How to Calculate Borrowing Capacity for a Home Loan in Australia: A Comprehensive Guide

Understanding your borrowing capacity is the first step toward buying a home in Australia. Lenders don’t just look at your income—they assess your entire financial situation to determine how much you can comfortably repay. This guide explains exactly how borrowing capacity is calculated, what factors influence it, and how you can improve your chances of securing a larger loan.


What Is Borrowing Capacity?

Borrowing capacity, also known as borrowing power, is the maximum amount a lender is willing to lend you for a home loan. It’s not a fixed number—it varies between lenders and depends on your financial profile. Lenders use a serviceability assessment to ensure you can afford the loan repayments, both now and if interest rates rise.

This assessment is guided by the Australian Prudential Regulation Authority (APRA) and the Australian Securities and Investments Commission (ASIC). Under responsible lending laws, lenders must verify your financial situation and ensure the loan is not unsuitable for you.

Key Factors That Determine Your Borrowing Capacity

Lenders consider several factors when calculating how much you can borrow. Here are the most important ones:

1. Income

Your income is the foundation of your borrowing capacity. Lenders look at:

• Base salary or wages: For PAYG employees, lenders use your gross annual income.
• Variable income: Overtime, bonuses, commissions, and allowances may be included, but often at a reduced rate (e.g., 80% of the average over two years).
• Self-employed income: If you’re self-employed, lenders typically require two years of tax returns and financial statements. They may use your net profit or an adjusted figure.
• Rental income: If you own investment properties, lenders may include a portion of the expected rental income (usually 75–80% to account for vacancies and expenses).
• Other income: Government benefits, child support, dividends, and trust distributions may be considered if regular and verifiable.

2. Expenses

Lenders scrutinise your living expenses to ensure you have enough surplus income to cover loan repayments. They look at:

• Household Expenditure Measure (HEM): A benchmark used by many lenders to estimate basic living costs based on your household size and location. If your declared expenses are lower than the HEM, lenders will typically use the HEM as a floor.
• Declared expenses: You must provide a breakdown of your actual spending on groceries, utilities, transport, childcare, education, insurance, entertainment, and more.
• Discretionary spending: Lenders will examine your bank statements for regular spending on dining out, subscriptions, and holidays.

3. Existing Debts

Your current debt obligations reduce your borrowing capacity. Lenders consider:

• Credit cards: Even if you pay off the balance monthly, lenders assume you could use the full limit. They typically calculate repayments at 3% of the credit limit per month.
• Personal loans and car loans: Monthly repayments are deducted from your income.
• HECS/HELP debt: While interest-free, these debts reduce your net income and are factored into your assessment.
• Buy Now Pay Later (BNPL) services: Afterpay, Zip Pay, and similar services are treated as ongoing expenses. Lenders will ask for statements and include them in your liabilities.

4. Credit History

Your credit report plays a crucial role. Lenders check:

• Credit score: A higher score indicates lower risk. Scores above 700 are generally considered good.
• Repayment history: Late payments, defaults, or bankruptcies can significantly reduce your borrowing capacity or lead to loan rejection.
• Credit enquiries: Multiple applications in a short period can signal financial stress.

5. Loan Type and Features

The type of loan you choose affects your borrowing capacity:

• Principal and interest (P&I) vs. interest-only (IO): IO loans have lower initial repayments but lenders may assess you on the P&I rate over the remaining term.
• Fixed vs. variable rate: Lenders often assess fixed-rate loans at the higher of the fixed rate or a buffer rate.
• Loan term: A longer loan term reduces monthly repayments but increases total interest. Lenders typically use a 30-year term for assessment.

6. Interest Rate Buffer

APRA requires lenders to add a buffer of at least 3% to the loan’s interest rate when assessing serviceability. For example, if your loan rate is 6%, lenders will assess your ability to repay at 9%. This ensures you can handle future rate rises. Some lenders use their own floor rate, which may be higher.

7. Dependants

The number of dependants (children or other family members) affects your living expenses and borrowing capacity. Lenders have standardised costs for dependants based on age.

8. Property Type and Location

The property you’re buying can influence your borrowing capacity:

• Standard residential: Easiest to finance.
• Apartments in high-density areas: Some lenders restrict lending if there’s an oversupply.
• Rural or remote properties: May require a larger deposit or have lower loan-to-value ratio (LVR) limits.

How Lenders Calculate Your Borrowing Capacity

Lenders use a net surplus method to determine borrowing capacity. Here’s a simplified formula:

1. Gross income – Tax = Net income
2. Net income – Living expenses – Existing debt repayments – Proposed loan repayments (including buffer) = Net surplus

If the net surplus is positive, you pass the serviceability test. The maximum loan amount is the one where the net surplus just reaches zero.

Lenders also consider the loan-to-value ratio (LVR). If your deposit is less than 20%, you’ll need Lenders Mortgage Insurance (LMI), which can reduce your borrowing capacity because LMI premiums are added to the loan amount.

