Erina resident, James asks
“My partner and I are interested in a property at Terrigal on the Central Coast, however it’s just above what banks will lend us. How can we increase our borrowing capacity?“
This is a common question because we often find that when people apply for a loan they are just not able to qualify for enough. Budget planning and persistence in settling loans both secured and unsecured is a guaranteed way to increase your serviceability and the below strategies are suggested ways on how you are able to increase your borrowing power.
Reduce Credit Card Limits
In my experience, I have found that a reduction in credit card limits is one of the first things to action. When a bank assesses your ability to afford a new loan, they have to consider your existing debts as well. With credit cards, you might have for example a $40,000 limit the bank will still factor that in as an ongoing debt.
Generally, the amount they factor in is between two and a half to three per cent of the credit card limit per month, so on a $40,000 credit card limit, as an example, that’s $1,200 a month that’s going into your serviceability calculation as an expense even if you have zero owing on the card.
By decreasing your credit card limits, some of that $1,200 per month will then go towards a proposed home loan, which increases your capacity. That’s generally the number one way to increase your borrowing capacity.
Refinance an existing Mortgage
Another avenue to pursue is refinancing if you have an existing mortgage. You may be paying a higher rate on your existing mortgage than you should be, and you could possibly refinance this mortgage into a lower rate loan and therefore decrease the repayment, which then increases your capacity for a new loan.
Extending Investment Home Loan Terms
Increasing your borrowing capacity can also be done by means of other investment home loans as these loan terms can be stretched back out.
For example, if you’ve had an investment property for 6 or 7 years, you took out a loan with 30 year term and you’ve got say 23 years remaining on that loan term, naturally you have to pay it off over 23 years, which means that the monthly repayment would be higher than what it would be at 30 year terms so extending the loan term reduces monthly repayments.
By refinancing that loan and stretching it back out to a 30-year term it is still tax deductible and you are able to claim the interest. You will pay a higher interest over the loan term, but you’re not forced to make the minimum repayment, you can continue making the same repayments that you were making when it was a 23-year loan term. The minimum repayment reduces which can then increase your borrowing power for a new home loan.
Pay out or consolidate car loans and personal loans
On a personal loan, it’s not uncommon to be paying between 13 and 15 per cent per annum and one way to increase your capacity is to pay those loans out.
If you are buying a house and you’ve only got a five or ten per cent deposit, then it’s likely not going to be possible but if you already own a property that has equity in it and you’re looking to either buy a new property or just refinance, then it may be worth considering consolidating those higher rate personal loans into the home loan and eliminating that repayment to reduce your overall commitment each month.
This then increases your borrowing power for a home loan.
Pay out or consolidate HELP debt
What we often see that causes an issue with borrowing capacity is HELP which are basically university debts. This type of debt to the government is paid back by the tax system after you reach a certain threshold or income threshold. At the moment, once your income exceeds $51,957, then you start paying two per cent of your income as a HELP repayment, then it goes up in tiers, up to a maximum of eight per cent of your income. Once you’re earning $107,214 and above, eight per cent of your taxable income will go to HELP repayments.
If you are earning say $108,000 a year, that equates to $720 per month in HELP repayments, so that obviously impacts your borrowing power for a home loan. Now with HELP, there’s no interest charged on it, but the HELP debt goes up based on the consumer price index (CPI) so inflation will increase the debt amount.
If you are able to secure a home loan, with the HELP debt still outstanding you’re better off not paying the HELP out because it’s an interest-free loan however you may have to pay it off to increase your borrowing power, particularly if there’s only a small amount owing on it. I have had situations in the past where there’s only been $5000 or $6,000 owing on a HELP loan and the client was able to pay the loan out resulting in a substantial increase in borrowing capacity.
Reduce Living Expenses
Lastly, another common way to increase your borrowing power is to reduce your living expenses. Lenders are now reviewing up to 4 months bank statements to confirm that the living expenses you have declared are in line with what you are actually spending. So it is wise to watch your spending in the lead up to applying for a home loan.
When it comes to boosting your borrowing power, you will want to implement smart and effective strategies to maximise your home loan application success. Lenders will look at the complete picture and knowing how banks assess your lending criteria, and how to be able to borrow as much as possible will be to your advantage.
Patrick is a Director and a Home Loan Specialist. He has been helping Australians with home loans since 2001. Prior to working as a mortgage broker Patrick was employed by Macquarie Bank for 3 years and also worked as an accountant for a publicly listed company. Patrick holds a Bachelor of Business majoring in Accounting and sub-majoring in Finance and Marketing from University of Technology, Sydney.