You can take a loan for all sorts of reasons in this day and age; however, not everyone will have the same borrowing power.
If the concept is new to you, and you’ve been contemplating taking out a loan, you will need to understand the influence borrowing power can have on your financial future. This is because if you are seeking to purchase a home and your borrowing power doesn’t permit this, you may end up disappointed.
Please note, specific ideas and products presented in this article may not be on offer by Monzi nor the lenders we work with. This article presents only general information. Consider seeking professional financial, taxation, legal or other advice to check how the information and ideas presented on this website relate to your unique circumstances.
What does borrowing power mean?
Borrowing power is the term given to the amount of money you, a company, or the government can borrow. Your borrowing power is subject to external influence, meaning that your income, credit score, debts and deposit size, will dictate the amount you can access.
Similar to the way your credit score operates, your borrowing power will increase if you are responsible with your spending and saving habits. Borrowing power is not exclusive to home loans; Lenders will assess the financial capacity of borrowers on all kinds of loan application. As a result, it’s smart to keep your potential borrowing power in mind before applying for a loan.
What affects borrowing power?
Many factors can potentially influence the state of your borrowing power. Let’s expand on each of these for a more in-depth discussion on the information that can help or hinder your application.
Your credit history reflects your reliability. Often, reliable borrowers have made repayments on-time and have avoided any debt. Although, life is not all smooth sailing and some applicants may have defaults listed on their credit report. This may not cripple your chances of approval. Instead, it may merely decrease your borrowing capacity.
To check your credit report and score, you can obtain a free copy from companies such as Equifax and Experian. This will allow you to assess the state of your credit to determine how it may impact your application.
Your annual income is typically the first detail a lender will consider when processing your application. This is because income often dictates how large your repayments can be. Another component your lender may look at is your saving habits. Typically for the previous three months, these saving habits can be a good indicator of your reliability to the lender.
The loan type
The type of loan you seek may impact your borrowing power. For example, if your credit score is slightly shabby and you’re after a home loan, your borrowing power will be low. However, if you are applying for a no credit check personal loan, your borrowing power may be unaffected.
Debts and living expenses, much like your income, may also be examined. A number of outstanding debts or on-going repayments may reeduce your borrowing power.
Lenders usually require a 20% deposit. This is because they consider 80% to be a good loan to value ratio. Generally speaking, your deposit amount will impact your borrowing power on home loans and car loans.
Lenders may consider your assets to determine your borrowing power. If you have a diverse investment portfolio or own a car or a boat, this may show that you are capable of saving over time.
How is borrowing power calculated?
Your borrowing power is calculated by comparing most of the details mentioned above. As a guide, your lender may subtract your living expenses and debts from your income, initially. This may give them an idea of what kind of repayments you can make. From there, they may go on to evaluate your credit report, assets, and deposit.
Depending on the loan and then lender, the procedure may be subject to change. However, if you can clean up your act, polish your credit history and show that your budget is under control, you may increase your approval chances.
Borrowing power calculator
There are many bank and broker websites available for you to calculate your borrowing power with. Generally, most calculators that determine how much you may borrow will ask for some key details. For example, this may your income before tax, your assets and liabilites as well as what kind of loan you would like to apply for.
They may also request some information on the types of bills you pay, whether you have any current loans and your credit card limits. The majority of these calculators exist for property loans. However, there are car loan calulators and personal loan calculators too.
Home loan borrowing power
Home loan borrowing power, or mortgage borrowing power, can easily be estimated by an online calculator. If you know what lender you’d like to borrow from, or which broker you’d like to use, they should have a calculator on their website.
Using this calculator can give you an estimate of your monthly repayments, along with the proposed total interest. As with all loan calculators, you should enter realistic numbers to get the most accurate calculation. However, keep in mind that this number is not the final calculation, and is subject to change during a lender’s assessment.
Once you receive your calculation, aim to borrow comfortably. It may not be smart to stretch yourself to the limits with repayments, just to borrow the maximum amount.
Personal Loan borrowing power
Personal loan maximum borrowing power is dependent on who you borrow through. With Monzi’s lender-finder service, the maximum is $10,000, and the minimum is $300. If you want a rough idea of what you can borrow, you will have to enter your details into an online calculator. These calculators may ask for a rough idea of what you intend to use the money for. However, this depends on your lender.
Some lenders may offer no credit check or bad credit loans. However, if you apply with Monzi, we cannot guarantee if you will be offered these products. Instead, we’ll simply do our best to pair you with an available lender. Your outcome will depend on the lender that you are dealing with and their individual policies.
Car loan borrowing power
Borrowing power calculators for car loans are perhaps the least common. Yet, they do exist and request similar information to other borrowing power calculators. Taking out a car loan may enable you to put down a significant deposit which can earn you a higher borrowing power for your vehicle.
