Before you start looking for your dream home, the first question you should ask is; what is my borrowing capacity?
Your borrowing capacity or borrowing power, is the amount you can borrow to purchase a property. It varies from lender to lender, with each lender using their own method to calculate your borrowing capacity. However, there are several common factors:
Today lenders operate under regulatory guidelines to ensure ethical and professional standards are upheld and legislation is in place to protect you from being granted a loan you could never repay.
It’s important to not rely solely on the legislation to protect you, but to also set your own responsible borrowing limits. A borrowing calculator is a great tool to help you determine the overall cost of a loan, the impact of interest rate rises and to provide a guide to your borrowing capacity. Additionally, there are steps you can take to help increase your borrowing capacity.
Banks assess your current debt level so it’s a good idea to 1) try and reduce this as much as possible before applying for a loan, or 2) effectively manage your debt by consolidating it into a single loan. Consolidating your debt can help you plan your finances easier and you may be able to refinance the consolidated amount into your new home loan.
A strong credit rating is important when applying for a loan so it’s important to be aware of any surprises potentially lurking in your credit history. Step one is accessing your credit file; you can apply for this through Veda.
If you find any issues in your credit file you can take steps to improve it. Bear in mind this can take time and you may need to negotiate with any potential lenders.
If you have a deposit less than 20% of the purchase price (LVR > 80%), you’ll most likely have to pay Lenders Mortgage Insurance (LMI); a one-off insurance that protects your mortgage lender in the event you default on your loan.
Therefore, your goal should be to save a 20% deposit. This will not only save you needing to pay LMI but will also improve your borrowing capacity in the eyes of your lender.
Lenders will examine your living expenses such as rent, bills, groceries and entertainment. If you have children school fees and childcare costs will also be included. It’s good practice to review your current spending habits and assess if and where you may be able to cut down. This will also help you to save for your deposit!
Cancel any unused credit cards. Banks consider any credit cards to be drawn to their full limit when assessing your application. For example, if you have two credit cards one with a $5,000 limit and another with $9,000, a lender will calculate your credit card debt as $13,000.
If you plan to buy a property under your own name but have dependents, you can split your on-paper expenses with your partner. For example, if you can prove that your partner does and will continue to provide for your dependents financially, they may not be counted as your dependents in your application.
It’s good to get into the habit of keeping your financial records in order to make it easier to provide the right income information to lenders. Simply completing your tax returns on time is a good place to start.
Often by providing only your last two months pay slips crucial income is missed such as bonus payments, overtime amounts regularly received and rental income from investments.
An organised presentation of your financial records in your home loan application can save you and the bank a lot of time.
A low interest rate will obviously improve your borrowing capacity, but there are other loan features that can also help, so it can pay to shop around. These include interest-only repayments, fixed or variable rates or a line of credit. Take the time to carefully research your options before committing.
If you already own property, you could use it as security for your new loan. While this minimises the risk for the lender, it can greatly increase your risk!
While you may be able to save money by not having to pay Lenders Mortgage Insurance if you borrow above their LVR limits, it can make refinancing with another lender more difficult and importantly, if you fail to meet your loan repayments, the lender is in a position to repossess your security, putting both properties at risk.
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Thanks for such great ways and tips. It helping me out. Kudos!
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