How to Calculate Your Borrowing Capacity for a Home Loan in Australia: A Step-by-Step Guide

Understanding your borrowing capacity is the first and most critical step in your property buying journey. Whether you’re a first-home buyer, upgrading, or refinancing, knowing how much you can borrow helps you set a realistic budget and avoid disappointment. In this guide, we’ll break down exactly how Australian lenders calculate your borrowing power, the key factors that influence it, and provide a practical step-by-step method to estimate your own borrowing capacity.


What Is Borrowing Capacity?

Borrowing capacity—also called borrowing power—is the maximum amount a lender is willing to lend you for a home loan, based on your financial situation. It’s not just a simple multiple of your income; lenders use a detailed assessment to ensure you can comfortably afford repayments, even if interest rates rise or your circumstances change.

In Australia, responsible lending laws require lenders to verify your financial position thoroughly before approving a loan. This means they’ll scrutinise your income, expenses, debts, credit history, and the size of your deposit. The goal is to ensure you won’t experience “mortgage stress,” typically defined as spending more than 30% of your pre-tax income on repayments.

Key Factors That Determine Your Borrowing Capacity

Lenders assess several core factors when calculating your borrowing capacity. Understanding these will help you see where you stand and what you can improve.

1. Income

Your income is the foundation of your borrowing power. Lenders consider:

• Gross annual salary or wages (before tax)
• Regular overtime or bonuses (usually averaged over two years)
• Rental income (if you own investment properties)
• Self-employed income (typically averaged over two years’ tax returns)
• Other income such as dividends, government benefits, or child support

Lenders will verify your income with payslips, tax returns, and bank statements. Any income that is inconsistent or hard to verify may be discounted or excluded.

2. Living Expenses

Under responsible lending rules, lenders must assess your actual living expenses, not just use a standard benchmark. They’ll look at your bank statements to see how much you spend on:

• Groceries
• Utilities
• Transport
• Entertainment
• Insurance
• Childcare
• Other regular commitments

If your expenses are higher than the Household Expenditure Measure (HEM)—a minimum benchmark used by lenders—they’ll use your actual spending. Reducing discretionary spending in the months before applying can boost your borrowing capacity.

3. Existing Debts and Commitments

All your current debts reduce your borrowing power because they consume income that could otherwise go toward mortgage repayments. Lenders consider:

• Credit card limits (not just balances)
• Personal loans
• Car loans
• HECS/HELP debt
• Buy now, pay later accounts
• Existing mortgages

Even if you pay off your credit card each month, the lender will often assess repayments based on the full credit limit. Reducing limits or closing unused cards can help.

4. Credit Score and History

Your credit score reflects your reliability as a borrower. A higher score can give you access to more lenders and better rates, while a low score may limit your options. Lenders also check your credit report for any defaults, late payments, or frequent credit applications.

5. Loan Type, Term, and Interest Rate

• Loan type: Principal-and-interest loans are assessed more favourably than interest-only loans because the debt reduces over time.
• Loan term: A longer term (e.g., 30 years) reduces monthly repayments, potentially increasing your borrowing capacity, though you’ll pay more interest overall.
• Interest rate: Lenders assess your ability to repay at a “serviceability rate”—usually 3% above the actual loan rate—to ensure you can handle future rate rises.

6. Deposit and Lenders Mortgage Insurance (LMI)

A larger deposit reduces the loan-to-value ratio (LVR), making you a lower risk. If your deposit is less than 20%, you’ll likely need to pay LMI, which protects the lender but adds to your costs. LMI doesn’t directly increase your borrowing capacity, but a bigger deposit can help you avoid it and potentially borrow more.

Step-by-Step: How to Estimate Your Borrowing Capacity

While only a formal pre-approval gives you a definitive figure, you can get a reliable estimate by following these steps.

Step 1: Calculate Your Gross Annual Income

Add up all verifiable income sources. For most employees, this is your base salary plus any regular extras like bonuses or overtime. Self-employed individuals should use the average of the last two years’ taxable income.

Example:

• Base salary: $90,000
• Regular overtime: $5,000
• Total gross income: $95,000

Step 2: Determine Your Monthly Net Income

Lenders use net income after tax (and often after other deductions) to calculate what you can afford. Use an online tax calculator or your payslips to estimate your monthly take-home pay.

For a $95,000 gross income, monthly net income might be around $5,800 (depending on your circumstances).

Step 3: List All Monthly Expenses

Review your bank statements for the last three months and categorise your spending. Be honest—lenders will check. Include:

• Rent or current mortgage payments
• Utilities (electricity, gas, water)
• Groceries
• Transport (fuel, public transport)
• Insurance (health, car, home)
• Childcare or education costs
• Entertainment and subscriptions
• Any other regular payments

Example monthly expenses:

Step 4: Account for Existing Debt Repayments

Add up all monthly repayments for:

• Credit cards (use 3% of the total limit as a notional repayment)
• Personal or car loans
• HECS/HELP (calculated as a percentage of income)
• Any other debts

Example:

• Car loan repayment: $400
• Credit card limit $5,000 (3% = $150)
• Total debt repayments: $550

Step 5: Calculate Your Surplus Income

Subtract your total expenses and debt repayments from your net income.

Example:

• Net income: $5,800
• Less expenses: $4,300
• Less debt repayments: $550
• Surplus: $950

This surplus is what you have available for mortgage repayments, but lenders will also apply a buffer.

Step 6: Apply the Lender’s Assessment Rate

Lenders don’t use the current interest rate; they use an assessment rate (often around 9% p.a., though this varies). This ensures you can still afford the loan if rates rise.

