Learn Exactly How to Calculate Borrowing Power

If you’re applying for a home loan, you probably want to know how to calculate borrowing power.

In fact, it’s the number one question people want to know.

So` we’ll show you exactly how your lender will determine your borrowing power.

Be prepared… It’s sometimes a bit dry because we’ll be digging into the details, so you can get all the behind-the-scenes information.

We want you to learn, exactly what we know…

Learn How to Calculate Borrowing Power for yourself

Every lender has their own unique formula (serviceability calculation).  Borrowing power, also called borrowing capacity, is referred to by your Lenders as serviceability.

The term serviceability comes from an assessment that you are able to service your loan commitments.

Your income is validated differently from bank-to-bank, to satisfy their own serviceability calculators.  

Here’s what your lender will want to analyse:

  • Your Gross Income Amount
  • Income Type (salary, commission, overtime, allowances, rental income, investment income etc)
  • Employment
  • Liabilities (what are they, how much do you owe, what are the repayments?)
  • Cost of Living (and other expenses or financial commitments)
  • Number of Dependants (How many?  What’s their age?)

There’s various buffers included within the calculation to ensure long term serviceability.

Buffers may be used to reduce your income (to determine your assessable income), or to add margins on top of interest rates.  Or both.

It’s complicated.

But your lenders serviceability assessment is for the purpose of ensuring long term affordability over the term of your loan.

The Borrowing Power Formula

Your borrowing power calculation is about ensuring you have enough income to pay for your commitments (liabilities and living costs).

To simplify exactly how to calculate borrowing power, it’s broken down in to steps below:

  • Gross Taxable Income – Tax = Net Income
    And then;
  • Net Income + non-taxable income = Total Net Income
    And then;
  • Total Net Income – Total Repayments – Living Costs = Your Net Surplus Income

Got a positive Net Surplus Income?

Great!

That means you have spare cash after paying for all your expenditure (which is absolutely mandatory!).

However, this assumes your lender actually accepts 100% of your gross income.

When calculating your borrowing power – your Gross Income will differ between lenders, as they alter it to determine your “Assessable Income” (it varies based on differences in unique bank-to-bank credit policy).

How to calculate your borrowing power, first depends on your type of employment…

Watch this video to see a real-life serviceability calculator in action.  Most banks use one almost exactly the same as this.

If you’re self-employed, there’s an interesting hack to TRIPLE YOUR BORROWING POWERfrom $257,000 to $856,000! (skip to 5 min 41 sec)

If you really want to know how to calculate borrowing power, you’ll need to dig deeper in to income analysis.  Click on the link that best matches your situation to learn more about how your income is analysed.

I’m self-employed      I’m an employee (PAYG)

What’s the term assessable income mean?

Quite simply, it’s the amount of income your lender is actually using in their calculation when assessing your affordability (serviceability).

Your income may be crunched down (shaded), depending on your income type and your employment type.

It’s influenced by your lenders opinion of that type of income.

Rental, Commission, Allowances or Bonus incomes are examples of income types that lenders like to shade.

Typically, your lender will have a fixed percentage for every type of income.

For example;

  • Bonus income often accepted at 50% (but only if it can be verified as consistent for 1-2 years).  Therefore;
  • Bonus income earned for less than the minimum time would be allocated $0.
  • Bonus income earned for longer than the minimum time would be allocated 50% of the actual amount you’ve earned.

Therefore, you might have 100% of your base income, plus 50% of your bonus income added.  This would then become your assessable income.

There are lenders that take 100% of the above incomes, so it pays to talk to a mortgage broker who really knows their stuff.

Request a Consult or Start a Chat if you have any questions.

So, your assessable income, is just your lenders calculation of your acceptable gross income.

To recap…

  • Your lender will use it’s own credit policy to determine your assessable income.
  • Depending on your income source/type, your lender may “shade” (reduce) your gross income for their assessment.
  • The practice of “shading” income is widespread, so if your income is significantly made up of rental, overtime, commission, bonus or some other allowance you might need to shop around to find the lender that suits you.
  • If all your income is accepted to 100%, then your assessable income should equal your actual gross income.

