How to cope with changes in your borrowing capacity
Nothing frustrates a client more than the goal posts moving, whether it’s a real estate agent amending the purchase price, a mortgage broker advising your borrowing capacity has changed or a bank adjusting your interest rate without warning mid-application.
Although almost certainly guaranteed in the current market, change can be a hard pill to swallow. But if you’re aware of what these changes could be, it’s much easier to accept and make peace with them when they occur.
Let’s visit the recent updates to the cash rate, and how this is significantly changing your borrowing capacity.
This time last year, the cash rate was 0.10 per cent and, as at today, it’s 3.60 per cent — the highest it’s been since May 2012.
As the Reserve Bank of Australia (RBA) increases the cash rate, those with a loan are naturally impacted with higher repayments. The effects are also being felt by prospective home buyers who are now dealing with a plummeting borrowing capacity.
For those impacted with a decrease to their borrowing capacity, I’ll go through some ways to counteract the changes, and improve your outlook.
First, let’s start by understanding what’s going on and why borrowing capacities are taking a dive.
The rising cash rate
With a laser focus of returning to an inflation range of 2 to 3 per cent (currently sitting at 7.8 per cent), the RBA has increased the cash rate for a record 10 consecutive times.
The increasing cash rate is reflected in higher interest rates, and higher monthly repayments on your mortgage. When you’re applying for a home loan, the lender will determine your borrowing capacity by assessing your income (which, sadly, is not likely growing in line with the cash rate) against your ability to make those higher repayments.
This means as rates increase, buyers will pay more interest, and the amount they can borrow will decrease.
This is also impacted by lenders stress testing your ability to pay back a home loan at a higher interest rate, typically around 3 per cent higher than the interest rate on offer.
In short, as rates get higher, so does the bar to pass this test.
What does this look like for you?
The impact of these rate hikes cannot be understated, having slashed the borrowing capacity of would-be buyers by tens or even hundreds of thousands of dollars within a matter of months.
A prospective buyer who could borrow $1,440,000 in April last year now only has the capacity to borrow $1,060,000 — that’s a difference of $380,000 in just 10 months.
I’ve put together some further examples of what banks are now offering after the 3.5 per cent increase in the cash rate over the last 10 months, based on a $190,000 household income with no kids:
|
Bank |
April 2022 |
February 2023 |
Change |
|
St George |
$1,445,000 |
$1,075,000 |
$370,000 |
|
Commonwealth Bank of Australia |
$1,440,000 |
$1,060,000 |
$380,000 |
|
Macquarie |
$1,405,000 |
$1,075,000 |
$330,000 |
|
Bankwest |
$1,515,000 |
$1,070,000 |
$445,000 |
|
NAB |
$1,340,000 |
$1,065,000 |
$275,000 |
|
AMP |
$1,440,000 |
$1,060,000 |
$380,000 |
|
ANZ |
$1,435,000 |
$1,065,000 |
$370,000 |
In good news, the governor of the RBA, Philip Lowe, has said he expects inflation to decrease in the year ahead. However, in a statement accompanying the March rate rise, he also noted that the RBA “expects that further tightening of monetary policy will be needed to ensure that inflation returns to target and that this period of high inflation is only temporary”. This means it may be a long road ahead before we see borrowing capacities return to a pre-pandemic level.
What can you do?
Right now, we’re seeing borrowing capacity fall faster than house prices, forcing prospective buyers out of certain markets. For many, it’s time to go back to the drawing board to rethink their plans as the goalpost of home ownership moves further and further away.
If your reduced borrowing capacity has priced you out of your ideal suburb, it may be worthwhile looking at surrounding areas that have a lower entry price for a similar style dwelling.
Take a drive around different neighborhoods to see if they appeal to you. If you are considering a sea/country change, try a weekend away in that area to get a feeling for the local community. Don’t be afraid to try out a few places before locking anything in!
If you are not willing to budge on the suburb, consider purchasing an apartment instead of a house or look at properties that may need a bit of TLC.
How to increase your borrowing capacity by $50k
If you’re still struggling to find a property you can afford with your reduced borrowing capacity, Atelier Wealth has crunched the numbers and put together some options to increase your borrowing capacity by $50,000.
Increase your pay
A $10,000 increase in income is enough to boost your borrowing capacity by $50,000. You can increase your income through a pay rise or by getting a new role with an increase in salary.
Close your credit cards
Lenders will evaluate your credit card by the total limit — no matter if you don’t use it or pay off your balance each month. If you own a credit card, it may be worth switching to one with a lower credit limit or closing off the card completely.
A good rule of thumb is every $1,000 of credit card limit reduces your home loan borrowing capacity by $5,000. So, to increase your borrowing capacity by $50,000, aim for around a $10,000 reduction to your credit card limit.
Cut your expenses
Many people are becoming ruthless in slimming down their living expenses (my family included), ditching eating out, cancelling streaming service subscriptions, opting for public transport where possible and even forgoing holiday plans. For me, my wife has stocked our office with instant coffee and placed a ban on takeaway coffees — much to my despair. I suggest taking a look at Bernadette’s Frugal February series on her LinkedIn for more cost-cutting tips.
Cutting back your daily living expenses will bump up your savings to go towards your property so these small sacrifices will help you get further in the long term.
Go P&I on your loan instead of interest only
If you are leaning towards interest-only repayments for the benefit of having a lower monthly repayment, you will inadvertently reduce your borrowing capacity. For example, if you opt for five years interest-only, the lender will calculate your capacity to repay over the Principal and interest (P&I) loan term — 25 years — which is where you get a reduction in your borrowing capacity.
Also bear in mind that interest-only loans attract a higher interest rate over a P&I loan. This will impact your borrowing capacity too, as the lender applies their assessment rate on the rate of your loan.
Say goodbye to your student debt
When applying for a home loan, a lender will consider your debts including any HECS or HELP debts. Lenders look at your ability to make repayments without experiencing financial hardship, and sometimes a student debt can be a determining factor in their decision to approve a loan.
A HECS/HELP debt on the average Australian income of $90,000 will reduce your borrowing capacity by around $60,000. While not the most urgent debt to pay off, if you do, this will certainly improve your borrowing capacity.
Pay off any car leases or personal loans
Like student debt, lenders will look at your current financial commitments, including any debts from car leases and personal loans. Reducing or paying out these debts will improve your ability to pay off a mortgage and, in turn, increase your borrowing capacity.
Choose your lenders selectively to get you what you want
Your borrowing capacity can change from lender to lender depending on their own criteria, which is why talking to your broker can make a big difference.
At the end of the day, hope is not lost when it comes to getting the best out of your borrowing capacity.
Aaron Christie-David is a director and mortgage broker with Atelier Wealth