What is borrowing capacity? Aug 5, 2019 | Uncategorized 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. Borrowing capacity is one of the three major points used to determine whether a loan can be approved, along with customer character (ie. credit history, employment history) and availability of collateral (ie. willingness to secure the loan and value of that security). In this article we explain the factors considered in calculating your borrowing capacity and how to increase yours. How is borrowing capacity determined? Your borrowing capacity is influenced by: The type of and value of security offered Your current asset to debt ratio Your income versus expenses (aka cash flow) Your borrowing capacity may differ for different types of loans. For example, home loans are a regulated financial product and are subject to lending regulations set by APRA, whereas business loans are unregulated, leaving the lender free to set their own approval guidelines. The borrowing capacity for home loans is generally much more conservative than for business loans. 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 $600k secured against a property with the value of $1M, your LVR would be 60%. 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. In certain cases where serviceability is sound but the applicant does not have a 20% deposit, they may be eligible to borrow up to 95% of the security value with Lenders’ Mortgage Insurance (LMI). Your Finance Adviser can help calculate the cost of LMI and assist in the paperwork for the application. Serviceability The serviceability calculation measures whether your income will cover your current expenses plus the additional cost of loan repayments. In the 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) Your expenses will be compared against a set minimum to ensure that it is realistic, then the lender will 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. The lender will also add on any potential additional revenue (eg. rental income from a new property) to complete the calculations. In the case that your income does not cover your expenses plus the cost of a new loan, the loan will be automatically declined. In certain cases this can be appealed, however it’s always best to speak with an expert before submitting an application to avoid a potential loan decline on your credit history. Assessment Rate The assessment rate is an interest rate used by lenders to account for fluctuations in interest rates over time. Lenders were previously required to use a flat assessment rate of 7% on any regulated financial product, however recent regulation updates introduced by APRA mean that lenders are free to determine their own assessment rate, as long as it is at least 2.5% above the loan’s interest rate. If you were previously declined for a loan due to tight serviceability, now would be a good time to speak with a lending specialist and look into resubmitting your application. If you’d like to find out your own borrowing capacity based on your current financial situation, get in touch with Your Finance Adviser for a free assessment to determine exactly how much you can borrow.