Keep in mind that cars begin depreciating immediately, meaning, at some point, you could end up owing more than the car is worth.
Investment loan borrowing power
Investment loans are typically used for property. They can also be used to purchase shares, but typically homes require loans and shares do not. The difference between investment loans and regular home loans, however, is that you have the potential to use your assets as a deposit.
For home loans, you can use your owner-occupied home as equity. However, the expenses for the home you already own do get accounted for. For shares and stocks, you can secure your loan against other assets in your portfolio. For example, if you have successful stocks invested in Coca-Cola, you may be able to use these to increase your investment loan borrowing power.
Borrowing with your equity
If you’re unaware of equity and its influence on your potential to borrow, you may find this is an option for you. If you currently have a mortgage, your property’s equity is the difference between its market value and what you owe.
Therefore, if you have paid off a large amount of your mortgage, you should have a lot of viable equity. This equity is typically used for investment properties, as it can be an alternative to a cash deposit. The amount of equity you can use may vary depending on your lender. So, contact them to determine your equity loan options.
Does equity increase your borrowing power?
Equity may be valuable to your borrowing power. However, it is typically an alternative to a cash deposit. So, if you have more equity than cash, it may potentially end up giving you more borrowing power than your cash deposit could.
Do you need a cash deposit if you have equity?
Based on what was said above, if you use your property’s equity, this may be able to supplement a cash deposit. As mentioned, however, it depends on your lender, and you may need to use some of each. If you are required to put some cash down, it may be around the 5% mark.
Advantages and disadvantages of borrowing
Stepping away from borrowing power for a moment, it is essential to consider the advantages and disadvantages of borrowing. This can help you to identify if taking out a loan is the best option for you.
- Loans may help you afford assets you may otherwise have been unable to, such as a house.
- Loans may be flexible. For instance, you may be able to get a loan with a fixed or variable rate. Moreover, extras such as offset accounts may be available on home loans.
- You may be able to refinance your loan if you find a better deal than the one you are currently with.
- Your loan may be secured against your possessions. As a result, if you fail to repay your loan, your lender may repossess the asset.
- Taking out a loan, particularly a home loan, is a long term commitment that you will have to repay.
- Large loans can impact your way of life. With the regular repayments, you may find that you have less money to spend at your leisure.
Can you increase your borrowing power?
The good news is, you can increase your borrowing power. It may take some time, but it can be done. Your two main options are to either increase your income or decrease your expenses.
Increasing your income can potentially be difficult. Consider seeking a pay rise if this is a viable option for you. A second job may be an option too. However, if you don’t have the time to do so, you could look at a guarantor loan too.
When it comes to cutting expenses, clearing up any debt you have is a worthy goal to work towards. However, this could also mean reevaluating your budget and identifying any areas you are overspending in. Reworking your budget to cut out unnecessary costs can be an excellent way to see your savings increase in a short period. Consider also reducing credit card limits and ensuring the loan you’re seeking is right for you.
For further details on creating a budget, check out MoneySmart’s free online budget planner.
Why is your credit so important?
Your credit is vital to your borrowing power because it reflects your reliability. As stated, if your history reflects a consistent ability to meet your repayment deadlines, your lender may view you more favourably.
On the other hand, if you have multiple defaults on your report, that suggest to the lender that you may not be able to cope with another loan. As a result, having bad credit may make it more difficult for you to receive approval on a loan application. After all, lenders may doubt your ability to repay it.
Most loans aren’t exempt from extra costs. As a guide, here are some extra charges you may encounter.
Settlement fees and discharge costs typically accompany home loans. As a result, to finalise the process, you will have to pay to fill out the appropriate documentation. Along with this, you could encounter property valuation costs.
Other fees you may encounter include application fees, lender’s mortgage insurance, annual fees, redraw costs. Given this, it may be helpful to speak to a financial advisor or mortgage broker if you cannot keep track.
Using a guarantor to increase the borrowing power
One viable way of increasing your borrowing power is using the aid of a family member. Co-signing a loan with your mother, for example, and using her home as equity can be a fast way to boost the amount you have access to.
The equity your guarantor gives you is used as security, meaning if you both fail to make the repayments, the bank can claim your guarantor’s equity. This is a spot most people would like to avoid backing a family member into, so, it may be best to ensure you’ll never let that happen before signing a contract.
For someone to be your guarantor, they typically must be a direct family member or spouse. They will need their good credit, a stable income and their property must have at least 20% equity and be located in Australia.
The criteria are strict. However, using a guarantor may be one way to access low deposit home loans.
Benefits and risks of a guarantor
Being able to borrow more is a strong advantage of using a guarantor. However, there another benefits and risks to be consider.
The additional benefits of a guarantor include being able to get into the property market faster. This can be a much better option than having to spend a considerable period trying to save up a 20% deposit.
