How Lenders Calculate Your Borrowing Power for an Investment Property
Understanding how lenders determine your borrowing power is crucial when stepping into the world of property investment. Whether you’re a first-time investor or expanding your portfolio, knowing the mechanics behind loan assessments can help you secure the right financing and avoid costly mistakes. In this comprehensive guide, we’ll break down the key factors lenders evaluate—from rental income and negative gearing to your existing debts—and provide actionable tips to strengthen your borrowing profile.
1. The Basics of Borrowing Power for Investment Properties
Borrowing power, also known as loan serviceability, is the maximum amount a lender is willing to loan you based on your financial situation. For an investment property, the calculation is more complex than for a owner-occupied home because lenders factor in potential rental income and the tax implications of negative gearing.
How Lenders Assess Serviceability
Lenders use a serviceability calculator that considers:
- Your gross income (salary, wages, self-employed earnings)
- Existing debts (credit cards, personal loans, car loans)
- Living expenses (based on the Household Expenditure Measure or your declared spending)
- The proposed loan repayments (at a higher assessment rate, not the current market rate)
- Rental income from the investment property (usually at a discounted rate)
- Negative gearing benefits (some lenders incorporate tax savings)
Most Australian lenders apply a net surplus ratio approach: your after-tax income minus all expenses and loan repayments must leave a surplus. If the surplus is too small, your borrowing power decreases.
Key Differences from Owner-Occupied Loans
| Factor | Owner-Occupied | Investment Property |
|---|---|---|
| Rental income | Not applicable | Included at 75–80% of market rent |
| Interest rate assessment | Lower buffer (e.g., 3% above current) | Higher buffer (e.g., 3% above) but may be offset by rent |
| Negative gearing | Not considered | Some lenders add tax benefits to income |
| Living expenses | Standard | May be adjusted if you have multiple properties |
2. The Role of Rental Income in Borrowing Power
Rental income is a double-edged sword: it boosts your income but is also subject to lender haircuts. Lenders don’t take the full market rent at face value because they account for vacancies, maintenance, and property management fees.
How Lenders Treat Rental Income
- Discount applied: Typically, lenders use 75–80% of the gross rental income. For example, if the property rents for $500 per week, the lender might count only $375–$400 per week as income.
- Evidence required: A rental appraisal from a licensed real estate agent is usually mandatory. For existing investment properties, tax returns or lease agreements are used.
- Short-term rentals: Income from platforms like Airbnb is treated cautiously; lenders may require a history of consistent earnings or exclude it entirely.
Table: Rental Income Assessment by Major Lenders (2024 Data)
| Lender | Rental Income Used | Notes |
|---|---|---|
| Commonwealth Bank | 75% of gross rent | Uses actual or appraised rent |
| Westpac | 80% of gross rent | Requires rental appraisal |
| ANZ | 75% of gross rent | May consider tax returns for existing properties |
| NAB | 80% of gross rent | Accepts lease agreements |
| Macquarie | 75% of gross rent | Conservative on short-term rentals |
Note: Policies change frequently; always verify with a mortgage broker.
Maximizing Your Rental Income Assessment
- Obtain a realistic rental appraisal from a reputable agent before applying.
- If the property is already tenanted, provide a lease agreement and recent rental statements.
- For new purchases, consider properties in high-demand rental areas to ensure strong appraisals.
3. Negative Gearing and Its Impact on Borrowing Capacity
Negative gearing occurs when the costs of owning an investment property (interest, maintenance, depreciation) exceed the rental income, creating a tax-deductible loss. This loss can reduce your taxable income, potentially increasing your after-tax cash flow.
How Lenders View Negative Gearing
Not all lenders incorporate negative gearing benefits into their serviceability calculations. Those that do typically add the estimated tax saving to your income. For example:
- Annual rental income: $20,000
- Annual expenses (interest, rates, etc.): $30,000
- Net loss: $10,000
- Tax saving at 37% marginal rate: $3,700
- Lender adds $3,700 to your assessable income.
However, lenders are cautious. They may only include a portion of the tax benefit or require you to have a stable income history. Some lenders ignore negative gearing entirely, which can significantly reduce your borrowing power.
Strategies to Leverage Negative Gearing
- Work with a mortgage broker who knows which lenders are generous with negative gearing.
- Prepare detailed tax projections showing the expected benefit.
- If you’re on a high marginal tax rate, negative gearing can be more advantageous.
4. Existing Debts and Living Expenses: The Hidden Drag
Your existing financial commitments are a major drag on borrowing power. Lenders scrutinize credit cards, personal loans, and even Buy Now Pay Later (BNPL) accounts.
How Debts Affect Serviceability
- Credit cards: Lenders assess the limit, not the balance. A $10,000 limit can reduce borrowing power by $30,000–$40,000 because repayments are calculated at 3% of the limit per month.
- Personal/car loans: Monthly repayments are deducted from your net income.
- HECS/HELP debt: Repayments are included as an expense, though some lenders are more lenient.
- BNPL: Afterpay, Zip, etc., are treated as ongoing expenses, often at a fixed percentage of your income.
Living Expenses: The Household Expenditure Measure (HEM)
Lenders use the HEM as a baseline for living costs, but if your declared expenses are higher, they’ll use the higher figure. The HEM varies by household size and income level. For a single person, it’s around $1,400–$1,800 per month; for a couple, $2,200–$2,800 (2024 figures).
