Calculating changes to your borrowing power

I've been asked a lot of questions recently about how different types of income/expenses change people's borrowing power. I'm sure other brokers on SS are asked about this too. Some general rules that I like to use are below. Hopefully it's of some use to the SS community.

When applying for a new loan, banks generally will calculate your overall income and ensure it's higher than your overall 'assessed' expenses. The banks assess the new debt (loosely speaking) you take on at an interest rate of around 7-8% at P&I repayments.

How different types of income/expenses are treated generally depends on a number of factors, including:
(a) the type of income/expense it is;
(b) which lender you look at, they treat different types of income/expenses differently;
(c) how much you're borrowing (the P&I repayment would be higher);
(d) tax rate used;
(e) the banks assessment rate (the 'buffer') that they use to check whether you can service the new loan;
(f) other factors (do you have existing debt with them, interest rate changes, APRA changes, etc).

Given the array of factors, the most common answer given to questions about income/expense changes is that it depends. However, below are some 'quick back of the envelope' guidelines that you can use as rough guidelines to think about it.

Salary/Business: Increase the average income earners salary by $1, will increase your borrowing power by $7.

For the average income earner (34-38% tax rate), increasing your gross income by $10,000 will increase your borrowing power by around $70,000. This will fall for higher income earners, as they will pay a higher marginal tax rate. Given salary rises are infinite, this is the most powerful way to increase your borrowing power long term.

Rental: For the average income earner, a $1 increase in rental income will increase your borrowing power by $5.5.

Can only include 80% of rental income generally. Therefore it's a bit lower than salary increases.

Discretionary expenses (e.g. rent, PPOR expense, foxtel, etc): Increasing your expenses by $1 will decrease your borrowing power by $12.

Given this comes out of net income, it has more of an effect than gross salary increases. Its why all those articles talk about reducing bad debts, etc.

Credit card limits: Increasing your limit by $1, will reduce your borrowing power by $5.

Credit card limits are generally assessed at 36% p.a. of the credit limit (regardless of whether you use it or not). Therefore a $10,000 limit reduces your borrowing power by $3,600 p.a. This is equivalent to about $50,000 in borrowing power.

These aren't anything but quick guidelines, if you want more specific responses your best talking to your broker. The actual amounts will vary from the above depending on the range of factors I've mentioned (and others) above.

I'm sure others can add some colour/have different general rules.

Cheers,
Redom
 
Kudos Redom! Thanks for the info - really useful.

Is it definitely right that an increase in expenses is much worse for borrowing capacity than an increase in credit card limit? :confused:
 
Thanks red liverbird - glad its of some use.

Yes raw expenses are treated more harshly. For example, purchasing private schooling at $12000 per year will do much more damage than a $12000 increase to your credit limit. Its because the interest expense is calculated on your servicing, rather than the credit limit itself t. While its calculated at an extraordinary rate (~36% p.a) - it has considerably less of an effect than increases to descritionary expenses.

Note, that doesnt mean to get a credit card over other debt. If you obtain a personal loan of $10,000 and pay 10% interest, you'll add $1000 to your 'expense' column. Whereas if you did the same with a credit card, you'd be adding $3600.

Again these are general rules, some lenders waive credit limits from servicing if you can show repayment history.

Cheers,
Redom
 
Generally around $300 p.m for each dependent.

However - the biggest hit to serviceability usually comes from a drop in income.

Cheers

Jamie

That's about $3,600 p.a increase in your assessed expenses, reducing your borrowing power by ~$50,000. Similar to a $10,000 increase to your credit limit.
 
Reason #357 , $50k serviceability each!

Usually even more than that when you factor in the loss of income when one parent stops working full time (not always the case but isn't uncommon).

But kids (for the most part) are pretty awesome.

Cheers

Jamie
 
Thanks red liverbird - glad its of some use.

Yes raw expenses are treated more harshly. For example, purchasing private schooling at $12000 per year will do much more damage than a $12000 increase to your credit limit. Its because the interest expense is calculated on your servicing, rather than the credit limit itself t. While its calculated at an extraordinary rate (~36% p.a) - it has considerably less of an effect than increases to descritionary expenses.

Ah, that makes sense now! Thanks
 
So if i have a property that is cashflow positive say $50 a week. Is that 50x52x5.5 = increased borrowing power?

Unfortunately not - its a bit complex so I'll have a crack at breaking it down.

There is a difference between your 'actual' expense that hits your pocket and the 'assessed' expense that a lender uses to see if your can borrow.

For example, if you are trying to take out an interest only investment loan of $300,000 at a 5% rate, your 'actual' mortgage expense will be $15,000 per year. However, it will be 'assessed' by the bank at ~7% and P&I repayments - around $24,000 per year.

Given this large difference, its very rare to purchase cash flow properties that will actually increase your borrowing power.

