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The strength of your borrowing capacity can have a significant effect on your property investment opportunities. As such, knowing your borrowing capacity and focusing on ways to improve it is an important step that serious investors should look at.
According to Ron Jeppesen, owner at Mortgage Choice Bundaberg, the most important factor in determining one’s borrowing capacity is their personal debt, including credit card debt and personal loans.
Total maximum credit limits are used to determine what the maximum monthly repayments are on your cards (i.e. 3 per cent of your total maximum credit limit). This helps the lender develop a sense of what your maximum monthly outgoings could increase to, explains Jeremy Cabral, editor at Finder.com.au.
Some of the other most important factors that Mr Cabral says determine your borrowing capacity include the value of the property, your guarantor, the term of the loan, market conditions, your net income after tax, your choice of lender, and the lender’s mortgage insurance.
“Many borrowers get confused with the concept of Lender’s Mortgage Insurance (LMI),” Mr Cabral says, “but it’s important to remember that it protects the lender in the case that a borrower defaults. LMI allows people to borrow over 80 per cent loan to value ratio (LVR). Buyers can borrow a maximum of 95 per cent of a property’s value using LMI. LMI doesn’t impact your borrowing capacity at the pre-approval stage, but may be required in order for you to get the loan,” he says.
A lack of understanding about this can lead to misconceptions about how much one can really borrow. While Mr Jeppesen says many of his clients have a fairly accurate idea of their borrowing capacity thanks to the prevalence of online calculators, Mr Cabral says that the errors in perception that do occur are two-fold.
“Firstly, borrowers often need to use a mortgage repayment calculator to work out that whether their projected monthly repayments are affordable. If your repayments are going to be twice your current rent, you could be in significant managing that cash-flow difference,” he says.
“A second error in perception is the savings level required to avoid Lenders Mortgage Insurance. Sure, a 20 per cent deposit is a worthy target, but after tax and buying costs, you likely need 25 per cent, as upfront taxes and buying costs can be around 5 per cent of the purchase price. So, on a $400,000 property, the savings required is actually $100,000 as opposed to what people immediately perceive as $80,000 (20 per cent of a property purchase price).”
With all this in mind, the question remains: How can you improve your borrowing capacity? There are a number of methods that can be used, according to Mr Cabral.
- Reduce credit card maximum limits
Lenders take credit cards into account when they work out how much you can borrow. Working on reducing your credit card debts to one card can help with this.
- Repay debts and/or reduce the amount of interest paid on debts
A key action would be to budget and work on reducing any outstanding debts as it will impact on what you are able to borrow
- Reduce regular expenses
Check your regular expenses and cut down on what you don’t need as lenders may mark them as a regular commitment.
- Reduce taxation to increase net income
Using an accountant to reduce tax paid on investments and income works to increase borrowing power, because the after-tax income is higher than previously. This tip is mainly for people who’ve been doing their own tax and have yet to engage professional assistance.
- Consider a fixed loan
If you are considering a fixed loan, the majority of lenders could add an average of 1.5% p.a. buffer on top of the standard variable interest rate. This is the new rate that your lender will assess your loan against because your repayments will be fixed for a period.
- Increase your income
When you get a promotion at work, or when you get your tax back its recommended you put 50% of it into a savings account (if you are saving for a deposit.)
- Keep financial records
By keeping good financial records you will be more aware of where your money is going and what is is doing. This enables you to plan for the future of your business and budget for your new mortgage repayments.
- Check your credit file and attempt to resolve any issues
If you’re unsure on how your credit is shaping up then you might consider checking Veda. They can send you a free report within 10 days, or you can pay an express processing fee of around $30.
- Increase your deposit
By increasing your deposit size you can increase your borrowing capacity. Lenders like to see you’ve consistently saved for your deposit because it then shows you can make regular repayments towards your loan.