How Do Lenders Figure out How Much I Can Afford?

Your Borrowing Power May Not Be as High as You Think

Before you start looking for a new home, you must ask yourself “how much can I afford to spend on a property”? It’s a key question because starting your search unprepared will lead to disappointment. You’ll find what seems like the perfect property for you, only to discover that your lender won’t offer you a loan that covers the value thereof.

This can seem unfair, especially if you have a lot of money saved. Furthermore, you may have checked to find how much can you afford to spend on a property using the many mortgage calculators online and come up with a higher figure than your lender’s amount.

Unfortunately, it’s the lender who has the final say. As a result, you need to know how lenders calculate your borrowing power. Knowledge of this process may help you to access more money.

Let’s start with the basics.

What Formula Do Lenders Use?

How lenders calculate your borrowing power varies, but you’ll find most use something similar to the below formula:

Your income after tax – living expenses – your commitments, both current and new – a buffer = your monthly surplus

This formula leaves the lender with a figure indicating your monthly surplus. The higher the surplus, the more borrowing power you have. However, you have to remember that lenders take other things into account too. A surplus is a good start, but you also need a good credit rating, stable income, and the ability to pay a deposit.

If you don’t have a surplus, there’s little point in applying for a home loan. Because you’ll soon find you can’t afford to spend as much as you thought on a property. You could reapply for a smaller loan, but this may not suit your needs.

Though most lenders use this formula, what they believe falls into each section can vary. For example, one lender may have a different buffer to another. Other lenders may look at your commitments differently.

Let’s look at each part of the formula separately.

What Counts as Income After Tax?

Before working out your income after tax, lenders need to figure out your gross income. This is the amount of money you receive each month, before tax.

Your gross income may include some, or all, of the following:

  • The base income that you receive from your employer. You’ll find that this is the only form of income that all lenders use in their assessments.
  • Any commissions that you receive for your work may be considered. However, lenders will want to see that you receive these commissions on a regular basis. A one-off commission may not count, but one you’ve received every month for a year may.
  • A percentage of the overtime that you work. Again, this varies depending on the lender. Some accept as little as 50% of your overtime, whereas others count all of it toward your gross income.
  • The bonuses you receive may count, assuming you receive them regularly. As with commission, a one-off bonus isn’t part of your regular income, so most banks will ignore it. On the other hand, they may accept an annual bonus as gross income.
  • Any rent that you receive from properties you’ve already invested in. Of course, this won’t be a factor if you don’t own any other properties. But it does provide an answer to the question of “why is property a great investment”?

Your lender will usually apply its own tax calculations to this gross income figure to work out how much you earn after tax.

As a final note, some lenders may add any tax-free money that you receive, such as benefits. Most accept Family Tax Benefits, assuming the children you have are below the age of 11. Any other accepted benefits depend on the lender.

What Are My Commitments?

Banks split your commitments into two categories:

  • Current commitments
  • New commitments

Existing commitments refers to anything that you’re paying out before the mortgage. New commitments refer to the outgoings you have once you have a mortgage.

Tell Me about Current Commitments

Again, each lender has different policies when calculating existing commitments. However, you should find that most take the following into account:

  • Any personal loans or credit cards that you’re actively making repayments on. With credit cards, lenders assume that you have maxed the card out. They will take your credit limit as a given, then add 2% or 3% of that limit to their calculations.
  • The repayments you’re making on any other mortgages you have. You may have to deal with your lender applying a higher interest rate, known as an assessment rate, to these repayments.
  • Some lenders may take your rent payments into account, assuming you have them.

You may think that living in rent-free accommodation means that you don’t have to worry about lenders counting your rent as an existing commitment. However, a few may add up to $600 per month to your existing commitments in this situation. This is so they can account for the possibility that you become a paying tenant before securing your home loan.

Tell Me about New Commitments

Your new commitments relate to the mortgage repayments you’ll make. You may think that lenders will use the interest rate they attach to your mortgage to calculate this.

But you’d be wrong.

Lenders use an assessment rate, which is usually a couple of percent more than their current variable interest rates.

There’s a simple reason for this. Lenders want to feel sure that you will be able to make your repayments, even if there’s a change to their variable interest rates. The assessment rate allows them to create a worst case scenario with regard to interest.

How Do My Living Expenses Differ From My Commitments?

That’s a good question. It seems like your living expenses should fall into the commitments category, but they don’t.

Instead, most lenders use something called the HEM (Household Expenditure Method) to figure out your living expenses.

The HEM takes a decremental approach to working out your living expenses. It applies a high-level expense to the first adult on the mortgage, with a similar expense for the first child. It then adds a lower expense onto the first figure for each additional adult and child.

This covers the bank in cases where two adults apply for a mortgage. It allows them to figure out if you’d still be able to make your repayments if one of the adults undergoes a change in financial circumstances.

As such, your living expenses are an estimate of how much everything else costs. Your commitments are more solid, as they generally refer to loan repayments.

What’s a Buffer?

Finally, we come to buffers. A buffer is a sum of money that a lender adds onto the formula we started with. It just gives the lender added confidence that you’ll be able to afford your repayments, even if an unexpected financial commitment comes along.

Not all lenders use buffers in their calculations. As a result, you may find it easier to secure a higher loan with a lender who doesn’t use a buffer.

A Word on Surpluses

Lenders will use either a dollar figure or a ratio to display your surplus.

The dollar figure is simple. It’s either an annual or monthly number that represents what you have left over after the lender applies its formula to your income.

The ratio is a little more complex. Referred to as the Net Surplus Ratio (NSR), it expresses your surplus using three digits, which are arranged as follows: 0:0:0.

A ratio of 1:1:0 shows that you have nothing left over once you’ve paid for the various things the lenders use in the formula at the top of the article.

If there’s a number in the final slot, this represents the percentage of your monthly costs that your income can cover after you’ve already made your various repayments. For example, a ratio of 1:1:5 shows that your income is high enough to pay 50% of your outgoings on top of your actual repayment. A high ratio improves your borrowing potential.

What Else Can I Do to Raise My Borrowing Power?

All’s not lost if your lender doesn’t believe you have the borrowing power to repay the home loan you want. There are several things you can do to improve your borrowing strength. These include:

  • Repay any outstanding personal or credit card debts. Focus on the largest debts first, as these tend to be the ones that collect the most interest. Once you’ve cleared them, you can move onto your smaller debts. The fewer debts you have, the more likely you are to be approved for the home loan you want. Of course, this assumes that your income covers the repayments.
  • Make sure you pay all of your bills on time. Each missed payment could result in a default on your account. Lenders take defaults very seriously because they’re evidence that you can’t meet your existing commitments. If your credit report already has defaults, you may need to wait until they clear before applying for a home loan. You can check your credit report using a service such as Equifax.
  • Save more money. Lenders want to see that you have genuine savings, which are savings that you place into an account in your name on a regular basis. The more genuine savings you can put toward a deposit, the more confident a lender will feel with you as a borrower.
  • Consolidate your existing debts. Having lots of debts on your credit report may make a lender wary. You could use a debt consolidation service to bunch your debts together. This makes it easier to keep track of repayments.


We hope that this article answers the question of “how much can I afford to spend on a property”. Speak to a lender for more detailed advice.

We can help you if you feel ready to move forward. Contact one of our buyer’s agents today to get a better deal when you buy a new home.

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