Our first home loan is the biggest financial commitment most of us will ever make.
After years of renting and saving, you can finally start the journey towards the great Australian dream; owning your own home.
Your home loan will dictate what you can afford, whether it’s the property of your dreams or just a property you can afford.
If you’re wanting to get the best finance you can, improving your borrowing capacity is the best way to increase your budget.
To help you do this, we’re sharing our best tips to help you improve your borrowing power.
What does borrowing power mean?
Your borrowing power is the amount of money a lender will let you borrow on a loan. The lender will calculate this using their own rules and risk appetite while considering the loan applicant's income, expenses, debt-to-income ratio, credit history and other indicators.
How can I improve my borrowing power?
Before you apply for a home loan, you should conduct your own financial analysis.
As a borrower, your loan application may be denied if you don't fully understand how lenders assess your borrowing capacity. This is why it’s so important to first speak to your mortgage broker before starting the home loan process.
Here are four ways to enhance your borrowing capacity in the eyes of potential lenders:
1. Cancel credit cards and pay debts
The more debt obligations you have, the less you can borrow for a new home loan. Before applying for a loan, you should minimise your ‘bad debt’ repayments in order to increase your good debt borrowing power.
This includes paying off credit card bills and other loans you have owing. Note, even credit cards without debt attached can still reduce your borrowing capacity in the eyes of the lender.
Paying off loans that attract high levels of interest should be your primary focus.
For current or former students, paying off your HECS can be another way to increase your borrowing power. Even though HECS debt doesn’t accrue interest, it does subtract from your earning power and can limit the amount you’re able to borrow.
2. A steady credit history
Maintaining a steady credit history is another easy factor to increase your borrowing capacity.
Paying all of your bills on time, even the minor ones, establishes you as a responsible borrower in the eyes of a potential lender. This factor will be a major contributor towards improving your chances of a home loan approval.
Comprehensive credit reporting, which has only recently become available in Australia, rewards good payers while penalising those who are late in paying their bills.
3. Reduce your expenses and stick to a budget
Reducing your expenses and saving more will demonstrate a financially sound saving record and help you save faster.
By planning a detailed budget and limiting your unnecessary expenses, you’ll be able to build a larger deposit and expand your borrowing power. A decent record of savings gives lenders the message that you have the potential to make consistent mortgage repayments.
Saving up for a larger down payment can also make you more attractive to a potential lender.
For more tips on how to save up a deposit faster, you can check out our blog here.
4. Extend your home loan term
In most cases, the longer the term of your home loan, the lower your monthly instalment payment. This means that a longer term can allow you to borrow more money while having less of an impact on your debt-to-income (DTI) ratio.
This is especially relevant for young and first home buyers who will have greater flexibility when extending the term of their loan.
Keep in mind that interest rates will fluctuate significantly over a loan term period of 25-30 years. Depending on your specific circumstances, your mortgage broker can advise you on the most advantageous home loan term for your situation.
Understanding the debt-to-income (DTI) ratio
The debt-to-income (DTI) ratio calculates the amount of income required to service debt. Simply put, it’s the percentage of your gross monthly income that is used to pay your monthly debt payments.
A low DTI ratio shows that a borrower has enough income to pay their debts, making them more attractive.
Why lenders look for low DTI ratios
A low debt-to-income (DTI) ratio shows an acceptable balance between income and debt. For example, if your DTI ratio is 10%, correspondently it means that 10% of your monthly gross income goes to that month’s debt payments.
Conversely, a high DTI ratio can signal that an individual has too much debt for the amount of income earned each month.
Why not talk to a mortgage broker?
If you're serious about borrowing money to buy a house, you should consult with a mortgage broker.
A qualified mortgage broker will not only help you understand your borrowing capacity and requirements but will also find the best home loans and mortgage rates available to you. You can also use our borrowing power calculator to better understand your budget in relation to your financial situation.