What’s going on guys Its Jordan de Jong here and today I want to talk about borrowing capacities, what the recent changes have been to assessment rates and the different methods you could use to try and increase the amount lenders will allow you to borrow. If you’re unsure what your borrowing capacity represents, simply put it’s the maximum amount of money a lender will allow you to borrow to purchase a property and it put in place to prevent you from borrowing more than you can afford to repay. There are numerous amounts of factors that have an impact on the total figure of your borrowing capacity, and these will vary between lenders as they all have their own calculation techniques and risk mitigation methods. One of the biggest factors is your assessment rate and it’s easy to presume that the interest rate on your loan package is the rate lenders will assess you on, however, lenders put a buffer on top of the interest rate as a risk mitigation method. For example, say you had applied for a home loan package at an interest rate of 3.5% pa for a $400,000 loan, you would calculate your repayments to be $14,000 a year ($400,000 x 0.035) or $1,167 per month ($14,000 / 12). With a buffer on top of this interest rate, lenders might asses you on something closer to 6%, so for the same loan, you would be evaluated at being able to repay $24,000 a year ($400,000 x 0.06) or $2,000 per month ($24,000 / 12). This is a massive difference of $833 ($2000 - $1,167) per month, lenders evaluate you on this higher amount to ensure that you can continue to repay the loan if interest rates were to rise in the future. A higher assessment rate means larger loan repayments, which ultimately decreases your borrowing capacity because based on your income and expenses there is only so much you can afford to repay. Don’t forget to smash that like button as it seriously helps out with the YouTube algorithm. Whilst this might seem a little overkill compared to what we need to repay, the finance industry regulator, Australian Prudential Regulation Authority is also known as APRA has recently loosened this requirement. Since 2014 APRA has required that all lenders must assess loans using the greater of either a 7% serviceability rate or a 2% buffer on the actual loan rate, On the 21st of May 2019, APRA removed this as they believed it is no longer required. https://www.apra.gov.au/news-and-publications/apra-proposes-amending-guidance-on-mortgage-lending Banks can now enforce their own serviceability floors and buffer rates, although APRA has proposed to lenders that their serviceability assessments should include an interest rate buffer of 2.5 per cent. A serviceability floor is the minimum rate lenders will assess you on, for context on the 30th of September Westpac dropped their serviceability floor down to 5.35%. So, as a hypothetical example, if you applied for a loan on a 2.5% interest rate, including APRA’s recommended 2.5% buffer the assessment rate would be 5%, however, because this is below the serviceability floor, you would still be assessed at 5.35%. Lenders play with these floor and buffer rates in hope of getting some media attention, promoting how competitive they are against other lenders, encouraging you to go to them first when you want a loan. Hoping you forget the fact that you do have to be able to repay the loan and behind the scenes, lenders are now becoming much tighter when calculating your outgoing living expenses. So, although it might seem like you can borrow more on these lower rates, lenders are now thoroughly checking how much you spend and If they see something they don’t like, they may deem you unable to service the loan. We have to take the good with the bad here and all-in-all it’s believed that borrowing capacities have increased by around 15% since the APRA changes and multiple rate cuts over the last 5 months. This means that you may now be able to get approved for a loan where you couldn’t have previously but just remember with a larger loan amount on the same LVR you will need a bigger deposit. In today’s lending arena a good rule of thumb to roughly calculate your borrowing capacity is to times your income by 6, so if you earn $80,000 a year, roughly speaking you should be able to borrow somewhere around $480,000. According to the Australian Bureau of Statistics as of May 2019, the average weekly earnings was $1,633.8, which is just shy of $85,000 a year, taking the previous rule of thumb the average Australian should be able to borrow around $510,000 https://www.abs.gov.au/ausstats/abs@.nsf/mf/6302.0 The ABS has also reported that in June 2019 the mean price of residential dwellings was $638,900, this limits the ability to be able to borrow that amount to only high-income earners or couples with double income. https://www.abs.gov.au/ausstats/abs@.nsf/mf/6416.0 This is why your first property is the biggest financial decision of your life because we only get one shot before maxing out our borrowing capacity and if you can’t get out of the market our borrowing power is locked up in that one asset. Growing up I would read Steve McKnight’s books cover to cover, with titles like 0 to 130 properties in 3.5 years, who wouldn’t? I would still highly recommend reading them to get the