Together with mortgage broker Maddie Wilson, Tash and Ana explore what really impacts borrowing capacity, uncover surprising strategies to boost it, and break down common misconceptions.
Whether you're a first-time buyer or looking to expand your property portfolio, this episode is packed with actionable insights that could help you maximise your mortgage potential.
Understanding borrowing capacity
Borrowing capacity refers to the amount a bank is willing to lend based on your financial situation. As Maddie explains, it’s not just about how much you want to borrow but how much the bank believes you can afford in repayments.
When you’re applying for a home loan , lenders assess your financial situation to determine a loan amount that aligns with your position. While it might seem like a straightforward calculation, many borrowers are surprised by the figures – sometimes feeling they can afford more, or in other cases, being shocked by how much they’re offered.
Ana reflects on how surprising borrowing limits can be. "Every time I've checked how much I could borrow, I've been shocked by the amount," she says. "My mum even said: 'Oh, that’s way too much!'"
Maddie agrees, adding that when interest rates were low, banks were happy to lend more, but now that rates have risen, her repayments have doubled. This effectively means her borrowing capacity has been cut in half.
Key factors affecting borrowing capacity
The trio dives into the three major factors banks consider when determining borrowing capacity:
- Income – Your salary, wages, and any additional earnings.
- Expenses – Your spending habits , including essential and discretionary spending.
- Debts – Any outstanding loans, credit cards, and other financial obligations.
Ana is surprised to learn that some expenses, like private health insurance, are considered fixed and can affect borrowing capacity in unexpected ways.
Maddie explains: "If you're above the Medicare levy surcharge threshold, the bank assumes you'll have to pay it and factors it into your expenses. They look at your income and demographic and estimate how much they think you should be spending each month, regardless of whether your actual spending is lower."
Managing debts to increase borrowing power
Maddie outlines how debts can significantly impact borrowing power. She warns about credit cards, explaining: "If you have a $10,000 credit card limit, even if you don’t use it, the bank assumes you could max it at any point in time. They'll take whatever the minimum repayments would be on that."
HECS debt plays a significant role in borrowing capacity, but not in the way many people assume. The actual debt amount is less important than the repayment percentage, which is determined by income level. Higher incomes result in larger HECS repayments, impacting how much lenders believe a borrower can afford in mortgage repayments.
Ana considers whether paying off a HECS loan early is a good strategy. Maddie explains that it depends on the situation. In some cases, eliminating a HECS debt can increase borrowing power, but only if the reduction in repayments meaningfully boosts the loan amount offered. If clearing HECS results in only a marginal increase in borrowing capacity while depleting cash reserves, it may not be worth it.
"If you have a $40,000 HECS debt and you're in the $100,000 threshold, and having HECS reduces your borrowing capacity by 30 grand, it doesn't make sense to pay off, does it?" she says.
"Because you only get to increase your borrowing capacity by 30 grand, but your cash is reduced by 40."
Increasing income to boost borrowing power
To counteract debt, increasing income can also help. Maddie suggests a few ways to do this:
- Negotiating a pay rise – Asking for a salary increase at your current job.
- Taking on a second job – Maddie shares: "That's what I did to help buy my home!"
- Overtime and allowances – She explains: "If you've been in your job for three years and you do a lot of overtime, and it's this time of the year, a lot of banks will only look at three months and then they'll annualise."
Ana wonders how banks treat income from investments like shares. Maddie explains that dividend income can be included, but must appear on a tax return and be realised gains. This means the dividends have to be received as cash rather than reinvested into additional shares .
Property investment and borrowing power
Tash brings up a common topic in property circles – using trusts to boost borrowing power. This involves structuring property purchases under a trust rather than an individual’s name, which can help separate liabilities and manage risk, potentially increasing borrowing capacity.
Maddie explains that while trusts can work, they require a long-term strategy.
"If a property is in a trust, you can't negatively gear that," she says. "It's not going against your personal income because it's not in your name – it's in the trust's name."
Maddie confirms that borrowers may only boost their capacity if properties are positively geared. This means the rental income exceeds all expenses, including loan repayments, so the property generates a surplus rather than a shortfall.
The impact of children on borrowing capacity
Ana, who's a parent, raises an important question: "How much do kids affect borrowing power?"
Banks factor in dependents when assessing borrowing power, often making automatic reductions without requiring detailed expense breakdowns. Even if actual childcare costs are low, simply having kids can reduce borrowing capacity significantly, as lenders assume a fixed financial burden associated with raising children.
Maddie confirms that children are a major factor. "As soon as you say that you have a dependent, it's a hit that can take off, say, 50 grand from the bank capacity," she says.
The discussion moves to parental leave, with Ana recalling friends who faced challenges securing a mortgage while on leave.
Maddie explains: "Banks usually need a return-to-work letter specifying your salary and hours when you come back. If you're switching from full-time to part-time, they'll assess your capacity based on the lower income."
Boosting your borrowing power
Maddie shares her top tips for increasing borrowing power:
- Increase income – Seek pay rises, take on side gigs, and maximise overtime.
- Reduce expenses – Cut back on discretionary spending and aim to live below the bank’s minimum expense benchmark.
- Lower debts – Consider paying down credit cards, personal loans, and HECS if it meaningfully boosts borrowing power.
- Use investment income wisely – Ensure dividends and other passive income sources are structured to benefit borrowing capacity.
- Plan for children and life events – Consider the impact of dependents, parental leave, and changes in employment.
Maddie leaves listeners with a key piece of advice: "Have a look at your savings. Have a look at what your rent is. Add them together. See what that looks like and what that will compare to a mortgage repayment. If it's less, then we calculate how much you need to save extra to practice a mortgage repayment and borrowing costs and body corporate insurances."
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Happy investing!