Table: Impact of Debts on Borrowing Power (Example)
| Debt Type | Limit/Balance | Monthly Repayment Assumed | Approximate Reduction in Borrowing Power |
|---|---|---|---|
| Credit card | $5,000 limit | $150 | $25,000 |
| Car loan | $20,000 balance | $500 | $80,000 |
| Personal loan | $10,000 balance | $300 | $50,000 |
| HECS debt | $30,000 | $250 (income-dependent) | $40,000 |
Based on a 6.5% assessment rate and 30-year loan term.
Tips to Improve Your Profile
- Reduce credit card limits or close unused cards before applying.
- Pay off small personal loans if possible.
- Avoid new BNPL accounts in the months leading up to your application.
- Track your living expenses and ensure they align with the HEM if you want to maximize borrowing power.
5. The Assessment Rate Buffer: Why You Borrow Less Than You Think
Lenders don’t assess your loan at the current interest rate. They apply a buffer—typically 3% above the loan’s actual rate—to ensure you can handle future rate rises. This is mandated by the Australian Prudential Regulation Authority (APRA).
How the Buffer Works
If the loan rate is 6.0%, the assessment rate might be 9.0%. This means your repayments in the lender’s calculator are higher, reducing your borrowing power. For an investment loan, the buffer can feel even tighter because rental income doesn’t always keep pace.
Example Calculation
- Loan amount: $500,000
- Actual rate: 6.0% → monthly repayment: $2,998
- Assessment rate: 9.0% → monthly repayment: $4,023
- The lender uses $4,023 in their serviceability test, not $2,998.
This buffer protects both you and the lender from rate shocks. In 2024, with interest rates elevated, the buffer has significantly reduced maximum loan amounts across the board.
What This Means for Investors
- You may need a larger deposit or lower purchase price than expected.
- Fixing your rate doesn’t escape the buffer; lenders still apply it.
- Some non-bank lenders have slightly lower buffers, but they often charge higher rates.
6. Practical Steps to Boost Your Borrowing Power
Now that you understand the mechanics, here are concrete steps to improve your borrowing capacity before applying for an investment property loan.
1. Clean Up Your Credit File
- Obtain a free credit report from Equifax, Experian, or illion.
- Check for errors and correct them.
- Pay down outstanding debts to lower your credit utilization ratio.
2. Choose the Right Lender
Different lenders have different policies on rental income, negative gearing, and living expenses. A mortgage broker can compare options and find a lender that suits your profile. For instance, some lenders are more generous with rental income from granny flats or dual-income properties.
3. Increase Your Income
- Provide evidence of all income sources: bonuses, overtime, rental from other properties.
- If self-employed, ensure your tax returns reflect strong earnings (lenders often average two years’ income).
4. Reduce Non-Essential Spending
- Cancel unused subscriptions and memberships.
- Lenders may review bank statements for discretionary spending; a few months of frugality can help.
5. Consider a Longer Loan Term
A 30-year term reduces monthly repayments compared to a 25-year term, boosting serviceability. However, you’ll pay more interest over time.
6. Use a Deposit Boost
A larger deposit reduces the loan-to-value ratio (LVR), which can sometimes lead to a lower interest rate or better assessment terms.
7. Common Mistakes to Avoid
Even savvy investors make missteps that hurt their borrowing power. Here are pitfalls to watch for.
- Overestimating rental income: Don’t assume the lender will take 100% of the rent. Always use the 75–80% rule.
- Ignoring body corporate fees: For apartments and townhouses, these can be significant and are included as expenses.
- Applying with multiple lenders simultaneously: Each application can leave a hard enquiry on your credit file, lowering your score.
- Forgetting about LMI: If your LVR is above 80%, Lenders Mortgage Insurance adds to the cost and may affect serviceability.
- Not factoring in rate rises: With the buffer already high, any increase in actual rates can strain your cash flow.
FAQ
How much rental income do lenders typically count?
Most lenders count 75–80% of the gross rental income to account for vacancies, maintenance, and management fees. For example, if the property rents for $20,000 per year, they might include $15,000–$16,000 in your income assessment.
Does negative gearing always increase borrowing power?
Not always. Only some lenders incorporate the tax benefits of negative gearing into their serviceability calculations. Even those that do may only add a portion of the tax saving. It’s best to check with your lender or broker.
Can I use rental income from my current home if I turn it into an investment property?
Yes, if you plan to rent out your existing home and buy a new one, lenders can use the rental income from the old property. You’ll need a rental appraisal and possibly a lease agreement. However, they will also factor in the debt on that property.
What’s the best way to improve my borrowing power quickly?
Reduce credit card limits, pay off small debts, and ensure your living expenses are in line with the HEM. Also, choose a lender that is generous with rental income and negative gearing.
References
- Australian Prudential Regulation Authority (APRA) – Residential Mortgage Lending Practices, 2024. https://www.apra.gov.au
- Australian Taxation Office – Rental Properties 2024. https://www.ato.gov.au
- Mortgage & Finance Association of Australia (MFAA) – Industry Report 2024. https://www.mfaa.com.au
- Reserve Bank of Australia – Statement on Monetary Policy, February 2024. https://www.rba.gov.au
- Commonwealth Bank – Investment Home Loan Serviceability Guidelines, 2024. https://www.commbank.com.au