How much should you borrow

Amid speculation of further interest rate rises, flow on effects from problems in the US sub-prime mortgage market and a recent cautioning by the Federal Treasurer Peter Costelloabout high risk lenders, it seems a wise time to think less about how much you can borrow, and more about how much you should borrow.

Your home loan borrowing capacity will vary significantly between lenders because they all use different formulas to calculate the amounts. It’s easy enough to find out, as most banks and large non-bank lenders have an online borrowing calculator. So we tested five bank calculators, the results showing maximum borrowing amounts varying by up to $20,000 on a $55,000 (gross) yearly salary. And this doesn’t even touch on non-bank lenders who now account for around 30 percent of the mortgage market.

So when you’re making one of the biggest investments of your life, how do you measure what’s a safe amount to borrow? The consensus seems to be around 30-40%. The Mortgage and Finance Association of Australia says that when determining your borrowing limit, lenders will take into account your income and expenses, estimated repayments, loan serviceability, your assets and liabilities, lifestyle and the size of your deposit. They use what is called the debt-service ratio - the ratio of loan repayments to your gross income. For single income earners, this ratio should not exceed 35%. For double income earners, the ratio should not exceed 40%.

But there are additional practical steps you can take to increase your borrowing power.

Pay off your credit card or just reduce your limit
As a general rule, lenders don’t like to see any debt so the first thing to look at is your credit card. You may not be able to pay off your card in full but even reducing your credit card limit will help because it lowers the risk of you running into financial difficulty. Resolving any outstanding credit issues will also give you a clean slate.

Consolidate your debts
If you have a car loan or a personal loan for another purpose, consider looking around to see if you can refinance to a lower rate of interest. 

Save a bigger deposit
The more you save, the less you need to borrow. And the less you borrow the less interest you will pay. If you save 20% of your home’s purchase price, you will also save by not paying mortgage insurance.

Get your loan pre-approved
It’s a good idea to know where you stand upfront, so you are borrowing based on what you can afford, not on the type of house you think you should be living in. Simply ‘pre-qualifying’ for a loan doesn’t guarantee you will get it. Try to be pre-approved, so you know your spending limit and there will be no hassles when you find the perfect home and want to put in an offer.

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