How To Calculate Borrowing Capacity

Pens at the ready people, it’s time to learn how to calculate your borrowing capacity!

There are two main contributing factors used to calculate borrowing capacity and these will give you a clear idea about how much you a lender may be willing to give you. They are:

  • Serviceability
  • Funds To Complete (FTC)

While borrowing capacity is probably not top of your list when asked what super power you’d most like to have, it’s definitely great to have up your sleeve when buying your first home.

Typically, ‘borrowing capacity’ refers to that top of the list item of serviceability — it asks what size of loan can you can service/pay back on a weekly, fortnightly, or monthly basis. Serviceability is your capacity to ‘provide good service’ when it comes to paying back the loan and is based on your income minus your expenses. When assessing you for pre-approval, serviceability is the first thing any lender will look at and what we’ll focus on here — though we’ll briefly come back to FTC at the end.

How Does Income Impact How You Calculate Borrowing Capacity?

Your gross income is the full amount of your total earnings before any taxes or deductions are made. A person’s gross income isn’t limited to what they make from their current employment though. It can include the following:

  • Base income
  • Overtime income that is regular and ongoing
  • Invoices for any freelance work done under an ABN
  • Tax-free income (e.g. Family Tax Benefits A & B)
  • Money earned from shares
  • Rental income from investment properties

These are all added up in the plus column to give you, hopefully, an impressive looking final figure. It’s important you include all income, as the more you have as your gross income, the better it will be for your borrowing capacity, that is until...

How Do Expenses Impact How You Calculate Borrowing Capacity?

Next we get to the list of things that want to attack, destroy, and ultimately debase your healthy looking gross income figure.

In the red corner we have existing commitments: any payments you’re required to make regularly. These payment obligations are entered into via an agreement or contract with another party. Examples of existing commitments that can affect your borrowing capacity include:

  • Rent
  • Credit card debts
  • Personal loans
  • Existing mortgages
  • Direct debits (lender dependent — e.g. utility bills, subscriptions, and memberships)
  • HECS (Higher Education Contribution Scheme) debt

In the blue corner we have living expenses:

These can be tricky to recall as they’re usually compartmentalised into the ‘don’t think too much about it’ part of our brain. However, when getting ready to apply for a home loan, you’ll have to throw the doors open and really examine how much it’s costing you to live. Start making a list now, because trust me, there will be things you’ll forget.

While it may seem arbitrary, it’s worth having a good look at all your living costs and working out what you actually spend every month on things such as:

  • Food
  • Clothing
  • Transportation
  • Health care
  • Amenities (electricity, gas, and water)
  • Phone
  • Internet
  • Streaming services
  • Alcohol
  • Fun (you have to add this because you can’t afford to live without it!)

Your living expenses will be calculated by lenders via a tool called the Household Expenditure Measure (HEM). The HEM helps determine the available income you have for repaying a home loan. It will also define the average dollar amount your household spends annually.

Even though it’s scary, it’s good to know this information because ultimately, it will help you budget, which will become increasingly important as your life continues.

How Lenders Further Calculate Your Borrowing Capacity

Up until this point, this is all stuff you can do on your own to calculate your borrowing capacity. After all, you are your own best advocate to make sure you aren’t going to borrow too much and get yourself in financial strife. When the lenders get involved, they’re likely going to take a safety margin and the fierce-looking mullet that was once your income will quickly get a buzz cut.

These borrowing capacity trimming considerations include the following:

  • Serviceability buffer — Also called an interest rate buffer, this is when lenders add an extra percentage to the interest rate as a ‘buffer’ to see if you could still afford to pay for your loan in the event of interest rates increasing. The usual buffer they tack on to these calculations is around 2.5% but can be higher in challenging economic times.
  • Surplus — As the word implies, this is any money left over, or your surplus funds after all your financial obligations have been met. Some might call it ‘savings’, and therefore any interest you’ve earned on your ‘savings’. It’s about as silly as the idea of ‘spare change’ and probably amounts to about the same amount of $3.85 for most of us.
  • Tax / Medicare tax levy — These cuts are calculated differently depending on a range of variables, but are unavoidable for Australian residents who earn above the Tax Free Threshold. The exact calculations depend on circumstances that affect the Medicare tax levy, such as your income, the income of your spouse, and if you were eligible for an exemption.
  • Negative gearing — If you own an investment property that’s actually costing you more than it’s earning.

Funds To Complete & Final Considerations On Borrowing Capacity

Calculating your borrowing capacity yourself before you approach a lender is a smart move. It arms you with knowledge and ensures you have a solid idea of the size of deposit you’ll need. This is important because:

When most lenders are providing pre-approvals, they do not take Funds To Complete (FTC) into account — FTC is simply the difference between the purchase price and the loan amount, plus enough money to cover the additional expenses.

Muahaha-ha! (Cue the maniacal laughter.) But you have read this article and know what your serviceability is and can therefore calculate the FTC you will likely require. So now you won’t look like a fool (hopefully), it’s them who will look like the fool for not suspecting how much information you’re armed with! (Maniacal laughter completed.)

Though seriously, there are many online versions of ways to calculate your borrowing capacity once you have the above figures, but don’t forget the additional buying expenses, for example:

So now you know what your borrowing capacity is and how much FTC you will require, remember, with Sucasa as your lender, you can apply for a loan with as little as 2% deposit!

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