In the process of buying a home? You’re not imagining your borrowing power shrinking, as the amount of money you could be approved to borrow for a home loan has fallen significantly since the first cash rate hikes.
The average person’s maximum borrowing capacity has dropped by approximately 20%, or $134,500, as a result of the last five interest rate rises, according to RateCity research.
This is based on ABS data for the average adult full time weekly ordinary time earnings at $92,030, at the average interest rate at the time for an 80% LVR home loan.
Change in maximum borrowing capacity, single person on the average wage
|Income||Rate||Max borrowing capacity|
|1 May 2022|
Source: RateCity.com.au. ABS.gov.au. CBA borrowing capacity calculator.
Note: Based on a person on the average wage (ordinary full- time earnings), at the average owner-occupier rate for 80% LVR home loans (principal & interest) at that time.
Since 1 May 2022, the Reserve Bank of Australia has hiked the cash rate from its record low of 0.10% to 2.35% - an increase of 225 basis points. The impact of these hikes have been significant for existing homeowners, who’s mortgage repayments have increased by almost $1000 in some instances.
For would-be buyers, these interest rate hikes have meant that the rates used to test your borrowing capacity have increased too. In turn, this has reduced the amount that a lender may offer a borrower as a home loan, as it has determined the borrower cannot afford a larger mortgage in a higher rate environment.
Priced out of the market: Borrowing capacity falling faster than property values
Rising interest rates are a key factor that typically pours cold water over a hot housing market. This works to lower demand – particularly from first home buyers with smaller budgets. Lower demand in capital cities like Melbourne, Canberra, Sydney has been accentuated due to the slower winter buying season.
However, while the amount that you may be approved to borrow from a home loan lender has plummeted dramatically, the value of property prices has not.
This means that millions of first home buyers, or anyone looking to take out a home loan, could find themselves priced out, having to adjust their expectations – and even their location – for their property purchase. Even in Sydney, which has recorded one of the biggest property value falls to date, there has been a 7.4% decline in prices since its peak in January 2022 – well short of the 20% decline in maximum borrowing capacity.
Keep in mind that if you look at borrowing capacity in isolation, shrinking borrowing capacity primarily impacts people who were planning on taking out home loans for the maximum they could afford to borrow. Australia’s biggest bank, CommBank, says that just 8.7% of new borrowers are borrowing at capacity:
Australian home buyers borrowing at capacity are more likely to be in areas where property prices are high compared to how much people earn. This may be why recent data shows bigger drops in property values in places such as Sydney. Other factors like supply, wage growth, and rental returns also play a role. Due to this, falling property prices are unlike likely to happen evenly across the country.
If you’re struggling to find a property to afford with your lower borrowing capacity, keep in mind that interest rates are expected to fall again. The big four banks suspect this may occur between late 2023 – 2024. The Reserve Bank of Australia has also hinted this may occur by the end of 2024. But if you cannot wait another two years to get a foot on the property ladder (and we don’t blame you), it may be worth considering your options, such as:
- Looking at bridesmaid suburbs – Some suburbs on the fringe of your ideal suburb may be a more affordable entry point into the lifestyle you’re seeking. These suburbs may have less amenities or be further from public transport, but you will be in proximity to your dream suburb.
- Increase your income – If there was ever a time to consider ways you could boost your income, this could be it. Increasing your income, whether through asking for a pay raise, taking on additional work, or starting a side hustle, is one way to increase your borrowing power.
- Be ruthless about expenses – If you’re not confident that you’ll be approved for a home loan amount that suits your goals, it may be worth being even more ruthless about your expenses. In the application process, banks and lenders look at one to three months’ worth of your bank statements and go through all your expenses with a fine-tooth comb.
This is when they categorise your spending to determine how much you spend on things like:
- Utilities – energy bill, internet bill, phone bill etc.
- Liabilities – existing debts, outstanding credit card balances etc.
- Entertainment – regular takeaway meals and dinners out, online shopping etc.
Consider comparing your options for every expense you have, from your phone plan to your energy provider, and look for more affordable options (if available). Also consider paying off any outstanding debts, such as a car loan or your HECS/HELP debt. If you have a credit card, you don’t necessarily need to cut it up, but it may be worth switching to one with a lower credit limit.
Banks and lenders will assess your expenses based on your maximum credit limit – even if you pay your card balance in full each statement period. Also, it goes without saying but try to avoid discretionary spending in the months leading up to your home loan application. Besides, cooking more meals at home and ditching UberEats could save you more money in the long run.
- Want to know how much you could be approved to borrow? Use RateCity’s Borrowing Power Calculator today.