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Why has my borrowing power decreased so much in the past year?

A little known fact. When you go for a home loan, the bank does not assess you at the rate for which you are applying.



No.


In fact, banks are required to assess you at a significantly higher interest rate. On average, the banks assess you with a 3% buffer above the home loan interest rate you are applying for.


Why is this?

The banks don't want to see you get in a financial pickle if interest rates rise. Imagine if your capacity to take out a loan was based on you only being able to afford the rate for which you are applying. One move upwards and you could be in big trouble.


Therefore, right now when you submit an application to a bank to buy a new home or refinance, the banks will assess you with a buffer to make sure will be ok and able to afford your repayments if rates go up.


So what does this actually mean in reality?


If you are applying to borrow $500k at 6.24% for example, when a bank assesses your capacity to borrow $500k, they will assess your ability repay this $500k at an interest rate between 8% and 9%.


Think about that for a second. Your loan is actually being assessed at an interest rate between 8% and 9%. It's called an 'assessment rate'. And right now it is high.


So how did we get to this rate being so high?


Since May 2022, there were 13 interest rate rises, in 15 months. Looking back to early 2022, you could still set up a home loan at an interest rate between 2% and 3%. In fact many home loan customers during Covid fixed their rates in the 2% mark (with some even at 1.89%)


When rates were at 2% - 3%, with the required buffer on top of the interest rate, banks on average had an assessment rate of 6%. However, now that the average home loan rate is above 6%, that same assessment rate is on average 8%. At worst, 9%.


How has this affected you if you are trying to buy a home right now or refinance?


In a nut shell, your borrowing power (how much you can borrow) is significantly less than what it was in early 2022.


For some home loan customers, this hasn't had an impact on them being able to borrow the amount they need. However, for others, it has caused a big problem.


The hard reality is that if you cannot secure the loan size you need, you cannot move forward with your home loan to buy or refinance. It is very black and white.


This is why more than ever right now, before you try to buy a new home or submit an application to a bank to refinance, have a broker crunch the numbers to see if you can actually achieve what you want to in the first place.


If the answer right now is no, it will only be through a change in your personal situation (perhaps a higher income, lower commitments) or a lowering of the 'assessment rate' used by the banks, that will positively impact upon your borrowing power.


When will it get better?


As yet, we have not seen banks start to reduce home loan interest rates, particularly variable interest rates. We have now had a couple of months where the RBA has kept the cash rate on hold, and to a great extent, this 'holding pattern' with regards to home loan rates has been matched by the banks.


While no one can predict the future, it is widely believed that by the end of this year we may start to see an easing in home loan rates. What we ideally want to see come with a reduction in home loan interest rates, is a reduction in the assessment rate.


So what do you do in the meantime?


If you find yourself in the situation right now where your borrowing power has been significantly affected or you are not even sure how you are affected, reach out to your broker for advice.


Sometimes it is better the devil you know. Find out what your borrowing power is. Then you can make a choice.


Knowledge is power. The more you understand where you are at, the better decisions you can make.



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