How do rising interest rates impact your borrowing capacity?

If you’ve been well-invested in the property market and like to stay up to date with the latest movements, you might have noticed that property prices have begun to stabilise, and in some states, drop. According to figures from CoreLogic, as of November 2022, dwelling values in Sydney fell by 10.2% since peaking in January — on a national level, prices dropped by 6.5%.

And while this may seem like good news for first-home buyers, the factors driving this change aren’t entirely positive.

Over the last few years, the country has been hit with several economic hurdles, from its first recession in nearly 30 years to the cost of living reaching unmanageable levels. Not only does this make it difficult for the average Australian to save for a deposit, but rising interest rates may also lock borrowers out of the market altogether.

In this blog, we’ll explain how rising interest rates can impact your borrowing capacity, discuss how interest rates rise and share tips on how you can better your chances at home loan approval.

Understanding your borrowing capacity

Before understanding why higher interest rates can impact your borrowing capacity, let’s first understand what this is. Your borrowing capacity is the amount of money a lender is willing to offer you when you apply for a home loan and is made up of several financial factors, such as:

• Your income

• Your current assets and liabilities

• Your monthly expenses

• Your credit score

• The amount you want to borrow

• The size of your deposit

• The type of loan you want to apply for (owner-occupied or investor)

• The value of the property you want to purchase

How is borrowing capacity calculated? Every lender has their own method for calculating borrowing capacity. Some of the most common ways a lender may determine your borrowing capacity are:

• Converting your annual income into a monthly amount.

• Using the Household Expenditure Measure.

• Using the loan’s features, such as the interest rate, repayment frequency and fees,

• Whether Lender’s Mortgage Insurance (LMI) is applicable.

These calculators are not only reserved for lenders. Prospective borrowers can gain an insight into their borrowing capacity before approaching a lender by using online borrowing calculators. This can give you an idea of how a lender may review your application and determine whether to approve you or not.

Now that we understand how important borrowing capacity is, let’s look at the correlation between increasing interest rates and borrowing capacity.

What happens when interest rates rise?

Variable interest rate home loans fluctuate with the market and are influenced by the Reserve Bank of Australia (RBA). The RBA is the country’s central bank and is responsible for dictating the official cash rate. If the RBA decides to increase the official cash rate, lenders are encouraged to do the same and increase their variable home loan rates, which can impact your borrowing capacity.

Lenders assess your application using a serviceability buffer of at least 3% serviceability buffer (3% is the minimum interest rate buffer expected by the Australian Prudential Regulation Authority, or APRA) . For instance, if you are applying for a loan with an interest rate of 5%, the lender will assess your ability to make repayments at 8%. And as variable rates continue to rise, so does your serviceability buffer, impacting the likelihood of approval.

So while you might have been eligible for a loan previously, with rates rising, the amount you were approved to borrow now drops, potentially locking you out of the market altogether. Reserve Bank’s Head of Domestic Markets, Jonathan Kearns, believes that the cash rate hikes so far have already reduced a borrower’s maximum loan size by around 20%.

How high will interest rates rise?

While no one can predict the RBA’s movements, many experts believe that the central bank will continue to increase the cash rate well into early 2023. RBA Governor, Phillip Lowe, has also alluded to more rate increases in the coming months, though this will depend on upcoming inflation data and labour market conditions.

This means that borrowers will need to get creative on how they can increase their borrowing capacity to secure approval.

Four tips to increase your borrowing capacity

While borrowing capacity requirements can vary between lenders, getting yourself into the best financial shape is never a bad idea. Here are four easy ways you can increase your borrowing capacity to better your chances of approval:

• Increase your deposit — Guaranteeing approval may mean having to wait a little longer before approaching a lender. You might want to use this time to grow your deposit to show a lender that you are a responsible saver. And remember that the larger your deposit, the less you’ll need to borrow. Tic:Toc can lend up to 80% of property value, and putting up a 20% deposit means you can avoid additional costs like Lenders Mortgage Insurance (LMI).

• Pay down debts or decrease credit limits — Lenders view debt as potential liabilities, which can impact your ability to make repayments. Make an effort to get debt-free or close any credit accounts you no longer use. Decreasing your credit limits can also reduce your risk level.

• Spend mindfully — Lenders will comb through your financial history and take a look at your spending habits. Revisit your budget and look for areas where you can reduce your spending.

• Consider your loan requirements when you’re considering which lender to apply for — Gone are the days of seeking home loan approval from The Big Four Banks. These days, borrowers also have access to online lenders who can offer competitive rates and flexible features. As an online lender, Tic:Toc don’t have massive overheads, which means we can pass those savings on to our customers.

Fast and simple home loan approval with Tic:Toc

From countless amounts of paperwork to unreasonable fees, getting home loan approval can often feel impossible. That was until we came onto the scene.

Tic:Toc is simplifying the home loan process by providing an automated experience. We use groundbreaking technology to get our customers the rates they want without the big price tag.

We understand how time-consuming home loan applications can be, which is why we developed a system that gives customers lending decisions in real-time. But our speedy application process hasn’t meant we’ve sacrificed quality customer service.

We take the time to explain how our rates work, so whether you’re a first-home buyer, a seasoned investor, or looking to refinance, Tic:Toc is here to help. Find out how much you could be approved for by contacting one of our lending specialists today.