Six steps to borrowing success
Most people believe borrowing capacity is solely derived from income and there isn’t any real way to boost it significantly without getting a bigger pay cheque. Just suppose there is a way to increase your loan amount without asking for a pay increase. Would that allow you to buy a property sooner?
The way banks determine your ability to make loan repayments is by taking your overall income, and reducing it by your living expenses. Now if you’re thinking the rest of this article will be about reducing your living expenses as much as possible, I can tell you now that’s not the case. As much as saving tips are exciting or painful (depending on how you view it), we’re going to dig a little deeper into the way banks calculate your borrowing capacity.
Borrowing capacity can be broken into two fundamental components. The first is serviceability. To determine this, lenders use income minus your living expenses. The leftover amount will be the funds you have to put towards a new home loan.
The second component is ‘funds to complete’. This is where lenders determine if you have enough money to complete the property purchase assuming the loan is approved. For example, if the lender lends you 80% of the value of the property, you’ll need to provide a 20% deposit plus pay for the property transaction costs which, as a yardstick for NSW is 5% of the property value.
It should be noted here, the percentages add up to 105% of the value of the property. This is because a house for sale at $400k does not cost $400k to buy. There are transaction costs such as solicitors fees and stamp duty to take into consideration. Funds to complete usually become an issue if you do not have a significant deposit size but there are ways to get around this, which we’ll get to shortly.
Now that you know the two things which determine your borrowing capacity let’s take a look at how to improve each component.
- Reduce your credit card limit – if you require your limits to be at their current levels, some lenders will not penalise your serviceability if you pay off your credit cards in full each month
- Reduce discretionary spending – things you can live without should be reviewed at this point and if you don’t need them you can cease that expense. Enter saving tips here!
- Select a lender with a higher serviceability calculation – there are some nuances in how the final borrowing amount is derived. Some lenders have a lower mandated living expense, while others have lower buffers when assessing your cash left over to make repayments.
Improving ‘funds to complete’
- Increase your deposit size – this could mean saving more money, selling assets or seeking financial assistance from friends and family. For those game to consider joint ventures, this could also help by pooling resources together from other property investors
- Choose a lender that offers Family Security Guarantors. This feature allows your parents who have a property with equity, to offer it as security to the lender. Without getting into the mathematics behind how this effectively reduces the Loan to Value Ratio (LVR) on the property you are wanting to buy, it allows you to increase your borrowings if your deposit size is too small. There are risks to consider by the parents involved in this arrangement.
- Pay Lenders Mortgage Insurance (LMI) to access higher LVRs. This will allow you to borrow more money to contribute to the purchase of the property. Some lenders go as high as 97% LVR with the LMI capitalised into the loan.
So there it is, some of the ways in which you can improve your borrowing capacity!
Ken is the Founder and Director of Avvora Finance. Avvora provides a range of lending products that cater for individuals and business owners. Ken holds a Diploma of Financial Services (Financial Planning) giving him a comprehensive knowledge of finance management and wealth creation. He has interests in property investing, financial markets and entrepreneurship. In addition, Ken has over six years’ experience in the superannuation industry with technical and working knowledge of investment fundamentals, insurance and superannuation legislation. He brings management experience and specialist knowledge in customer service initiatives.
Disclaimer – This information is of a general nature only and does not constitute professional advice. We strongly recommend you seek your own professional advice in relation to your particular circumstances.