This then links into avoiding the lender’s mortgage insurance (LMI). LMI is an additional fee you are charged if your deposit is less than 20%. Guarantors also improve your chances of approval. This may be useful if you are trying to become a first homeowner.
The risks, on the other hand, remain ever-present. They are generally to do with the safety of your guarantor’s assets and your relationship with them. You will be putting their property in potential danger, along with their credit report. This is particularly nasty considering this debt was not theirs. This can thereby place strain on your relationships with these family members.
Are there other ways to borrow?
Co-buying is one last option you may be able to use when taking out a loan. When you co-buy, you are signing a legal contract to split ownership by a pre-determined ratio. For example, you and your partner may choose to purchase a property split by 50% each. This means you each legally own half of the property. This is referred to as a joint tenancy agreement.
Relationships don’t always last; co-buying is an excellent way to ensure one person isn’t left in crippling debt. However, it can also be useful if you can’t find a guarantor, and instead wish to get the help of your siblings, for example. Co-buying with a different ratio of ownership is called a tenants-in-common agreement, and ownership is divided whichever way the buyers desire.
How can you become a guarantor?
If the tables turn and you are asked to be someone’s guarantor, you should consider all factors before making your decision. Becoming a guarantor and aiding someone else’s borrowing power is a big commitment. Arguably the most crucial consideration is your relationship with the borrower, and whether you trust them.
After this, you should consider financial advice to make sure you understand what you will be entering into. Limiting your guarantee by time and amount is an excellent way to protect yourself. You can also request the loan does not exceed 90% of the property value to limit your exposure. You can also opt to get guarantor protection, to create a safety net for you and your assets.
What happens if your loan isn’t approved?
If your lender ends up making the decision not to lend to you, you may be left stumped on what your next step should be. The first thing to keep in mind is that it may not be a wise apply again immediately. This is because too many loan applications will hurt your credit score.
The best step to initially take is to ask your lender why they rejected your application. If your lender rejects you, it most likely means they don’t view you as being as reliable as they’d like. If they reject you due to your credit report, they legally have to notify you. However, if this wasn’t the cause, try asking them why they made their decision.
Before applying again, try giving it some time. During this time, re-evaluate your credit report, create a budget and pay off any debt you have. You may even consider consolidating some of the debts to make them easier to manage.
Once you believe you have taken the right steps to improve your position, you may be able to apply again.
What goes on your credit report?
There is a handful of information that will remain on your credit report for specific periods. Ranging from two to seven years, it may be smart to work out what’s on your report so you can gauge how long your credit repair will take.
Your repayment history and credit accounts will display on your credit report for two years each. This means whether you do or don’t make repayments on time, along with the details of any credit account that you open.
Defaults, enquiries, and court judgements remain on your credit report for five years. Defaults being any overdue debts. Paying off these debts does not remove them from the report. Enquiries are applications for credit, credit accounts, and credit cards. Court judgements that require you to to pay anything owed, along with charges, fees and interest will also remain for five years.
Five years minimum
Bankruptcies and debt agreements are a minimum of five years, dependent on their severity.
Serious credit infringements are any acts where you have attempted to obtain credit fraudulently. Alternatively, if you have ceased repayments without contacting your credit provider for six months, this also qualifies. Paying the infringement off may allow it to be reduced to a default.
Is it a good idea to seek pre-approval?
Home loan pre-approval may help you gauge your potential borrowing power. Typically, you will not know your real borrowing power until your lender evaluates you. Pre-approvals are also very subject to change. They expire after three to six months, and if your circumstances change, your pre-approval will no longer be valid.
A pre-approval is just an idea of where you’re standing, helping you to gauge what you can work towards. They are not guaranteed approval. They are also far better for taking to auctions, to prove to the agent you’re serious, than for use as a gauge of borrowing power.
Borrowing power at auctions
Typically, if you are operating through a broker, they will be able to advise you on what exactly you’re going to need to qualify for the amount you plan to spend. Therefore, you must have a basic understanding of your borrowing power before you get to auction.
Pre-approval is helpful for this. However, it may be smart not the attend an auction without understanding exactly what your borrowing power is. Which may mean getting loan approval before attempting to bid on a home. This also will prevent heartbreak if you get attached to a property and then realise you aren’t approved for the adequate funds.
How can Monzi help?
Unfortunately, Monzi doesn’t offer a borrowing power calculator. Instead, our lender-finder service may match you with an available lender offering personal loans from $300 to $10,000.
We’re 100% online and paperwork free. If you apply with us during business hours, we may be able to match you to a lender within 60 minutes.
All you need to do now is click the ‘apply now’ button. From there, choose the amount you want, and put in your preferred repayment options. Then it’s over to us to do our best to match you to a lender who can potentially help. If we match you with a lender, then they will be in touch with you. That’s all sorted then! You have a lender without having to do the legwork yourself.
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