What Exactly is Borrowing Capacity?
Strict regulations in the Australian banking industry mean that lenders have a legal responsibility to ensure that their customers can afford to repay their loans. Each lender has their own unique method for calculating an individual's borrowing capacity, and the calculations may differ between products.
Along with creditworthiness (as determined by your credit score), borrowing capacity is an important determinant of whether your loan will be approved. In this article we explain the factors considered in calculating your borrowing capacity and the steps to take from there.
Components of Borrowing Capacity
Your borrowing capacity is influenced by:
- The type of security offered
- The value of that security
- Your current asset to debt ratio
- Your cash flow.
The borrowing capacity for home loans is generally much more conservative than for business loans. Home loans are classed as regulated financial products, which means that the lenders have greater legal responsibility should the loan not be suitable for your circumstances.
Security and LVR
Loan to value ratio (LVR) is a measurement of the total loan value against the value of the security. For example, if you have a loan of $800k secured against a property with the value of $1M, your LVR would be 80%. For a home loan, you can generally borrow up to 80% of the property value, or 70% for most commercial properties. However, this also depends on your monthly expenses and the loan serviceability.
Serviceability measures whether or not your income will cover your current expenses plus the additional cost of loan repayments. In any loan application you will be required to list all expenses, including:
- Existing loan and credit card commitments
- Living expenses including rent, schooling, food, transport costs and other general living expenses
- Tax (for self-employed applicants)
The lender will compare this against a predetermined minimum to ensure that it is realistic based on your personal situation (eg. the minimum living expenses of a family of 4 are higher than a single person). They will then add on the estimated loan repayments and compare this to your income to ensure that you can maintain your lifestyle with the new loan expense.
If your income does not cover your general expenses plus the cost of a new loan, the loan will be automatically declined in order to protect both the customer and the lender. As such, it’s best to speak with an expert and calculate your serviceability limits before submitting an application.
The assessment rate is an interest rate used by lenders to substitute an average rate over time. It is used in serviceability calculations instead of the current interest rate to cover the risk of rate fluctuations. Although you may be able to afford repayments at the current rate of 3.75%, the lender will calculate at a much higher rate (most lenders are currently using around 7%) to ensure you can cover repayments in future.
If you’d like to find out your own borrowing capacity based on your current financial situation, get in touch with the experts at Lendfin and we’ll help determine exactly how much you can borrow.