How to maximise your borrowing power and loan affordability
Your credit card limit and personal debt plays a large role in determining how much money you can borrow come time to apply for a mortgage.
Regardless of how much debt you have accumulated on the cards or loans, the banks will still hinder your borrowing power based on the fact that your total credit card limits ‘could’ be used at some point, in turn lessening your ability to meet their repayments should you ever accumulate debt on those credit cards or loans.
In simple terms; they look at how much debt you are in, as well as how much debt you could get in.
Have you ever tried using a ‘how much can I borrow?’ calculator and noticed that they ask you for your ‘total combined limit on your credit cards’ instead of ‘how much debt do you have on your credit cards’?
This shows that the banks assume any credit limit, no matter how big or small – is potentially a line of credit that could be used at some stage in your life and will directly impact your mortgage repayment ability in their eyes.
How do lenders determine your monthly credit card repayments if you do have an actual debt?
If you are in the position of having debt on the aforementioned credit cards, banks will have to assume your repayment rate and percentages to assess how much of your income it will eat up.
Given that most cards average between a minimum of 1.5% to 5% repayments per month, most banks assume you will have a repayment rate of around 3%.
For example: If you have a card with a $20,000 line of credit on it and a bank assumed 3% minimum repayment – your monthly disposable income will be lessened by $600. That is $7,200 a year that the banks believe you won’t be able to repay from your income.
Now imagine if you are like many people and have numerous credit cards? Your borrowing power will be significantly less and it may make the difference between buying your dream home and buying an average home, regardless of what you can truly afford to repay.
What other factors affect how much money you can borrow for a mortgage?
While there is no way to be 100% certain of what each lender requires, there are a few key points that are used by most institutions when assessing your ability to repay a loan and thus whether or not they will grant you the home loan.
The confusion in the marketplace about what factors actually matter to the lender when applying for a mortgage is largely due to the fact that each lender is different and they change their criteria depending upon how valuable mortgages are to them at that given point in time. When the GFC hit Australia, most lenders tightened their strings to the point of making it nearly impossible to receive a loan – this was used as a safety tool by many big banks.
After talking with St.George about home loans only recently, they mentioned the following points:
- Your income and financial commitments
- The cost of your lifestyle and living expenses
- Your prospective property purchase & its value
- The loan you are looking at, the term of this loan and the type of loan
- Assets you can offer as security against the loan
- Your credit history
Your income and financial commitments
Lenders look at your income stream, your ability to repay the loan and the security by which you are employed. Self employed people will have a harder time showing they are secure, while people who have held a job for a solid amount of time will be looked upon more favorably.
Your financial commitments are also taken into account, in the sense that the lender wants to know whether you have any existing debts, car loans, lines of credit or perhaps even credit cards that are debt free but still open.
The lower your commitments, the more money they are willing to lend you. That means things like car loans and other regular expenses should be limited where possible to enlarge the amount of money you have to service the mortgage should you be accepted.
The cost of your lifestyle and living expenses
It is also wise to look at your lifestyle, the amount of money you require to live it and what expenses you incur on a regular basis. The lenders are looking to understand whether or not you can truly afford the repayments while still maintaining a lifestyle that is suitable for you.
Many people apply for loans and plan to sacrifice a large amount of their money, at the expense of their lifestyle – which is one of the main reasons people end up defaulting on their home loans as inevitably people revert to the lifestyle they are used to.
Your prospective property purchase & its value
Just because you buy a house at $X doesn’t mean the lender believes it is worth $X.
The lender will actually value the property themselves to ensure it is a sound purchase and not overvalued or undervalued. This is basically a way for the lender to understand whether or not your purchase makes sense and will provide a return to them should the worst case scenario occur and they need to repossess your house.
The tip here is ensure your property is on par with market value and you are not attempting to purchase a house on emotion; it needs to be a sound investment as well.
The loan type and term of loan
The borrowing power may also be affected by the type of loan you are looking at and its corresponding interest rate. The lower the interest rate, the lower your repayments, the more likely you are to meet the minimum required. The longer you choose to repay your mortgage, the less financial stress each repayment you will face (on average). For instance your repayments may be easier to manage over 30 years than say 25 years (even though the interest charges over that time will be more).
Assets you can offer as security against the loan
The lenders will also look at what existing assets you have available. This could be a car, your share portfolio, an existing property or some other tangible asset that can be used by the lender should you not meet the loan repayments.
Be sure to list as many assets as you can. Include the possessions/contents you own and their insured value, your investments, savings and any other significant items like cars, bikes and boats.
Your credit history
Your credit history is a very important part of the home loan application process. The lender will check to see that you have no red flags against your name for defaulting on previous loans, credit cards or other lines of credit.
You can check your credit history for free here and see what the lender is going to see when they do a credit check.
It is suggested that if you find any red flags against your name, do whatever you can to ensure they are removed before applying for the loan. It could be as simple as a late mobile repayment that has put a note on your credit report.