There are typically two parts to the home buying equation.
In simple terms, it can be expressed as:
Home Purchase Price = Deposit Available + Loan from Financial Institution
Say you have a deposit of $100k, and you will borrow $400k from the bank; your home purchase will end up being $500k, including stamp duty and other costs.
Applying the formula, it will be:
$500,000 (home purchase) = $100,000 (deposit) + $400,000 (loan)
If your deposit is lower, your loan will increase. If your deposit is higher, your loan will decrease. To illustrate,
Lower deposit:
$500,000 (home purchase) = $50,000 (deposit) + $450,000 (loan)
Higher deposit:
$500,000 (home purchase) = $150,000 (deposit) + $350,000 (loan)
No deposit:
$500,000 (home purchase) = $0 (deposit) + $500,000 (loan)
From the above three expressions, the income you need to buy a $500,000 home depends on the loan you need.
Let’s explore the income you need to borrow $400,000, assuming you have a $100,000 deposit.
How do lenders assess borrowing capacity?
In very simple terms, lenders assess your borrowing capacity using the monthly surplus income available to service the loan.
To illustrate,
Borrowing capacity = monthly income – monthly expenses & commitments
In our example of $400,000, they check if you have sufficient surplus to meet the repayments.
Let’s say the interest rate is 6.5%, and the loan term is 30 years.
And for comfort, lenders will add a buffer to the interest rate, let’s say 2%.
The assessment rate then becomes 8.5% with the buffer included.
Using this free mortgage repayment calculator, you can work out the monthly surplus required to service a $400,000 loan.
In our example, you need a surplus of roughly $3,100 each month to qualify for the loan.
Your net monthly surplus is calculated by subtracting all expenses and commitments from your net income.
So, if your commitments and expenses are $2,000 a month, you’ll need a net income of roughly $5,100 to service the debt.
Using this free income calculator, the approximate income you need to buy a $500,000 home, assuming you need a $400,000 loan, is $77,000 gross per year, excluding superannuation.
This is an oversimplified way of calculating your borrowing capacity.
Lenders apply minimum living expenses using a benchmark commonly known as HEM. Your expenses are then calculated based on income, family size, and location. The minimum applies if you are frugal and spend below the benchmark.
The repayments of your commitments are also sensitised with a buffer added to the interest rate.
Other factors that may affect your borrowing capacity are:
- age
- employment type and history
- residential arrangement and history
- account conduct and credit history
- deposit, property type and value
- economic and market factors factors
- lender’s risk appetite, source and availability of funds
The list above is not exhaustive, but it gives us a good idea of how favourable the lender will see your application.
Other factors you need to consider are purchase costs such as stamp duty, government charges, conveyancing, etc. Is your deposit sufficient to cover all these additional costs? Or do you qualify for stamp duty concessions? Click here to find out more.
Increasing borrowing capacity
Considering the borrowing capacity expression:
Borrowing capacity = monthly income – monthly expenses & commitments
The greater the gap between income and expenses, the higher your borrowing capacity will be.
You can increase your borrowing capacity by:
- increasing your income
- decreasing your expenses
- decreasing your commitments – loans, credit cards, interest-free payments, etc.
- combining all of the above
If you are self-employed or have a side hustle, try reducing your expenses, as the net profit is used to calculate servicing, not just the wages you pay yourself (if any).
Some lenders will rely purely on your wages if that is sufficient to service the debt you are seeking, thereby isolating and disregarding your business financials.
The more important question
Regardless of the home you want to buy, the loan the bank will offer, and the deposit you have, what can you afford?
Affordability is measured by your ability to meet the loan repayments. If the bank agrees to lend you $400,000 but your repayment budget only allows for a $300,000 loan, can you source a bigger deposit or buy a cheaper property?
Click here to learn how to calculate your true buying power.
Disclaimers
- This information is provided as general guidance only.
- The figures quoted are indicative and subject to change.
- Individual contracts may vary.
- Based on the information provided, I assume no responsibility for any consequence relating directly or indirectly to any action or inaction you take.
- I cannot guarantee and will not be responsible for any damage or loss related to the accuracy, completeness, or timeliness of the information.
- Approval is not guaranteed and is subject to lender credit assessment criteria.
- Your full financial situation must be considered and reviewed before any offer or acceptance of a loan product.