Why can’t I borrow as much as I want?
Douglas Piening 23/4/2018
Contrary to some in the media it is not Brokers who insist that consumers “max out” their borrowing. Many clients first question is “How much can I borrow?” and their preference is to extend themselves as close to their limit as possible.
This month I will cover off the basic principles that form the borrowing calculations we all must live by.
- Eligible Income
As a rule, if it isn’t in your Tax return the bank won’t recognise it. Whether your income source is regular employment, self-employment or casual work you will need to produce up to date, verifiable documentation to show what you earn.
Not all income is treated equally. Investment income (such as dividends from shares) and rental incomes are often shaded to account for their volatility. Income which is earned overseas or in a foreign currency is also generally shaded to account for foreign exchange risk.
Other income may include add backs arising from self-employment which may include additional Superannuation, Depreciation and Interest expenses incurred.
- Living Expenses
This is a hot topic. Nearly everyone underestimates the amount that it costs them to live. The banks will use minimum benchmark amounts which will differ according to your family structure or income levels (yes you read correctly – some lenders will attribute higher living expenses to people with higher incomes). If your stated expenses are higher than their benchmarks they will use the client figures provided.
- Existing Commitments
Existing commitments relate to existing financial commitments such as car finance, investment loans, existing home loans and credit cards. Credit card limits severely reduce borrowing capacity. Every $10,000 of card limit is assessed to be a monthly commitment of around $300 or $3,600 per year. If you want to increase borrowing potential, reduce your credit card limits.
Once identified with supporting information and appropriate scrutiny a surplus is hopefully identified. Those surplus funds can be used toward a loan repayment and your capacity to borrow is worked out from there.
Case Study – Frank and Marie
Frank and Marie have a combined monthly income of $9,500 after the tax man has taken his share. They are married with 2 children and their breakdown of monthly expenses is as follows:
Food & Groceries – $1500
Transport – $500
Clothing & Personal Care – $200
Entertainment – $800
Utilities & Rates – $600
Education – $500
Insurances – $300
Total – $4,400
They have a credit card with a limit of $20,000 (assessed monthly commitment of $600) and 3 years remaining on a car lease which costs $700 per month.
After subtracting their commitments and monthly expenses from their income they have $4,200 which they can contribute to loan repayments.
Assessment Rate versus Real Rate
When calculating borrowing limit, the lenders will use an assessment rate, which is a rate higher than the current interest rate. This provides a buffer to borrowers in the (all too likely) event that interest rates increase. In this case we will work on a 7.5% Assessment Rate.
Based on a 30 Year Principal and Interest loan at 7.5% a monthly repayment of $4,200 equates to a maximum loan of around $640,000.
Their actual repayments would be around $2,950 at present so in theory they should be able to save or get ahead of their mortgage by around $1,250 each month, which of course they should try to do whilst we are in a low rate environment (which won’t last forever but we’ll discuss that another time).
Douglas Piening is a Mortgage and Finance Broker with Piening Financial Solutions and is passionate about providing advice you can trust. Whether it’s buying a home, refinancing a loan, investing, building or renovating, Doug brings a wealth of knowledge and expertise to assist with your lending needs.
You can contact Doug at email@example.com or (m) 0408 671 524.
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This information is of a general nature only and does not constitute professional advice. You should always seek professional advice in relation to your particular circumstances.