The world of credit and borrowing money is a tightly regulated industry. Lenders are required to comply with ‘responsible lending conduct’, and they have strict obligations as outlined by ASIC.
In simple terms, these guidelines mean that a lender needs to be confident that a borrower can afford their loan. The lender must not offer a customer a credit contract that is unsuitable for them. They need to be able to repay the loan without falling into financial hardship. ASIC’s website says:
‘The responsible lending obligations involve:
- making reasonable inquiries about a consumer’s financial situation, and their requirements and objectives
- taking reasonable steps to verify a consumer’s financial situation
- making a preliminary assessment (if you are providing credit assistance) or final assessment (if you are the credit provider) about whether the credit contract is ‘not unsuitable’ for the consumer
- if a consumer requests it, being able to provide the consumer with a written copy of the preliminary assessment or final assessment (as relevant).’
This is where your lifestyle can affect your loan borrowing power. Your spending habits can have a direct impact on the amount a lender is willing to offer you. So let’s take a closer look at how this works.
How is borrowing power calculated?
Every lender has their own system to ascertain an applicant’s borrowing power. But the Australian industry benchmark is based on a system created by the Melbourne Institute.
The Household Expenditure Measure (HEM) looks at demographic information and average lifestyle expenses and calculates a figure based on four specific expense tiers – student, basic, moderate or lavish.
A lender uses the HEM as a comparison tool when assessing a loan application. If the applicant spends more or less than their respective HEM expense tier, it helps the lender establish their loan suitability. Additional calculations are applied, but essentially the HEM figure can be utilised when calculating borrowing capacity.
Factors that affect borrowing power
Every dollar you earn and every cent you spend can have an effect on your borrowing power. Do you order UberEats more than once a week? Do you get your car detailed every month? Do you send your children to a private school? These are all elements that a lender will consider when assessing a loan application.
Some of the key factors they look at include:
- Your income and existing financial commitments – including current personal debts such as credit cards, car finance, unsecured or outstanding student loans.
- Your living expenses – such as your weekly food shopping, regular utility bills, your children’s school fees and transportation costs.
- Deposit amount – the higher your savings, the better your borrowing power. It provides the lender a demonstration that you have the ability to save.
- Credit history – your credit history gives an indication of your reliability and your capability to meet your financial obligations.
- Existing assets – if you already own assets such as a vehicle, investment property or a share portfolio, it can directly influence a lender’s decision.
How to tidy up lifestyle factors
It’s not uncommon for lenders to want a significant amount of financial data accompanying an application. Bank statements for multiple months will give them a clear understanding of your habits, so ideally you should prepare well in advance.
Being able to display solid savings and spending that isn’t over the top will put you in a good position when it comes time to talk to your lender.
Creating sound habits prior to borrowing will also help prepare for the reality once you do have regular loan repayments to make. If you know that your lifestyle could already use a little financial finesse then you could consider making some of these changes:
- Pay bills on or before the due date – late payment fees add up and depending on your service provider they can also be listed on your credit report.
- Start saving – hopefully you already have some savings, but setting up a separate savings account and automating regular deposits will help build your balance.
- Assess any discretionary spending – go through your monthly transactions and start culling. Cancel any subscriptions you no longer need and if you identify areas where you spend excessively, commit to cutting back. This could be takeaway meals, non-essential retail shopping or regular nights out. You don’t have to stop everything, just be mindful not to overspend.
- Keep your accounts in the black – overdrawn accounts with dishonour fees can be detrimental and raise red flags for your lender.
Speak to a professional
Here at First Financial, we have a dedicated team that understands that building wealth is something everyone can achieve if they start early enough and use a systematic, structured approach.
By putting effective strategies in place, you can improve your borrowing power. If you’d like to discuss your personal situation with one of our advisers, please contact us today.
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