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Is my home loan limit based on salary?

Is my home loan limit based on salary?

You’ve found your dream home and are looking to see if you can get a home loan that covers the purchase. In your research, you may wonder if there’s a limit to how much you can borrow based on your salary. 

When you’re shopping for a home loan, lenders may limit how much you’re able to borrow based on multiple factors, with salary being one of them. Your maximum home loan may be based on your debt-to-income ratio and ability to repay the debt. 

If you want to check your borrowing capability, you can get an estimate with a borrowing power calculator.

How much can I borrow for a mortgage?

Lenders take a variety of factors into account when considering a home loan application from a salaried individual. Your credit history plays an important role, as does your employment history and current income. If you have any recurring debt at the time of your loan application, that will also be considered.

When it comes to the question of how much you can borrow for a mortgage on your current income, the debt-to-income ratio (DTI) is often an important factor. This metric is used by most lenders to determine your capacity to repay your loan comfortably without any financial hardships. 

DTI is calculated by comparing the salary you earn to the total of all your debts or liabilities, including credit cards, existing loans, tax debt, and more. 

As an example, imagine a couple who both earn $80,000, for a combined household income of $160,000. They’re looking at buying a property costing about $900,000, paying a 20% deposit and borrowing $720,000. They also both have $2,000 limits on their credit cards. 

In this scenario, the couple’s combined liabilities include:

  • $720,000 for the new home loan
  • A combined monthly limit of $4,000 on their credit cards
  • Total debt: $724,000

The couple’s DTI would be calculated by applying the following formula: $724,000 ÷ $160,000 = 4.53 DTI

In other words, the couple’s total debt will be 4.53 times their combined income.

How does DTI affect my borrowing limit?

How much you can borrow for a mortgage based on your income will in part depend on your DTI, and also the expected mortgage payments. You can work out what your mortgage repayments might be to get a better idea of if you can afford to repay a mortgage. 

When you apply for a home loan, a lender will look at if the loan may push your DTI ratio too high. If this happens, some lenders might be reluctant to approve your loan application. 

A high DTI is generally over 6 (or 6 times your income) and is considered high risk. Lenders may think a DTI above 6 could put you under financial stress if your financial situation were to suddenly change, or if interest rates were to rise drastically. On the other hand, if your debt-to-income ratio is below 6 and falls within the lender’s limits, you’re more likely to be eligible for financing.

Keep in mind that DTI is not a rigid measurement. Some lenders are more willing than others to take on riskier borrowers with higher debt ratios. That’s why it is important to research a few lenders and understand your options.

How can I improve my chances of getting a home loan approved?

Your debt-to income-ratio may be one of the first factors a lender considers during your home loan application. Your other living expenses may also be considered, and could make the difference between the approval or rejection of your home loan application.

As you prepare for your home loan application, you may want to go through all your debts and see how you can reduce them and cut them out entirely, especially if you don’t use them. For example, if you’ve got a $2,000 limit on your credit card but you hardly ever use it, you could consider cancelling the card or reducing your limit. 

You may also want to look for other non-essential expenses you can cut down on as well, such as entertainment subscriptions, going to music festivals or sporting events, costly gym memberships, or even eating out regularly.

How does a lender evaluate my ability to repay the loan?

Lenders are primarily focused on your ability to repay the loan and work this out by considering your current income and debt situation. Your credit history or how you’ve borrowed and repaid debts previously can be just as crucial when looking at your capability to repay a home loan.

Lenders will also be interested to know how you managed repayments if you’ve previously purchased a property with a mortgage. Demonstrating that you’ve previously managed large debt repayments can be a ‘compensating factor’ that could help some lenders be willing to work with a relatively high debt ratio. 

It’s not just one factor that determines how much you can borrow, as mortgage lenders take multiple factors into account to find your maximum home loan amount, including your salary, your debt-to-income ratio and your daily living expenses.

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This article was reviewed by Personal Finance Editor Alex Ritchie before it was published as part of RateCity's Fact Check process.

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