When applying for a home loan, lenders typically look at how much you earn and how much you spend to determine your overall borrowing capacity.

However, they also assess the type of lender you are and what kind of risk you might present to them.

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Income

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Lenders will first look at your income to determine how much they can lend you. While the figure itself is important, they are also interested in how regular or secure that income is.

If you’ve just started a new business, that is less appealing to a lender than a full-time employee who has been at the same job for five years.

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Expenses

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Lenders will look at your regular expenses, both in terms of fixed costs and how you spend your money.

The first thing most banks will want to know is how much debt you already have and what your regular repayments might be. There’s no way to avoid those obligations, so if they are too high, a lender might consider you at risk of defaulting on a loan. To improve borrowing capacity, you can potentially consolidate some higher interest debts.

The second part of the expense evaluation will be your personal spending habits. If you’re a single person living at home with your parents, your expenses are very different to a married family with four kids.

Lenders ask you to estimate your weekly bills, which they cross-reference with your bank statements from the past three months.

However, most lenders will apply a minimum dollar allocation to expenses known as the Household Expenditure Measure (HEM), which is used to use to estimate a borrower’s living expenses.

You can potentially boost your borrowing capacity by cutting back on your regular expenses, however, lenders will still apply the HEM to your monthly estimate of living costs.

Creditworthiness

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All lenders will assess what type of borrower you are. If you have a good record with borrowed money, that will normally mean you have a good credit rating.

Lenders will look at your credit rating, and if it’s low, you might be either declined or forced to pay higher interest rates. This will lead to a lower borrowing capacity as well.

Different lenders will take varying approaches when dealing with low credit score borrowers. A normal lender will not charge higher interest because of your credit score. Instead, they are more likely to decline your application. A specialist lender may lend to someone with a low credit score, but will likely charge a higher interest rate.

When you have determined the type of lender and the interest rate you’ll be paying based on your credit risk and job security, you will be able to determine your borrowing capacity.

Lenders will assess your home loan application based on the underlying interest rate plus a serviceability buffer. This is around 3% above the current interest rate.

Lenders want to make sure you will be able to pay back a loan and won’t be in financial stress by doing so. They also want to know that, should interest rates rise in the future, you’ll have the capacity to withstand those higher costs based on your income level and expenses.

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