People always ask “how much can I borrow?” when it comes to home loans. While most banks will have an online calculator to crunch the numbers, the figures produced may not be realistic or achievable. Banks, in reality, will look closely at your income and expenses to assess your borrowing capacity, especially if you’re running your own business.
Getting your finances in order before you apply for a home loan is always advisable before setting the process in motion. A finance broker can help you with the following three main factors banks will assess you on.
3 Key Things Banks Look At To Assess Borrowing Capacity:
1. Income
Income is a key factor in determining the amount you can afford to borrow. A bank will need to know your income can comfortably cover your mortgage repayments, other costs associated with owning a home, as well as give you money leftover to live on. A bank will look at how much you bring in through a variety of sources, including: salary, rental income and business drawings.
There are some income scenarios banks won’t look favourably on, such as, being on a probation period at a job or income largely derived from working overtime.
2. Expenses
A bank will always compare your income with your expenses, because even if you have a large income, you may have a large amount of expenses.
To get a good idea of your expenses, a bank may break down your living expenses into categories: insurance, education, entertainment etc. They’ll also look at other financial liabilities you may have, for example, existing home loans, student loans, credit cards, car loans etc.
If you have credit card(s), they’ll look at your credit limit. For the purposes of calculating serviceability, the bank will assume your credit limit is full drawn, even if you pay it off every month.
3. Deposit
Thanks to the Global Financial Crisis in 2007/2008, banks are reluctant to lend 100% finance anymore. The general rule is they like to see a 20% deposit when someone is buying residential property.
If you don’t have a 20% deposit, don’t feel like you have to bow out of the market. There are banks who will lend on less. For a minimum deposit for a home loan, you may be able to get 5% of the purchase price if you shop around, but you will incur lenders mortgage insurance (LMI). LMI provides security for the bank should you default on your loan. The LMI premium is added to your fortnightly or monthly mortgage payment.
Further Things To Consider
Your current financial position needs to make a bank feel secure about lending you money. So if you’re:
A business owner – be aware that banks will typically want to see two years of financial statements. This can have an impact on what you can borrow if one year was markedly less profitable than the other. Talk to your finance broker, they may know of certain banks that are happy to look at one year in isolation.
An individual – understand that certain banks have an appetite for certain income sources. If you’re on wages, that’s fine. If you’re on job probation there are only a certain number of banks who’ll help you.
Getting overtime – be mindful that what you bring in is not always what banks consider income in your application. Most banks will include overtime. But banks get nervous about overtime if it’s a large proportion of your income because it’s not consistent and guaranteed.
Next Steps: How Your Finance Broker Can Help
Your finance broker will analyse your history, look at all your financials, and give an indication of which banks will suit your situation best to apply to for a home loan. They’ll also give you an idea of how much you will realistically get.
If you’re running your own business, a broker will look at your draft financials and advise what’s achievable. If you’re not quite where you need to be, they can help you with planning so you’re on track with your earnings so a bank will consider you more favourably.
Meeting with a finance broker is also good idea for deposit planning. They will help to ensure your finance is sorted, and advise you if you need to push harder to get where you need to be.
Summary
A finance broker can tell you what is achievable in terms of a home loan and help you set realistic expectations. They’ll look at your position from all three aspects – income, expenses and deposit – and advise if any of them needs work to get your home loan application approved.