Ep2: How much can I Borrow?
Welcome to the Weekend Investor.
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I'm Max Lending, your industry insider, and we're lifting the lid on the finance market, guiding you on how to cut through the jargon, manage your finances and get investing into the property market.
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Let's get stuck into it.
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All right.
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In this instalment, we're gonna dive into the complexities of the actual borrowing calculations.
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A common question that I get, I'm just walking down the street.
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I hear this.
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Hey, Max, how much can we borrow?
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This is not a simple question to answer, though.
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Most people think it's taking the interest rate and just timesing it by the amount of funds you actually want.
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It's far from it.
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Our focus today though is understanding these factors that are going to influence the amount you can borrow, and it's going to be beyond just the rate.
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We'll take a live example of a couple of clients who are wanting to get into their own home, and this will provide a practical illustration.
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So grab a coffee, get comfortable.
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Let's begin.
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Here's the scenario.
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We have a husband and wife wanting to borrow for their first house.
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The male applicant is full time and earns $100,000 a year plus super.
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The female applicant works part time and earns $60,000 a year plus super.
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They have one young child.
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The male applicant has $20,000 worth of HECS debt.
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The female applicant has no HECS.
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They are currently renting.
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They have one credit card of $10,000 limit.
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And a car loan with $20,000 remaining.
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Oh, I'm liking this one.
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It's gonna be a fun one.
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The reason I like this scenario is it's a very typical representation of the common person out there.
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Now warning, if I get a little heated in some of my comments, don't take it personally.
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I'm just passionate.
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Few people last week weren't happy with me calling them idiots.
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It's out of love.
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All right.
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You're an idiot out of love.
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OK.
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Let's put these details into the weekend investors servicing calculator.
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Based on all the factors above, the maximum loan that this couple can borrow is around 550,000.
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Let's break down how we got there and what's actually affecting it.
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As we go through this though, I want you to put yourself in their shoes and see what you could do to clean up your financial life.
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And free up some cash flow.
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Let's break down the different elements in this scenario and shed some light on them.
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We've got the assessment rate, there's HEX or HELP debt, whatever you like to call it.
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There's one child.
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This will need to be factored in for the living expenses.
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There's a credit card and a personal loan.
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All the above are going to play a crucial role in determining the borrowing capacity.
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Let's start with the assessment rate.
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The interest rate is not the rate that actually the bank goes off when working out if you can afford the funds.
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As a borrower, you actually have to show servicing on a 3% buffer rate.
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They call this buffer the assessment rate.
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So if your interest rate is 6%, then the assessment rate is going to be 9%, so 6 3.
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It serves as a form of stress test to ensure the borrowers can manage the potential interest rate rise.
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UhWithout facing any sort of significant financial strain.
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Essentially, the buffer is intended to safeguard the borrowers against themselves for unexpected changes, as an example in their financial circumstances, or you know, the RBA was to increase the rates.
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It promotes also responsible lending.
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The 3% buffer might sound like a lot, but in reality it's keeping you safe.
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Let's move on to the HECS debt.
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In the example, the male applicant earned $100,000 a year, and he also had HECS debt of around about $20,000.
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Now, that works out to be about $500 per month getting deducted from his payslip.
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If he actually paid off this HECS, then the maximum loan that he could service would jump from $550,000 to $620,000.
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That's a $70,000 jump just by paying off the HECS.
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I understand HECS is seen as a form of an interest free loan, but it really isn't.
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It's linked to inflation rate and for this couple, maybe it's something they should consider to be able to increase their borrowing capacity.
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Now a big item on all servicing calculators.
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is living expenses.
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In the industry though, we like to call this HEM.
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HEM's not the bottom of your trousers, it stands for household expenditure measure.
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It's a benchmark used by the lenders to determine the living expense of the borrowers.
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It's based on various factors such as your household size, the location you live in, uh the inflation rates, and also your household income.
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It then standardizes all these factors and it comes up with a minimum monthly cost of living expense as such.
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If it wasn't there though, then the banks would need to go through everyone of your bank account transactions to determine what your actual monthly living expense really is.
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Now I don't know about you, but I really wouldn't want bank knowing how many subscription services I'm signed up to or how many times I go McDonald's a month in reality though.
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Most people spend well above the living expense benchmark, so it's probably really wise for you to sit down one night and list out all your expenses to see where you're actually overspending and where you could potentially cut back.
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Let's have a look at the impact of the dependent on servicing.
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If we remove the dependent from our client's example, the servicing goes up from 550K to 600K.
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That's a 50K increase.
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So if you're a couple thinking of having a child or even more kids, keep in mind that a child roughly is going to affect the borrowing capacity around about 40 to $50,000 per kid.
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Now, I'm definitely not saying hold off on having kids.
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Not at all.
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All I'm doing is arming you with the information so that you can choose what best suits your goals.
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Let's move on to the personal loans now and the credit cards.
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These applicants have one credit card for $10,000.
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That's the limit, that's not the balance, the limit.
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And they've got a personal loan, so a car loan of $20,000.
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By closing down the credit card, looks like that their capacity is actually going to increase by 50,000.
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And by paying off the car loan, the capacity will increase by another 70,000.
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So really, look, by closing off just the credit card and paying out the car loan, their servicing goes from 550K, which was their maximum, to a new maximum borrowing capacity of 670K.
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Now that's a huge difference.
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In all honesty, the quickest win here I see for this couple to be able to maximise their borrowing capacity is to close down that credit card.
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They don't have anything owing on it anyway, and to pay off that car loan.
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As soon as they do that, they can borrow up to 670,000, which is a big difference when you're looking at 550.
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Now let's do one more calculation where the clients take some time to pay off their HECS, cancel their credit card, and pay out their remainder of that car loan.
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Now, looks like they jumped from a 550K maximum borrowing capacity, well, to a whopping 730,000 to $740,000.
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That is a massive difference.
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Well guys, consider yourself informed.
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Hardly anyone out there actually understands the complexities of the borrowing calculations.
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Most mortgage brokers don't even understand it, but it's a vital part of the information you need to make an informed decision.
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By examining your personal factors beyond just the interest rate and getting into the nitty-gritty such as the assessment rate, hem, your personal financial commitments, you're going to get a clearer picture of how much you can borrow.
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Thank you guys and girls for listening to today's episode.
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I hopefully provided you with a bit more of a practical information.
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Stay classy and I'll see you at the next one.
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If you have a question that you would like answered on the show about budgeting, mortgages or finance, then drop us a line either via our socials, e-mail or website.
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Details available in the show notes.
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Any opinions and views expressed in this program are just that opinions.
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All information is general in nature and should not be seen as financial, economic, legal, investment, accounting or tax advice.
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This program makes no representation or warranty as to the accuracy or completeness of any information contained in this program.
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You should consult a professional advisor in relation to your own personal circumstances.