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Calculating changes to your borrowing power

By Redom Syed

Promoted by Confidence Finance.

Finance experts are often asked questions about how different types of income/expenses change people's borrowing power.

When applying for a new loan, lenders generally will calculate your overall income and ensure it's higher than your overall 'assessed' expenses. The banks assess the new debt (loosely speaking) you take on at an interest rate of around 7-8% at P&I repayments.

How different types of income/expenses are treated generally depends on a number of factors, including:
(a) the type of income/expense it is;
(b) which lender you look at, they treat different types of income/expenses differently;
(c) how much you're borrowing;
(d) tax rate used;
(e) the banks assessment rate (the 'buffer') that they use to check whether you can service the new loan;
(f) other factors (do you have existing debt with them, interest rate changes, APRA changes, etc).

Given the array of factors, the most common answer given to questions about income/expense changes is that it depends. However, for ease of use, below are some quick ‘back of the envelope' guidelines.

 

1. Salary/Business: Increase the average income earners salary by $10,000, will increase your borrowing power by ~$75,000.

The impact of this will fall for higher income earners, as they will pay a higher marginal tax rate. Given salary rises are potentially infinite, this is the most powerful way to increase your borrowing power long term.

2. Rental: For the average income earner, a $10,000 increase in rental income will increase your borrowing power by ~$50,000.

Can only include 80% of rental income generally. Therefore, it's a bit lower than salary increases. Note there is also an implied cap with many lenders, plenty won’t take yields above 6% into consideration (CBA, NAB). 

Note, when there is investment debt against rental income earned, some lenders will allow those interest payments to be ‘added’ back to offset the taxation consequences of this income (negative gearing). When included, the rental income impact gets closer to salary rises.

3. Credit card limits: Increasing your limit by $10,000, will reduce your borrowing power by ~$35,000.

Credit card limits are generally assessed at 36% p.a. of the credit limit (regardless of whether you use it or not). This reduces your borrowing power by around $35-45k. Note a few lenders will exclude credit card limits if repaid in full every month.

4. Discretionary expenses (above bank minimums) - Increasing your expenses by $10,000 p.a. will decrease your borrowing power by ~$120,000.

Given this comes out of net income, it has more of an effect than gross salary increases. Given part of APRA changes increased minimum living expense figures banks had to use, this had a large impact on decreasing borrowing power.

5. Having another dependent reduces your borrowing by about ~$35,000.

Increasing the number of dependents adds at least $250 p/m to your monthly minimum expenses, depending on your current income level and the lender used. 

Note, the impact of children usually has larger impacts with changes in income too.

6. Going Interest only on a loan for 5 years instead of Principle and Interest repayments on a $500,000 loan will reduce your borrowing power by ~$35,000.

One of the changes APRA forced recently was having banks apply higher effective assessment rates for interest only debt (via shortened loan terms).  

Now, most lenders will assess a 5 year interest only term over a 25 year loan period instead of 30. For a $500k loan, this increases the assessed repayment by a little over $200 p/m, having about a $33,000 impact on your borrowing power.

7. Having ANY HELP debt on a median income will reduce your borrowing power by ~$60,000.

HELP repayments are based on a sliding percentage depending on your income. On an $80,000 income, 6% of your income is withheld to repay this loan. That means an additional expense of $400 p/m. This reduces your borrowing by around $60,000.  

Therefore for some at the edge of servicing that have a small HELP debt, it may make sense to repay this loan. Repayments are based on income, not loan balance/size.

8. Obtaining a novated car lease for a $20,000 vehicle that includes all running expenses instead of a personal loan will reduce your servicing by ~$40,000-60,000.

Novated car leases usually include things like interest, fuel, car servicing, etc, into the monthly repayment amount, whereas personal loans usually have lower repayments because they only include the interest repayment. The other car costs can be included in the banks minimum living expenses for those that have personal loans. Therefore, Novated car leases do more damage as they potentially ‘double dip’ the living expenses.

Note the impact on borrowing power varies significantly depending on the specific arrangements of the lease. I’ve used an online calculator that breaks down the novated car lease costs for a $20,000 car – the additional running costs other than finance equate to around $400 p/m. This varies depending on finance terms, km’s driven (fuel cost impact), etc.

9. Deciding to buy a $500,000 property (100% financed) to live in vs rent @ $500 p/w will reduce your borrowing power by approximately ~$180,000.

The assessed expense for a $500,000 owner occupier mortgage debt is around $3.4k p/m (despite only paying $1.75k p/m in interest). If instead, that someone rented the same place at $500 per week ($2,166 p/m), lenders will take it exactly at $500 p/w in servicing assessment. No loading applied for rental expenses.

In this scenario, that’s a whopping ~$1,250 difference in your monthly expenses. Therefore, under some lender calculators, you’ll be able to borrow $180,000+ more for investments by making the choice to rent instead of buy in this scenario.

More analysis and a detailed explanation of how to manage your portfolio safely is available in our E-book: How to Grow a Multi-Million Dollar Portfolio.