fundamentals of property investing although some of the regulation has changed today. I’m still baffled with those numbers, and it almost feels like they had an unlimited borrowing capacity back then, I’ll read an extract out of his book which explains how this was possible. The way to get around reaching your borrowing limit is once the ABC bank has said ‘no more’, create a new trust structure and approach a different bank, which will then provide you with a further $300,000 to invest with. How is this possible? Well, as long as the loan is not in default, the debt to the ABC Bank is owed by the trustee company on behalf of the trust; you have no personal liability and do not need to record the guarantee on your personal financial statement. After discussing this method with my broker, he explained that this strategy may have worked in the past, but he doesn’t believe it will work under the new Positive Credit Reporting and Open Banking that we are now dealing with. With a trust borrowing, you do need to offer a personal guarantee, so this should be disclosed at all times when applying for finance, and under these new changes, banks will likely have full access to the details. Investigating further into these, Open banking is going to give you more control over the data that lenders hold on you and will allow you to ask that your data be sent to other lenders. On the 1st of Aug 2019, Open Banking Legislation was passed by the Australian Parliament. The Big Four need to provide access to product data and customer data for credit cards, debit cards, deposit accounts, savings accounts, transaction accounts and personal loans by July 2020 and all other lenders will follow after that. Comprehensive Credit Reporting (CCR) also known as positive credit reporting is Australia’s new credit reporting system aimed at making it easier for lenders to form comprehensive and balanced assessments of applicants’ credit histories. The credit report includes information about current accounts held, what accounts have been opened and closed, the date default notices were paid and whether repayments were met. Now this is not financial advice, and I would highly recommend you going to talk to a mortgage broker about your current situation, However, here are some ways that may help increase your borrowing capacity. One: Try different lenders outside of the big 4 banks, as discussed before all lenders have their own calculation methods, interest buffers and serviceability floors and you will have varying borrowing limits between lenders. Two: Get your credit score, lenders will check your credit score when you apply for a loan, understanding the current position of your credit score will help you identify any red flags that lenders might pick up on and start improving the cause of those red flags or address the issue if it hasn’t been reported correctly. Three: Pay off your debts, the interest on credit cards and personal loan all factor heavily into your outgoing expenses and by reducing these “Bad Debts” your outgoing expenses will come down and you should be able to borrow more. Four: Increase your income, this is fairly obvious as the more you earn, the more you the debt you can service and lenders will view you as being able to afford a larger repayment. Five: Reduce living expenses, sit down and go through your last 3 months spending trends, and try to cut out excess spending or bad habits that are costing you money such as spontaneous shopping sprees or the $40 a day for three coffees and lunch. Six: Reduce excess credit limits, once you have paid off your credit cards, try to close them down completely, or if you can manage to pay them off on time, reduce excess limits, instead of having a $15,000 limit bring it down to $3,000 and pay it off monthly. Seven: Save a bigger deposit, the ability to save more money every month provides lenders with a clean consistent saving record, demonstrating you can make regular mortgage repayments. Eight: Split liabilities, be careful when splitting liabilities with your partner, if you only own 50% of the asset, lenders may consider you still 100% liable for the debt and only take 50% of the rent or income, this only works when you can prove that your partner can and will service their portion of the debts. Nine: Apply for a loan in one individual's name and leave all the living expenses I the second person’s name, allowing the larger income earner to increase their borrowing capacity, this could also be achieved through nominating ownership percentages. Ten: If you are rent vesting, put the lease in the lowest income earners name so it doesn’t impact the largest income earners borrowing capacity, lenders will need proof that the lowest income earner can service the rent. Eleven: Take a longer mortgage term, going from 25 years to 30 years or even 40 years if possible, will reduce your monthly expenses allowing you to service more. However, this does increase the total amount of interest you pay over the life of the loan. As always, seek your own professional financial, legal & property buying advice for your current situation, these videos are just my opinion and should never be considered as personal financial advice. 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