How to Work Out What Rates Do to Your Borrowing Capacity

Your home loan interest rate directly changes how much a lender will let you borrow. A higher rate means a smaller loan amount on the same income, and a lower rate lifts it.

If you are posted to RAAF Base Richmond and thinking about buying, this matters before you look at a single property. This article shows how the link works, what you can control, and how to check your own numbers.

How Does the Interest Rate Affect Borrowing Capacity?

A higher interest rate lowers your borrowing capacity because the repayments on each dollar borrowed go up, and lenders only lend what your income can support.

Lenders also test your application at a rate higher than the one you will actually pay. This is called a serviceability buffer. The exact buffer and the way each lender applies it differ, so the same income can produce different results at different lenders. Your borrowing capacity result will depend on your income, debts, living costs and the lender you choose.

The rate you see advertised is only one input. Your other commitments, such as a car loan or credit card limits, also reduce what you can borrow.

A Worked Example: Same Loan, Different Rate

At an illustrative rate of 6.75% p.a., a $600,000 principal and interest loan over 30 years costs about $3,891 a month. At 7.75% p.a. the same loan costs about $4,298 a month.

Consider an RAAF member with a stable household income who wants to keep monthly repayments near $3,900. At the illustrative 6.75% p.a. rate, that suits a loan of about $600,000. If the rate were one percentage point higher, the same $3,900 a month would support roughly $544,000. That is around $56,000 less in loan size, a smaller loan amount.

This is a target repayment example only. A lender's assessed borrowing capacity is tested at a higher rate than the loan rate, and also depends on income, debts and living expenses.

The member checks the numbers with a broker before inspecting homes. They set a search budget based on the lower figure, then compare lenders on rate and features. The outcome is a budget based on a comfortable repayment, to be confirmed by a lender assessment, with fewer wasted weekends on properties out of reach. These figures are illustrative only and your own result will differ.

Which Home Loan Features Can Improve Your Borrowing Capacity?

No feature guarantees a higher borrowing amount, but a lower rate, fewer debts and a smaller loan to value ratio (LVR) can all help your position.

A few practical steps are worth considering:

• Close or reduce credit card limits you do not use, because lenders usually count the limit, not the balance.
• Pay off or consolidate a car loan before applying if that suits your wider plan.
• Ask about a rate discount, which can lower your repayments over time. Discounts depend on your deposit size and lender, and a lower rate can come with fewer features or higher fees.

The trade-off is that clearing debts can use up savings you may want for a deposit, so weigh both together.

Variable Rate, Fixed Rate or Split Rate: What Changes for You?

A variable rate moves with the lender's decisions, a fixed rate stays set for a period, and a split loan divides your balance between the two.

A variable rate can fall, but it can also rise. A fixed rate gives certainty on repayments for the fixed term, but it may limit extra repayments and can carry break costs if you leave early. A split rate gives some of each, though it also gives you two balances to manage. If a fixed term is nearing its end, the fixed rate expiry calculator can show what comes next.

For ADF members, postings can change plans quickly. Ask any lender whether a loan is portable or can be rented out later without a rate change, because policies differ.

Does a Mortgage Offset Account Help With Rate Impact?

An offset account reduces the interest charged by counting your savings against the loan balance. It does not raise your borrowing capacity, but it can cut the interest you pay.

The cost is that loans with a linked offset often have a higher rate or an annual package fee. It tends to suit people who will keep a real cash balance in it, so check the numbers against a loan without one.

Why Get Pre-Approval Before You Start Searching?

Pre-approval shows you roughly what a lender may let you borrow before you make an offer, so you can search with a guide to your budget. It is not a final approval, and the lender will reassess your finances and the property before settlement.

It can also lapse after a set period, and a rate or policy change in that time may alter the outcome. Read more on getting loan pre-approval and how it fits your timing.

What Should ADF Members Check Before They Apply?

Check how the lender treats your ADF income, including allowances, and whether your deposit size triggers Lenders Mortgage Insurance (LMI). Treatment of allowances varies between lenders.

DHOAS can subsidise interest on loans from approved lenders. Eligible first home buyers may avoid LMI through the Home Guarantee Scheme. Some lenders offer LMI waivers for particular professions, which may not include uniformed ADF members. Eligibility rules apply. Our page on home loans for ADF members explains the options. If you are based at Richmond, our RAAF Base Richmond mortgage broker page is also a good place to start.

If you need to talk about tax on a property you plan to rent out, speak with your accountant, as outcomes depend on your own circumstances.

Want to know where you stand? Call one of our team or book an appointment at a time that works for you. We will run your numbers across lenders and show you how different rates change what you can borrow.

Frequently Asked Questions