By the way, not all lenders will shade in all situations, so talk to us if you’d like to know which lenders will shade your income.

Your bank will “pretend” your interest rate is much higher than it actually is…

Another trick when it comes to learning how to calculate borrowing power, and something we haven’t yet mentioned…

The assessment rate.  This is your actual interest rate, plus a margin.

It’s the rate used for assessment of your ability to repay the loan, according to the lenders assessment criteria (serviceability).

When calculating repayments on your mortgages, your lender will generally add at least 2% to your interest rate.  This buffer is used to ensure long term affordability.

And whilst you must add 2%, the assessment rate is also required to be a minimum of at least 7%*.

For example:

  • Assume your current interest rate is 4%.
  • Your lender must add 2%, but 6% would still be below the minimum rate of 7%.
  • Therefore, your assessment rate would be at least 7% (many lenders have a higher minimum rate).

The assessment rate reduces your borrowing capacity, but it’s a responsible lending practice.

It’s really in your best long term interests as most loans are 20-30 year terms.  So it’s better to play it safe for you, for the housing market, and the economy in general.

Your existing liabilities at other financial institutions may also have the assessment rate applied to them during your borrowing power calculation.

Therefore repayments on your existing/continuing loans may be assessed at a much higher repayment amount than you’re actually paying.

This further reduces your borrowing capacity and many people find it annoying, but it’s responsible lending and we’re lucky to live in a country where lenders are held accountable.

* This is called the floor rate, and 7% is a minimum requirement for Australian Deposit-Taking Institutions (ADI), although most lenders have a higher floor rate than 7%.  However, some of our lenders are not ADI’s and therefore are not mandated to have that floor rate, but most still do.

The First 6 Questions Asked When Determining Your Borrowing Power…

When determining how to calculate borrowing power, you should extract each of these items separately.

Your lender will quickly seek to understand these specific questions, as it helps to determine what income can be used in the assessment.

1) What’s your employment type?

Are you permanent full-time or part-time, casual, contractor, self-employed, temporary, something else?

2) What’s your minimum income?

PAYG employee?

  • Your base salary/wage excluding overtime, commissions, allowances, etc.

Self-Employed?

  • Your Net Profit (before tax)

3) Is there any additional income or allowances you are paid?

PAYG employee?

  • Overtime, bonus, commission, car allowance, shift allowance or some other allowance?
    • Is it paid to you as a condition of your employment? (ie. is it a permanent part of your pay?)
    • Is it the exact same amount every pay, or does it vary from pay to pay?

Self-Employed?

  • Are there any “add-backs” we can utilise within your tax returns?
    • Depreciation, directors salaries, interest expense, one-off expenses, something else?

4) Any other investment income?

If so, what is it, how can we verify it?

  • Rental income?  What type of property and rental income is it? (Standard residential, holiday letting, commercial, etc)
  • Investment income?  You may require 2 years history to be acceptable

5) Any ongoing liabilities?

If so, what are they? (amount owed, repayments, remaining loan term)

6) What’s your cost of living?

You’ll need to estimate your ongoing monthly living expenses – things like utilities, insurances, household spending, etc.

And then…

Now that your lender has your income amount, the income type and your ongoing commitments, they can quickly assess your maximum borrowing power, based on those numbers.

If you do this yourself, it can help you get a fast start to see whether your goals are realistically aligned to the lenders borrowing capacity guidelines.

  • Ask you lender what percentage of each income type they accept.

For example;

  • Are you a tradie and paid via your ABN?   If so, most lenders will want your tax returns for 2 years.  Or;
  • Are you relying on commission income?  Do you need a lender to accept 100% of it?
  • Maybe you have a company car, and you’re lender won’t boost your income?

There’s a million other examples of how employment length, income variations, and income stability could impact whether or not a lender accepts that income source.

For more information choose your situation below:

I’m self-employed      I’m an employee (PAYG)

What to do if your bank says no…

Sometimes 9 out of 10 lenders will say no, but you might fit perfectly in to the one that you probably never would have found by yourself.

What we’ve found is, very often when you do fit 1 out of 10 loans, you’ll still get a loan that’s just as good as (or better than) the first loan you tried out.

Request a consult now..

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