Example Calculation

Let’s say you’re a single applicant with:

• Gross annual income: $100,000
• Monthly living expenses: $2,500
• Credit card limit: $10,000
• No other debts
• Desired loan: $400,000 over 30 years at 6% interest

Lender assessment:

• Monthly gross income: $8,333
• Tax (approx. 30%): $2,500
• Net monthly income: $5,833
• Living expenses (using HEM if higher): $2,500
• Credit card repayment (3% of limit): $300
• Proposed loan repayment at 6%: $2,398
• Buffer repayment at 9%: $3,218

Using the buffer rate: $5,833 – $2,500 – $300 – $3,218 = -$185 (deficit). This means you might not qualify for a $400,000 loan. You’d need to reduce the loan amount, increase income, or cut expenses.

Comparison of Lender Assessment Criteria

Different lenders have varying policies. Here’s a comparison of how some major Australian lenders treat common income and expense items:

Note: Policies change frequently. Always check with a mortgage broker or lender for current criteria.

Practical Tips to Improve Your Borrowing Capacity

If your borrowing capacity is lower than expected, here are actionable steps to boost it:

1. Reduce or Cancel Credit Cards

Lowering your credit card limit or closing unused cards can significantly increase your borrowing power. Even a $10,000 limit can reduce your capacity by around $30,000–$40,000.

2. Pay Down Debts

Eliminate personal loans, car loans, and BNPL balances. This frees up income and improves your credit score.

3. Cut Discretionary Spending

Lenders review your bank statements for at least three months. Reduce non-essential spending well before applying. Cancel unused subscriptions and limit dining out.

4. Increase Your Deposit

A larger deposit reduces the LVR and may eliminate the need for LMI, increasing your borrowing capacity.

5. Consolidate Debts

If you have multiple high-interest debts, consolidating them into a single lower-interest loan can improve serviceability.

6. Choose a Suitable Loan Product

Some lenders offer professional packages or loans with lower assessment rates for certain professions (e.g., medical, legal). A mortgage broker can help you find the most generous lender for your situation.

7. Get a Guarantor

A family guarantee can help you borrow more without LMI, but the guarantor’s finances will also be assessed.

8. Improve Your Credit Score

Pay bills on time, correct any errors on your credit report, and avoid multiple credit applications.

Common Mistakes That Reduce Borrowing Capacity

• Underestimating living expenses: Be realistic. Lenders will cross-check with bank statements.
• Applying with multiple lenders: Each application leaves a credit enquiry, which can lower your score.
• Changing jobs before applying: Lenders prefer stable employment. Probation periods can be a red flag.
• Ignoring BNPL accounts: Even small BNPL limits are treated as ongoing commitments.

Using a Borrowing Capacity Calculator

Online borrowing capacity calculators can give you an estimate, but they’re not a substitute for a full lender assessment. They typically use the HEM and standard buffer rates. For a more accurate figure, speak to a mortgage broker who can assess your situation against multiple lenders’ policies.

FAQ

1. What is a good borrowing capacity for a home loan in Australia?

There’s no universal “good” amount—it depends on your income, expenses, and property goals. As a rough guide, many lenders will lend up to 6–7 times your annual income, but this varies widely. A mortgage broker can help you understand what’s realistic.

2. How can I increase my borrowing capacity quickly?

The fastest ways are to reduce or cancel credit cards, pay off existing debts, and cut discretionary spending. Even small changes can have a big impact because lenders use a buffer rate and conservative expense estimates.

3. Does Afterpay affect my borrowing capacity?

Yes. Buy Now Pay Later services like Afterpay are treated as ongoing expenses. Lenders will ask for your statements and include the repayments in your living costs. It’s best to close or limit these accounts before applying.

4. Can I borrow more if I have a guarantor?

A guarantor can help you borrow up to 100% of the property value without paying LMI, effectively increasing your borrowing capacity. However, the guarantor’s financial situation will be assessed, and they are liable if you default.

5. How does a HECS debt affect my borrowing capacity?

HECS/HELP debt reduces your take-home pay because repayments are deducted from your salary. Lenders include it as a liability, which lowers your net income and borrowing power.

References

1. Australian Prudential Regulation Authority (APRA) – Prudential Practice Guide APG 223 Residential Mortgage Lending (2023). Retrieved from https://www.apra.gov.au
2. Australian Securities and Investments Commission (ASIC) – Responsible lending guidance (2024). Retrieved from https://asic.gov.au
3. Commonwealth Bank of Australia – Home loan borrowing power calculator and lending criteria (2024). Retrieved from https://www.commbank.com.au
4. Westpac Banking Corporation – Home loan serviceability assessment (2024). Retrieved from https://www.westpac.com.au
5. Australian Taxation Office – HECS-HELP repayment thresholds and rates (2024). Retrieved from https://www.ato.gov.au