Why Income is Key to Getting Your Loan Approved?

When you’re applying for a home or investment loan, your income is one of the most important factors lenders consider. It helps them decide if you can afford the loan and how much they’re willing to lend you.

What is Borrowing Capacity and Why Does It Matter?

Borrowing capacity is simply how much a lender thinks you can afford to borrow based on both their rules and government affordability guidelines for regulated credit. This is based on all of your assessable income, current debts, and other financial commitments. Knowing your borrowing capacity is essential because it ensures that you’re taking on a loan you can manage without financial stress.

Why Your Income Matters Most

Your ability to make regular loan repayments—what lenders call “servicing income”—is crucial. Lenders look at different types of income to see if you can handle the loan, including:

• Your Salary or Wages
• Part-Time and Overtime Pay
• Income from Casual Jobs (usually with a consistent income over 3-6 months)
• Rental Income
• Dividends from Investments
• Income from a Trust
• Business Profits
• Some Government Pensions
• Insurance Payments

For certain incomes, like bonuses, lenders might only count a portion (say 80%) to account for any variability.

Equity and Debt-to-Income Ratio: Why They Matter

While having equity (like owning a portion of your home) is important, your ability to make repayments is even more critical. Lenders also check your Debt-to-Income (DTI) ratio, which ideally should be less than six times your gross income. This ratio helps them ensure you’re not taking on more debt than you can handle.

The Buffer

Australian banks are required by APRA (The Australian Prudential Regulation Authority – the regulatory body in Australia that oversees the financial services industry to ensure the stability, safety, and soundness of financial institutions) to add a three (3) percent margin to the actual home loan rate to ensure that you home loan repayment is manageable should interest rates rise.

At the time of writing this article (September 2024) it is generally expected that we are at or near the height of the current rate increasing cycle that started in May 2022 when the RBA raised the official cash rate from the historically low level of 0.10% to 0.35%, marking the beginning of its efforts to tighten monetary policy in response to rising inflation. 

So while we are near the absolute highest rates are likely to go the three percent buffer has reduced peoples borrowing capacity by a significant degree and in some cases it has even restricted people being able to refinance loan limits they already have even if it results in a cheaper repayment (there are exceptions to this rule so call us to learn more).

Credit Score and Reporting

Your credit score plays a significant role in loan approval. In Australia, VEDA and Illion are the main credit reporting agencies in Australia. A VEDA score below 500 can make it tough to get approved, while a score of 750 or above is ideal. Positive credit reporting gives lenders a clear view of your credit history with other financial institutions, so when looking to get pre approved for any form of finance it’s important to keep your repayments on time and avoid defaults.

Tips to Boost Your Borrowing Capacity

If you want to increase your borrowing capacity, here are some steps you can take:

• Reduce or Close Credit Card Limits: High credit limits can reduce how much you can borrow.
• Avoid Buy Now, Pay Later Services: Services like Afterpay and Zip Pay can indicate you’re stretching your budget to a potential lender
• Limit Credit Applications: Too many applications can hurt your credit score.
• Cut Down on Car Loan Repayments: These can eat into your ability to afford a new loan.
• Stick to a Budget: Lenders will ask about your living expenses, so cutting back before applying for a mortgage can help show you’re ready to manage the repayments.

Take the Next Step

Curious about how much you can borrow? Find out with AXTON Finance expert mortgage broker in Sydney today by booking a quick 15-minute FREE discovery meeting here.