Understanding the Basics of Borrowing Capacity

What Is Borrowing Capacity and How Do Lenders Calculate It?

Borrowing capacity is the maximum amount a lender will allow you to borrow based on your income, expenses, existing debts, and the serviceability buffer they apply to your loan application. Lenders assess your ability to repay a loan at an interest rate that is at least 3.0 percentage points above the actual loan product rate, meaning you need to prove you can service repayments at a much higher rate than you'll actually pay.

Consider a buyer earning $95,000 per year with a car loan repayment of $480 per month and average monthly living expenses of $2,200. If they apply for a variable rate loan at 6.2%, the lender will assess serviceability at 9.2%. At that higher rate, a $500,000 loan would require monthly repayments of roughly $4,060 on a principal and interest basis over 30 years. After accounting for tax, the car loan, declared expenses, and the buffered repayment figure, the lender determines whether sufficient income remains. In this scenario, the buyer's borrowing capacity might sit closer to $420,000, not the $500,000 they were hoping for. The assessment is mechanical, and the outcome is often lower than buyers expect.

Income: What Lenders Count and What They Don't

Lenders include base salary, and in some cases a portion of overtime, bonuses, rental income, and other verifiable earnings. Full-time employees on a salary generally receive the most straightforward assessment. Casual and contract workers may need to provide additional evidence, often spanning two years of tax returns and employment history. Rental income from an investment property is typically assessed at 80% of the actual rent received to account for vacancy periods and maintenance costs. If you're purchasing an owner occupied home loan and you also hold an investment property, that rental income can support your borrowing capacity, but only after the lender deducts the costs associated with that investment, including the loan repayment on the investment property itself.

Self-employed applicants are assessed on their taxable income after deductions, not their business turnover. A builder operating a successful business might show $180,000 in revenue but only $68,000 in taxable income after claiming vehicle depreciation, equipment, and other work-related deductions. The lender will base the serviceability calculation on the $68,000 figure. This is where self-employed borrowers often face a lower borrowing capacity than they anticipated, particularly if they've structured their tax affairs to minimise income.

How Existing Debts Reduce What You Can Borrow

Every ongoing commitment you have reduces your borrowing capacity. Car loans, personal loans, credit card limits, buy now pay later arrangements, and other home loans all count against you. Lenders assess credit cards based on the full limit, not the current balance. If you have a credit card with a $15,000 limit and a zero balance, the lender will still factor in a monthly repayment obligation based on that $15,000 limit, typically calculated as 3% to 4% of the limit per month. That means the card could be costing you $450 to $600 per month in serviceability terms, even if you never use it.

Closing unused accounts or reducing credit limits before you apply can make a material difference. In our earlier example, if the buyer with the $480 car loan also held two credit cards with combined limits of $20,000, those cards alone could reduce borrowing capacity by $80,000 to $100,000, depending on the lender's credit card calculation method. Paying down or closing those cards three months before lodging a home loan application allows the updated position to flow through to your credit file and improves the assessment.

The Debt-to-Income Limit and Why It Matters

From 1 February 2026, lenders operating as authorised deposit-taking institutions can only write up to 20% of new owner-occupier loans and 20% of new investor loans to borrowers with a debt-to-income ratio of six times or greater. If your total borrowings, including the new loan, exceed six times your gross annual income, you fall into that restricted category. For a borrower earning $100,000 per year, a total debt position above $600,000 triggers the limit. This doesn't mean you can't borrow that amount, but it does mean the lender has less room to approve your application and may apply stricter criteria or decline the loan if their quarterly allocation is already committed.

The limit applies to each lender separately and is measured on a rolling quarterly basis. Non-bank lenders are not currently subject to the same restriction, which means they may still approve loans that sit above the six times threshold without the same portfolio constraint. Understanding where your application sits relative to this limit helps you choose the right lender and set realistic expectations about loan amount and structure.

Living Expenses and the HEM Benchmark

Lenders assess your living expenses using either your declared expenses or a benchmark figure called the Household Expenditure Measure. The HEM is based on Australian Bureau of Statistics data and varies according to household size, income level, and location. If your declared monthly expenses are $2,800 but the HEM for a household of your size and income is $3,400, the lender will use the higher figure. You cannot simply declare lower expenses to increase your borrowing capacity if those figures fall below the benchmark.

If you have dependants, childcare costs, school fees, and other family-related expenses, those will be factored in on top of the HEM. A single applicant with no dependants will have a lower living expense assessment than a couple with two children, even if both households report similar discretionary spending. This is one reason why dual-income households with children often face tighter serviceability outcomes than single applicants or couples without dependants, despite the higher combined income.

How Loan Structure Affects Borrowing Capacity

The type of loan you choose has a direct impact on how much you can borrow. A principal and interest loan requires higher monthly repayments than an interest-only loan, which means your serviceability is tested at a higher threshold. For an investment loan structured on an interest-only basis for the first five years, the lender will still assess your capacity to service principal and interest repayments over the full loan term, or in some cases assess serviceability on the interest-only repayment with a reduced loan term.

A fixed rate loan is assessed at the fixed rate plus the 3.0 percentage point buffer. A variable rate loan is assessed at the variable rate plus the buffer. If you're considering a split loan, the lender will assess each portion separately and then combine the result. Choosing a longer loan term, such as 30 years instead of 25 years, reduces the monthly repayment and can improve your borrowing capacity, but it also means you'll pay more in total interest over the life of the loan unless you make additional repayments.

What You Can Do to Improve Your Borrowing Capacity Before You Apply

Start by reviewing your current debts and closing or reducing any accounts you don't need. Pay off small debts in full if you can, and avoid taking on new commitments in the six months before you plan to apply. If you're self-employed, speak to your accountant about the trade-off between claiming deductions and demonstrating income for lending purposes. In some cases, reducing deductions for one financial year to show a higher taxable income can improve your borrowing capacity enough to offset the additional tax paid.

If you're hoping to use rental income from an existing investment property to support a new purchase, make sure the property is tenanted and that you have a current lease agreement in place. Lenders won't give you credit for potential rental income on a vacant property. If you're in a casual or contract role, stay in that role for at least 12 months before applying, and be prepared to provide payslips, a letter from your employer, and tax returns if required. Switching jobs or moving to a new contract shortly before applying can complicate the assessment and delay your approval.

When to Get Pre-Approval and How Borrowing Capacity Fits In

Pre-approval gives you a clear understanding of your borrowing capacity before you start looking at properties. It's not a guarantee, but it's a formal assessment based on the information you've provided and the documentation you've submitted. A pre-approval is typically valid for three to six months, depending on the lender, and it allows you to move quickly when you find a property that fits your budget.

If your borrowing capacity comes in lower than expected, pre-approval also gives you time to address the issues before you commit to a purchase. You might choose to pay down debt, increase your deposit, or adjust your search to a lower price range. Going through the process early means you're making decisions based on real numbers, not assumptions.

Call one of our team or book an appointment at a time that works for you. We'll walk through your income, expenses, and current commitments, run the calculations across multiple lenders, and give you a clear picture of where you stand and what your options are.

Frequently Asked Questions