’s also a good idea to keep a paper trail for one-off expenses to demonstrate where the money went. 

2. Reduce Your Credit

Consider that you own two credit cards with a limit of $10,000 each. While calculating your borrowing capacity, lenders will consider a potential debt of $20,000 on your hands, which can significantly bring down your borrowing capacity. This is true even if you pay your bills regularly and have no outstanding amounts on your credit cards. The simplest way to work around this is giving up that extra credit card if you don’t need it. 

Paying down your credit also helps improve your borrowing capacity. You may not be able to clear all your loans before applying for a mortgage, but you may consider paying down high-interest rate debts like your credit card debt and personal loans. Another idea is to roll up your smaller debts into a single loan, especially if you have many debts on your file that can lead to raised eyebrows. This might also benefit you with a potentially lower interest rate and a single monthly repayment that’s easier to manage than several payments spread over the month.

3. Boost Your Savings

Many lenders require proof of genuine savings for at least three months as part of their eligibility criteria for a home loan. Besides, having a good amount of upfront deposit can save you thousands in Lenders Mortgage Insurance (LMI). If you can save a 20 per cent deposit, you won’t even be required to pay LMI.

Besides building a regular saving habit, you may also take advantage of the First Home Owners Grant offered by some of the states to boost your deposit for the house. 

4. Be Financially Disciplined 

Paying all your bills and repayments consistently each month helps you build your credit score over time. However, even a single missed payment can stay on your file for years and hurt your mortgage application.

For lenders, a good credit score is an indicator of your creditworthiness and maintaining a clean credit history makes you a responsible borrower, improving your borrowing capacity, as well as your chances of mortgage approval.

It also makes sense to regularly check your credit report and ensure that the information is correct. You can get a copy of your credit report, free of cost once every year, from most credit reporting bodies like Equifax, Experian and Illion. Once you get the report, go through it minutely and immediately dispute any incorrect entries to have them removed from the file.

5. Weigh Your Options

The type of loan that you apply for can impact your borrowing capacity, too. Generally, lenders calculate your home loan serviceability at a higher interest rate than what you have applied for. Lenders do this to protect themselves and you from potential rate hikes that might put you in an adverse position. However, suppose you opt for a fixed-rate mortgage. In that case, your repayment capacity for the period is usually calculated at the same rate you have applied for, which might allow you to borrow more than a variable rate mortgage.

Different lenders also calculate your borrowing power differently. You can crunch the numbers on multiple lender websites using their free borrowing capacity calculators to get a fair estimate of how much you can borrow. However, as much as you shop around for a mortgage, avoid applying for credit with multiple lenders as it can reduce your credit score and borrowing capacity consequently. An easier way of finding a right-sized loan is connecting with a mortgage broker who will suggest the best possible deals and options for your requirements and help you organise your mortgage application to increase your chances of approval. 

Getting Ready For Your First Sydney Home Loan

If you are a first time home buyer, a broker can make your journey simpler by suggesting competitive mortgage deals and holding your hand throughout the application process. At Wealthy You, we offer advice and guidance every step of the way. 

Visit our dedicated service page for first time home buyers or call us directly (02) 7900-3288 to have a confidential discussion regarding your home loan. We will do our best to facilitate your purchase by helping you fill forms, review properties and make informed decisions. We help you navigate complexities with ease and confidence.