When you’re shopping for a home loan lenders may put a limit on how much you’re able to borrow based on multiple factors, with salary being one of them. So, you may ask what my limit for a home loan based on my income is?
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.
The answer isn’t set in stone and isn’t a one-size-fits-all answer as there are multiple factors lenders will consider. The limit on how much you can borrow is based on your debt-to-income ratio and ability to repay the debt. And not really any specific loan limits set by lenders. In other words, lenders determine your maximum home loan based on salary, current debts and your ability to repay the loan amount.
How much can I borrow for a mortgage?
Lenders take into account a variety of factors 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) takes precedence over all other factors. This metric is used by most lenders to determine your capacity to repay your loan comfortably without any financial hardships and is based on your existing debts and income.
Let’s quickly break down the concept of DTI to better understand it.
DTI is calculated based on the amount of money you earn divided by the total of all your debts or liabilities. These debts and liabilities will include credit cards, existing loans, tax debt, etc.
As an example, you’re a couple who both earn $80,000, which is a household income of $160,000. You’re looking at properties costing about $900,000, with 20% deposit so borrowing $720,000 and you both have $2,000 limits on your credit cards. In this scenario, your combined liabilities include:
- $720,000 for the new home loan
- A combined monthly limit of $4,000 on your credit card
- Total debt: $724,000
Your DTI would be calculated by applying the following formula: $724,000 ÷ $160,000 = 4.53 DTI
What this tells you is that your total debt is 4.53 times the combined income.
How does DTI affect my borrowing limit?
Going back to how much you can borrow for a mortgage based on your income. The answer to this question will largely depend on your DTI, which also includes the expected mortgage payments.
You’ve worked out what your mortgage repayments might be and looked at your current liabilities and think you should be sufficient to repay a mortgage. A lender will look at if your monthly payments, including a new mortgage, 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 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.
Don’t let a high DTI discourage you, since it’s 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 the first thing considered during your home loan application. Some lenders also give importance to other living expenses. If you’ve got high living expenses, they may be due to high debts, even unused debts. These can make all the difference between approval or rejection of your home loan application.
As you prepare for your home loan application, 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, consider cancelling the card or reducing your limit. You should also look for other non-essential expenses you can cut down on as well. These may include entertainment subscriptions, going to music festivals or sporting events, costly gym memberships, or even eating out regularly.
- If you want to check your borrowing capability, you can get an estimate with a borrowing power calculator.
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 is 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 help some lenders be willing to work with a relatively high debt ratio. This is called a ‘compensating factor’.
It’s not just one factor that determines how much you can borrow, for mortgage lenders take into account multiple factors. And while it’s true that the maximum home loan is based on salary, lenders take into account the debt-to-income ratio and your daily living expenses.