If you’re planning to purchase a home, chances are you’ve come across the term “borrowing power.” It refers to the maximum amount of money a lender is willing to lend you for a home.
Your loan borrowing power isn’t a random figure. It depends on a multitude of factors. Let’s take a closer look at five such factors.
Income
First things first, mortgage lenders assess your annual and monthly income. This helps them understand how you will repay your home loan every month. In simple words, the more you earn, the higher your borrowing power.
This is especially true when you’re applying for a loan with a co-borrower, such as your spouse. Dual-income households are more likely to have high borrowing power and low interest rates.
Expenses
Expenses are any outgoing payments that go towards your household expenditures. This includes:
- Groceries
- Utilities, such as water, electricity, and gas
- Communication bills, including phone, Internet, and streaming subscriptions
- Transportation
- Healthcare
- Entertainment, such as dining out, movies, and vacations
- Maintenance costs
Many lenders use the Household Expenditure Method (HEM) to calculate your living costs. It considers your property’s size, household size, number of dependents, and lifestyle to get an accurate picture of your monthly expenses.
Previous Debts
In addition to expenses, your previous debts also impact your home loan borrowing power. A debt is any contractual agreement between you and a credit provider, be it secured or unsecured. Examples include:
- Student loans
- Existing mortgages
- Credit card loans
- Business loans
- Car loans
- Insurance loans
- Line of Credit
- Overdraft
Generally, the more debt you have, the lower your home loan borrowing power.
Consider using a borrowing power calculator to skip guesswork and get an accurate estimate. Simply enter your gross (before-tax) income, existing debt amounts, living expenses, and other financial expenses.
Credit Score
All lenders are required to meet the “responsible lending” guidelines. In simple terms, they are required by law to ensure that a borrower can afford to repay the home loan. This is why lenders pay special attention to your credit score.
It is a three-digit number between 300 and 850, indicating the likelihood of a borrower repaying debts. A good credit score, such as above 600, will give lenders confidence and increase your borrowing power. Here’s how you can increase your credit score:
- Pay your bills on time
- Limit new credit applications
- Don’t make too many hard credit inquiries
- Pay down outstanding loans
Loan Type and Term
A loan with a lower interest rate comes with lower repayments, increasing your borrowing power. In comparison, high-interest loans decrease borrowing power.
A longer loan term, such as 25 to 30 years, generally means lower monthly repayments. As a result, you can borrow a greater amount. A shorter loan term, such as 10 to 15 years, can help you save on interest. But it can significantly reduce your borrowing power.
Consider your financial stability and debt tolerance when choosing a loan type and term.
