How do I know how much I can borrow?
Source: Canva, 2024
Knowing how much you can borrow to buy a home or investment property in Australia involves understanding lender requirements, calculating your finances, and assessing personal affordability. Here’s a guide to help Australian buyers estimate their borrowing capacity and feel confident in their financial readiness.
1. Calculate Your Debt-to-Income (DTI) Ratio
The debt-to-income (DTI) ratio is a crucial factor Australian lenders use to determine how much you can afford to borrow. This figure compares your monthly debt obligations to your income, indicating how much of your income is available to service a mortgage.
Front-End DTI: This ratio considers only housing expenses, including potential monthly mortgage repayments, property taxes (rates), insurance, and, if applicable, body corporate fees. Australian lenders generally look for a front-end DTI under 30% of gross income.
Back-End DTI: This ratio includes all monthly debt payments, like credit card payments, car loans, student loans (HELP debt), and the proposed mortgage repayments. Lenders in Australia often prefer a back-end DTI under 40%.
Example Calculation: If your gross monthly income is AUD 8,000, keeping housing costs below AUD 2,400 (30%) and total debts below AUD 3,200 (40%) is generally advisable for meeting lender criteria.
2. Assess Your Income Stability
Australian lenders focus on income stability when determining borrowing power, as they want assurance of your ability to make regular repayments.
Steady Employment: Lenders usually want to see at least 12-24 months of stable employment within your current role or industry. If you’ve recently changed jobs but remain in the same field, this may still work in your favour.
Self-Employed or Contract Work: If you’re self-employed or on contract, lenders often assess your income average over the past two years. You may need to provide additional documentation, like tax returns, BAS statements, and business financials.
3. Review Your Credit Score
Your credit score impacts the interest rates lenders are willing to offer. A higher score can lead to better loan terms and a lower interest rate, which increases your borrowing capacity.
Credit Score Ranges in Australia: Generally, a score of 700+ is considered good, and 800+ is excellent. If your score is below 600, it might be challenging to secure a loan with favourable terms, though it may still be possible.
Impact of Interest Rates: The higher your credit score, the more likely you are to receive lower interest rates. Over the course of a loan, even a small reduction in your rate can significantly impact your monthly repayments and the total borrowing amount you can afford.
4. Determine Your Deposit and Loan-to-Value Ratio (LVR)
The size of your deposit, usually 5-20% of the property’s purchase price, is a major factor in determining how much you can borrow in Australia.
Typical Deposit Requirements: For most Australian loans, a 20% deposit is ideal. A lower deposit (typically below 20%) may still be possible, but it usually incurs Lender’s Mortgage Insurance (LMI), which increases overall costs.
Loan-to-Value Ratio (LVR): LVR is calculated by dividing your loan amount by the property’s value. A higher deposit reduces the LVR, lowering the lender’s risk and potentially securing better loan terms.
Example Calculation: If you’re purchasing a property for AUD 500,000 and have AUD 100,000 for a deposit, your LVR would be 80%, a comfortable ratio for most lenders in Australia.
5. Estimate Monthly Living Expenses and Bills
Lenders in Australia assess your living expenses to ensure you can afford your mortgage repayments comfortably. These include bills, groceries, transport, childcare, and insurance, all of which can vary by location and lifestyle.
Budget for Additional Property Costs: Owning a home involves costs like council rates, water charges, and maintenance. Calculate these potential expenses based on your target property type and location.
Build an Emergency Fund: Ideally, have a fund that can cover 3–6 months of living expenses to help manage financial surprises, such as sudden repairs, without impacting mortgage repayments.
6. Consider Loan Terms and Interest Rates
Your borrowing power depends on the mortgage term and interest rate, both of which affect your monthly payments and total borrowing amount.
Loan Term: A 30-year loan generally has lower monthly repayments than a 15-year loan, allowing you to borrow more. However, shorter loan terms save on total interest costs, potentially reducing financial strain in the long run.
Fixed vs. Variable Rates: Fixed-rate mortgages provide predictable payments, which can help with budgeting. Variable rates, however, may offer lower initial rates but can fluctuate with changes to the Reserve Bank of Australia (RBA) cash rate. Considering these options in light of your risk tolerance and financial plans is key.
7. Use an Australian Mortgage Calculator
Mortgage calculators can help you estimate how much you may be able to borrow by factoring in your income, expenses, deposit, and interest rates. This gives a preliminary idea of your affordability.
Input Details: Provide your gross income, monthly debts, deposit amount, interest rate, and loan term. A mortgage calculator will estimate your borrowing amount and monthly repayments based on these details.
Online Tools: Many Australian banks and financial institutions offer mortgage calculators tailored for Australian lending criteria. Using a few different calculators for comparison can help you get a realistic borrowing range.
8. Seek Mortgage Pre-Approval
Mortgage pre-approval from an Australian lender gives a formal indication of how much you can borrow. Pre-approval is based on a thorough review of your finances, which can streamline your property search and enhance your negotiating position.
Required Documents: To secure pre-approval, you’ll typically need payslips, recent bank statements, identification, and details of existing debts. Self-employed individuals may also need to supply tax returns and business statements.
Limits on Pre-Approval: Remember, pre-approval is generally valid for 3-6 months and may come with conditions. Also, the amount you’re pre-approved for represents the maximum you can borrow; it’s wise to borrow only within your comfort zone.
9. Consider Your Future Financial Plans
Finally, think about any upcoming lifestyle changes or financial goals that could impact your ability to make mortgage repayments over time.
Career and Income Projections: Consider potential income changes, such as promotions, career changes, or plans to reduce work hours. Your ability to afford repayments long-term depends on the stability of your income.
Other Financial Goals: If you’re saving for future plans like a wedding, family, or starting a business, consider how mortgage repayments might affect these goals. Ensure that taking on a mortgage won’t restrict your ability to fund other priorities.
Example Scenario
Let’s say you have the following financial profile:
Gross Monthly Income: AUD 10,000
Monthly Debt Payments: AUD 1,200 (credit cards, car loan)
Available Deposit: AUD 100,000
Credit Score: 750
Based on this:
Front-End DTI: Ideally, keep housing costs below AUD 3,000 per month (30% of gross income).
Back-End DTI: Total monthly debt payments should be under AUD 4,000 (40% of gross income).
Estimated Borrowing Capacity: With a 20% deposit of AUD 100,000 and assuming a 4% interest rate, you may be able to afford a property priced around AUD 500,000, though actual borrowing power depends on lender requirements.
This calculation gives a rough idea of your borrowing capacity. Local property rates, LMI, and lender criteria could affect the final loan amount.
Final Thoughts
Understanding your borrowing power in Australia involves assessing your income, debts, deposit size, and lifestyle. Using mortgage calculators, consulting with a lender for pre-approval, and considering DTI ratios can give you a clear picture of your affordability. Always strive to borrow within your comfort zone to ensure financial stability while allowing for future goals and expenses.