 

At Confidence Finance, we believe that long term property investing is a game of finance and property finance is a science. Understanding how each part of lending works is our specialty. We use this insight to develop a unique understanding about how lending works in Australia. We then use this expertise to help our clients grow, finance and protect successful property portfolios.

 

About the author:

Redom Syed is the CEO & Founder of Confidence Finance. In 2017, he has been recognized as one of Australia’s youngest ever to reach the Top 100 brokers in Australia. Prior to becoming a finance specialist, Redom worked as a Senior Economist at Federal Treasury, where he became a published author on the design of the International Financial System.

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  ["title"]=>
  string(72) "Mortgages in a tighter lending economy and why Brisbane is a good option"
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Tune in to the latest episode of Property Showcase, the podcast with the inside track on the products and businesses that will help turbocharge your portfolio, maximise returns and make your overall investment experience seamless and stress-free!

" ["fulltext"]=> string(818) "

To hear more about these services, make sure to tune in to this episode of Property Showcase!

 Make sure you never miss an episode by subscribing to us now on iTunes!

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Son Pham is the accredited Head of Mortgages at Rethink Financing\/Rethink Investing. He has over 6 years\u2019 experience writing loans, over 12 years in the wealth management industry working for the likes of CBA, AMP and private practice and he is also a licenced financial planner (AFSL 326450). He has multiple investment properties that are cash flow positive which help pay his mortgage on his home and fund his lifestyle.<\/p>\r\n

Son is able to write all types of residential and commercial property loans.<\/p>\r\n

In this episode of Property Showcase, head of mortgages at Rethink investing Son Pham joins host Tim Neary to unpack how an investor should approach getting a mortgage in place with banks tightening down on serviceability.<\/p>\r\n

Hear from\u00a0Son\u00a0about:\u00a0<\/p>\r\n

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    In this episode of Property Showcase, director of investment services for Open Corp Michael Beresford,\u00a0joins\u00a0editor of Real Estate, Tim Neary to share why he disagrees that the cooling market means that the best times are behind us.<\/p>\r\n

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Will Magee has had ambitions to enter into the Australian property market for quite some time, but it has been more than just finances holding him back.  Having been granted permanent residency just two weeks ago, Will is wasting no time and is now in the process of signing papers and finding his first investment property.

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In this episode of the Smart Property Investment Show, Will joins host Phil Tarrant to share why he is purchasing his first property in partnership with his brother, discuss the complications that can arise from such a strategy, and unpack the ongoing plan for building a joint property portfolio with his brother.

Will will also share how they approached saving for their first property, why he is taking out the mortgage in his name exclusively, and share their savings plan for the year ahead.

If you like this episode, show your support by rating us or leaving a review on iTunes (The Smart Property Investment Show) and by following Smart Property Investment on social media: FacebookTwitter and LinkedIn.

If you have any questions about what you heard today, any topics of interest you have in mind, or if you’d like to lend your voice to the show, email [email protected] for more insights!

RELATED AREAS OF INTEREST:

From property in Australia to a ski lodge in Japan
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A property investment plan years in the making
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Median house prices in regional Victoria outperformed that of Melbourne in the June quarter, the latest REIV figures reveal. 

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Median house prices in the regions rose 4.0 per cent to $419,500 but in Melbourne they dipped by 0.6 of a percentage point to $840,000.

The result in Melbourne was due to a 0.8 of a percentage point fall in prices achieved at auction; this was despite a lift of 2.3 per cent in private sales.

Inner Melbourne suffered due to auction prices, where median prices fell by 4.9 per cent to $1,459,000 but it was middle Melbourne that was hardest hit, with a 5.4 per cent drop to $974,500.

Outer Melbourne had a good quarter with the median rising by 0.5 of a percentage point to $681,000.

Apartment prices in regional Victoria grew by 3.7 per cent to $304,500 while the metro media was up by 0.5 of a percentage point to $604,000.

REIV President Richard Simpson said that despite fewer sales, many sectors of the market were performing well.

“2017 was a bumper year and while the trendline has flattened, despite the fall in median house prices in the June quarter, median prices are still up this calendar year for both houses and units, in Melbourne and in the regions,” Mr Simpson said. 

In particular there was been strong growth in regional centres which is probably due to the first-home buyers’ concessions said Mr Simpsons.

“The first-home buyers’ concession has been a boon for regional areas. A new entrant to the property market buying a house at the regional median will pay no stamp duty, while a first home buyer of an apartment in Melbourne at the median price would pay stamp duty of nearly $25,000,” he said.

Mr Simpson said that more prospective buyers are looking towards regional Victoria which is also having an effect in Melbourne.

“Melbourne’s outer perimeter continues to grow. Small increases in the June quarter mean that the median prices for both houses and units have risen over 10.5 per cent from a year ago.

Mr Simpson said moving forward that vendors need more realistic expectations as the highs of 2017 are now over.

“Negative chatter about the future of the sector coupled with stronger lending controls by financial institutions has created some uncertainty and vendors need to be realistic with their price expectations,” Mr Simpson said.

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Regional Victoria showing up Melbourne in price performance, new data finds

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