Doing some math on the calculators, you'd need more than an 8.5% rental yield before properties add to your borrowing power.

In terms of existing properties in your portfolio, if you switch from your existing lender (say Lender A) to another lender (say Lender B), then Lender B may take your 'actual' interest repayment, whereas Lender A will take your 'assessed' interest repayment. In this case, a positive cash flow property may indeed add to your borrowing power - but you'd have to calculate your rental income x 80%.

This is where switching lenders at the right times is a very important part of building a finance plan.

Cheers,
Redom
 
For example, if you are trying to take out an interest only investment loan of $300,000 at a 5% rate, your 'actual' mortgage expense will be $15,000 per year. However, it will be 'assessed' by the bank at ~7% and P&I repayments - around $24,000 per year.

That's different with each lender. Perhaps its worth adding a section to the original post about this?
 
That's different with each lender. Perhaps its worth adding a section to the original post about this?

Dave's point is true. I briefly mentioned it on point (e)?

An assessment rate is the interest rate that the bank uses to calculate whether you can afford to repay a loan.

General rough rule is the higher the assessment rate used by the bank, the less you can borrow from that lender (although the assessment rate is only one factor in calculating borrowing power). Its why ING are viewed as very conservative, they have an 8% assessment rate. Whereas someone like Macquarie are more loose - they have a 7% assessment rate.

All banks use different assessment rates and its one of the reasons why your borrowing power changes depending on which bank you go to.

Cheers,
Redom
 
Unfortunately not - its a bit complex so I'll have a crack at breaking it down.

There is a difference between your 'actual' expense that hits your pocket and the 'assessed' expense that a lender uses to see if your can borrow.

For example, if you are trying to take out an interest only investment loan of $300,000 at a 5% rate, your 'actual' mortgage expense will be $15,000 per year. However, it will be 'assessed' by the bank at ~7% and P&I repayments - around $24,000 per year.

Given this large difference, its very rare to purchase cash flow properties that will actually increase your borrowing power.

Doing some math on the calculators, you'd need more than an 8.5% rental yield before properties add to your borrowing power.

In terms of existing properties in your portfolio, if you switch from your existing lender (say Lender A) to another lender (say Lender B), then Lender B may take your 'actual' interest repayment, whereas Lender A will take your 'assessed' interest repayment. In this case, a positive cash flow property may indeed add to your borrowing power - but you'd have to calculate your rental income x 80%.

This is where switching lenders at the right times is a very important part of building a finance plan.

Cheers,
Redom

Is that net or gross?
 
Unfortunately not - its a bit complex so I'll have a crack at breaking it down.

There is a difference between your 'actual' expense that hits your pocket and the 'assessed' expense that a lender uses to see if your can borrow.

For example, if you are trying to take out an interest only investment loan of $300,000 at a 5% rate, your 'actual' mortgage expense will be $15,000 per year. However, it will be 'assessed' by the bank at ~7% and P&I repayments - around $24,000 per year.

Given this large difference, its very rare to purchase cash flow properties that will actually increase your borrowing power.

Doing some math on the calculators, you'd need more than an 8.5% rental yield before properties add to your borrowing power.

In terms of existing properties in your portfolio, if you switch from your existing lender (say Lender A) to another lender (say Lender B), then Lender B may take your 'actual' interest repayment, whereas Lender A will take your 'assessed' interest repayment. In this case, a positive cash flow property may indeed add to your borrowing power - but you'd have to calculate your rental income x 80%.

This is where switching lenders at the right times is a very important part of building a finance plan.

Cheers,
Redom

So that point seems sort of mute then in the OP although still worth mentioning for older investors who bought a while ago and now rent for much more.

So buying now with rents wont actually make gain you any more buying power?

So really you are relying on capital growth then, aren't you.
 
So that point seems sort of mute then in the OP although still worth mentioning for older investors who bought a while ago and now rent for much more.

So buying now with rents wont actually make gain you any more buying power?

So really you are relying on capital growth then, aren't you.

Capital growth only increases your deposits available, not your serviceability which is what Redom's thread is all about.

It's possible to increase your servicing if yields are above 6.25% and interest rates sub 5%, if you make using of OFI at actual repayments. Add in other options like AMP and you can shoot your serviceability to the moon if you can keep LVR's to 80%.

There's no hard and fast rules for servicing, hence why it requires a bit of finesse to squeeze every last dollar possible.
 
Capital growth only increases your deposits available, not your serviceability which is what Redom's thread is all about.

It's possible to increase your servicing if yields are above 6.25% and interest rates sub 5%, if you make using of OFI at actual repayments. Add in other options like AMP and you can shoot your serviceability to the moon if you can keep LVR's to 80%.

There's no hard and fast rules for servicing, hence why it requires a bit of finesse to squeeze every last dollar possible.

Sorry lamen terms ha

OFI?

AMP?
 
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