Using a mortgage calculator, input:

• Loan amount (try different figures)
• Term: 30 years
• Interest rate: 9% (assessment rate)
• Repayment type: principal and interest

Find the loan amount where monthly repayments equal your surplus. That’s your estimated borrowing capacity.

Example calculation:

• Surplus: $950/month
• At 9% over 30 years, monthly repayments per $100,000 borrowed are about $805.
• $950 / $805 × $100,000 = approximately $118,000

But wait—that seems low! This is because the assessment rate is high, and we haven’t accounted for the fact that your rent will be replaced by mortgage repayments. A more realistic approach is to use a comprehensive online borrowing capacity calculator, which factors in the lender’s assessment rate and the replacement of rent with mortgage costs.

Step 7: Use an Online Calculator for a More Accurate Estimate

Most lenders and comparison sites offer free borrowing capacity calculators. These tools incorporate typical lender policies and assessment rates. Input your income, expenses, debts, and deposit size to get a realistic range.

Example using a typical online calculator:

• Gross annual income: $95,000
• Monthly expenses: $4,300 (excluding rent, as this will be replaced)
• Car loan: $400/month
• Credit card limit: $5,000
• Deposit: $100,000

Estimated borrowing capacity: $450,000 – $520,000

This range depends on the lender and the specific calculator’s assumptions. Always use a few different calculators to get a broader picture.

How Different Lenders Assess Borrowing Capacity

Not all lenders use the same criteria. Some specialise in certain professions or offer higher borrowing power. Here’s a comparison of typical policies:

Always compare multiple lenders, as borrowing capacities can vary by tens of thousands of dollars.

Common Mistakes That Reduce Your Borrowing Capacity

Avoid these pitfalls when preparing your finances:

• High credit card limits: Even if you don’t use them, the limit is assessed as a liability.
• Unnecessary subscriptions: Streaming services, gym memberships, and other recurring costs add up.
• Frequent job changes: Lenders prefer stable employment (usually 6–12 months in the same role).
• Applying with multiple lenders at once: Multiple credit enquiries can lower your credit score.
• Not checking your credit report: Errors can reduce your score. Get a free copy and fix any mistakes.

How to Increase Your Borrowing Capacity

If your estimated borrowing power is lower than you’d like, consider these strategies:

1. Reduce expenses: Cut discretionary spending for at least three months before applying.
2. Pay down debts: Close unused credit cards and pay off personal loans if possible.
3. Increase your deposit: A larger deposit reduces LVR and may help you avoid LMI.
4. Improve your credit score: Pay bills on time, limit credit applications, and correct errors.
5. Consider a guarantor: A family member can use their property as security, increasing your borrowing capacity without a larger deposit.
6. Choose a longer loan term: Extending to 30 years reduces monthly repayments (though you’ll pay more interest).
7. Shop around: Different lenders have different policies; a mortgage broker can help find the best fit.

The Role of Pre-Approval

Once you’ve estimated your borrowing capacity, the next step is to get pre-approval (also called conditional approval). This is a lender’s written indication of how much they’re willing to lend you, based on a preliminary assessment. Pre-approval gives you confidence when making offers and shows agents you’re a serious buyer.

To get pre-approval, you’ll need:

• Proof of income (payslips, tax returns)
• Bank statements (usually 3–6 months)
• Identification documents
• Details of assets and liabilities

Pre-approval typically lasts 3–6 months and is subject to a property valuation and final credit check.

FAQ

How accurate are online borrowing capacity calculators?

Online calculators provide a good estimate, but they can’t account for every lender’s specific policies or your unique circumstances. They’re a useful starting point, but for a definitive figure, speak to a mortgage broker or apply for pre-approval.

Can I borrow more if I have a larger deposit?

Yes, a larger deposit reduces the loan-to-value ratio (LVR), which lowers the lender’s risk. This can increase your borrowing capacity and help you avoid LMI, which can be a significant cost saving.

Does my HECS/HELP debt affect borrowing capacity?

Yes. Lenders treat HECS/HELP as a liability because repayments are deducted from your income through the tax system. The debt amount and your repayment income threshold are factored into your overall assessment.

How can I find out my credit score?

You can obtain a free credit score from credit reporting bodies like Equifax, Experian, or Illion. Many online services also provide free scores and reports. Check your score well before applying for a home loan.

What is the Household Expenditure Measure (HEM)?

The HEM is a benchmark used by lenders to estimate minimum living expenses. It’s based on the average spending of Australian households. If your actual expenses are lower than the HEM, the lender will use the HEM. If your expenses are higher, they’ll use your actual spending.

References

1. Australian Securities and Investments Commission (ASIC). “Responsible lending.” MoneySmart, 2024. https://moneysmart.gov.au/borrowing-and-credit/home-loans/responsible-lending
2. Australian Prudential Regulation Authority (APRA). “Prudential Practice Guide APG 223 – Residential Mortgage Lending.” APRA, February 2023. https://www.apra.gov.au/sites/default/files/2023-02/APG%20223%20-%20Residential%20Mortgage%20Lending.pdf
3. Reserve Bank of Australia. “Household Debt and Mortgage Stress.” RBA Bulletin, December 2023. https://www.rba.gov.au/publications/bulletin/2023/dec/household-debt-and-mortgage-stress.html
4. Commonwealth Bank of Australia. “How much can I borrow?” CBA website, 2024. https://www.commbank.com.au/home-loans/calculators/how-much-can-i-borrow.html
5. Money.com.au. “Borrowing Power Calculator.” Money.com.au, 2024. https://www.money.com.au/calculators/borrowing-power-calculator