How the Banks Calculate Borrowing Capacity

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If you’re in the market for a new home or investment property, you’re probably wondering how much you can afford to borrow. Understanding how the banks calculate your borrowing capacity is a critical first step in the home-buying process. Here’s what you need to know.

What is Borrowing Capacity?

Borrowing capacity is the maximum amount of money that a lender will let you borrow to purchase a property. This amount is based on a range of factors including your income, expenses, credit history, assets, and liabilities. The lender will assess your borrowing capacity to determine how much money they are willing to lend you.

How is Borrowing Capacity Calculated?

The banks use a range of formulas and factors to calculate your borrowing capacity. Here are some of the key elements that go into the calculation:

  1. Income

Your income is one of the primary factors that lenders consider when assessing your borrowing capacity. This includes your salary, wages, bonuses, and any other income streams you may have.

  1. Expenses

Lenders will also consider your expenses when determining your borrowing capacity. This includes things like your living expenses, credit card and loan repayments, and any other regular expenses you have.

HEM, or Household Expenditure Measure, is a benchmark used by Australian banks to assess a borrower’s ability to repay a loan. It’s an estimate of a borrower’s living expenses based on the number of adults and children in their household and their location.

The HEM is calculated using data from the ABS (Australian Bureau of Statistics) Household Expenditure Survey, which measures the average household expenditure for different types of households. The HEM figure varies depending on the number of adults and children in a household, as well as the location and lifestyle factors such as owning a car or eating out.

Banks use the HEM figure to estimate a borrower’s living expenses. Living expenses are subtracted from income to determine borrowing capacity. For example, if a borrower has an income of $80,000 and their HEM figure is $30,000, their borrowing capacity would be $50,000.

It’s worth noting that some lenders may use a higher or lower HEM figure than others, which can impact a borrower’s borrowing capacity. Additionally, some lenders may also take into account a borrower’s actual living expenses, rather than using the HEM figure, which can result in a more accurate assessment of their ability to repay a loan.

Overall, understanding how banks calculate borrowing capacity and the role of the HEM figure can help borrowers to better prepare for the loan application process and make informed decisions about their borrowing options.

  1. Credit History

Your credit history will also play a role in your borrowing capacity. Lenders will look at your credit score and history to determine how reliable you are at repaying debts.

  1. Assets

Your assets, such as savings, investments, and other properties, will also be taken into account when determining your borrowing capacity. These assets can act as security for the loan and may increase the amount that you can borrow.

  1. Liabilities

Your liabilities, such as any outstanding debts or loans, will also be considered when determining your borrowing capacity. The more liabilities you have, the less you will be able to borrow.

Tips for Maximizing Your Borrowing Capacity

If you want to increase your borrowing capacity, there are a few things you can do:

  1. Reduce your expenses: By reducing your living expenses and paying off any outstanding debts or loans, you can improve your borrowing capacity.
  2. Increase your income: Consider taking on additional work or finding ways to increase your income streams to improve your borrowing capacity.
  3. Improve your credit score: By paying bills on time and reducing your debt, you can improve your credit score and increase your borrowing capacity.
  4. Use a mortgage broker: A mortgage broker can help you navigate the lending process and find a lender that is willing to lend you the maximum amount possible.

Calculating your borrowing capacity can be a complex process, but understanding how the banks evaluate your application can help you make informed decisions about your property purchase. By taking steps to improve your credit score and reduce your expenses, you can increase your borrowing capacity and improve your chances of securing a loan that meets your needs.

If you want to get a quick idea of what your borrowing power might be, use our borrowing power calculator or call us and we can help do a more in depth analysis as well as find suitable loan options that meet your borrowing needs.

Karlie Scharfenberg
Karlie Scharfenberg

Director & Senior Finance Broker

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