Calculating borrowing capacity: what you should know

. 3 min read

For those of you who are looking to apply for a mortgage application, it helps to have a general idea as to how banks calculate your borrowing capacity. That way, you can position yourself financially to successfully obtain the loan you want.

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Basic Formula for Calculating Borrowing Capacity

Banks follow this basic formula to calculate your borrowing capacity:

Gross income - (tax - living expenses - existing commitments - new commitments - buffer) = monthly surplus

Whilst banks all adopt this general framework, they differ in how they assess each dataset, as discussed below.

Gross Income

Gross income can come from different sources. However, based on the consistency of income produced by these sources banks may decide to assess a reduced amount. The following is a breakdown of these sources:

  • Base income

All lenders would take base income in its entirety in their assessment. This is warranted by its consistency and relative stability as compared to other sources.

  • Overtime

In most cases, lenders would only accept 50% of overtime payments as part of their calculations. This is because overtime work occurs on an occasional basis. However, for roles where overtime work is regular and ongoing such as firefighting and emergency services, lenders would accept 100%.

  • Bonuses

Bonuses are irregular so banks would unlikely accept 100%. Where they are regular, you would be required to produce a 2 year statement to prove this regularity.

  • Commission

Lenders may accept 100% commission as long as it is consistent and ongoing. They would require you to produce a 1-2 year history indicating this regularity.

  • Family Tax Benefits A and B

Family tax benefits A and B are also accepted if your child is under 11 years of age. Other tax-free income is assessed case by case.

  • Rent Income

If you have investment properties that have rental income, only about 75-80% of the income counts towards the assessment. This is to take into account costs associated with owning the rental property including maintenance, management, rental vacancy. Hence a monthly rental income of $1000 would only have $750 considered.


Different lenders consider your tax expenses differently. If you have an investment property that is negatively geared, for example, some lenders would take into account the tax benefits resulting from that arrangement.

Living Expenses

Lenders typically use the Household Expenditure Measure to estimate your living expenses. The method takes into account metrics such as family size, the location of residence and lifestyle. For households with children, expenses are usually assessed high for the first child. Subsequent child is assessed with lowered expenses.

Furthermore, borrowers who apply for mortgage separately from their spouse would also have their spouse’s expenses assessed. However, some lenders may leave out these expenses where the spouse is also receiving income.

New and Existing Commitments

Any existing debt obligations that you have would reduce your borrowing capacity. These include HECS, car loans, other existing mortgages etc. As for existing mortgages, lenders may either choose to use the actual repayments or use a higher assessment rate.

Credit Cards

For credit cards, banks will calculate a 2-3% minimum monthly repayment obligation of the approved credit limit. This applies even if balance on the credit card is nil. This is to act as a safeguard given that the credit may be accessed to its limit at anytime.

If we consider a credit limit of $15,000, the monthly repayment calculated would be $450. This could reduce borrowing capacity by $60,000. Hence if you are looking to apply for a mortgage, it is important that you reduce credit limit as much as possible and also cancel unnecessary credit cards.


On top of all the debt and expenses, lenders would also consider your ability to service the loan in the event the interest rates increase. Hence in their assessment, they would add a margin generally about 2.5% to the variable rate.

Furthermore, lenders would assess your repayments as if it was a Principle and Interest loan. This is so even if in actuality, the loan is interest only.

Three Methods of Displaying Your Borrowing Capacity

Having taken into account all the above factors, banks have different methods of displaying your borrowing capacity. The Net Surplus Ratio, Debt, Debt Service Ratio and Uncommitted Monthly Income are the three most common ways.

Net Surplus Ratio:

This is calculated as (After tax monthly income - monthly living expenses)/Total Monthly Commitments). Typically a 1:1 ratio is the minimum for eligibility - anything under such 1:0.9 would not.

Debt Servicing Ratio (DSR)

DSR is a debt service measure that lenders use to determine what proportion of a household income is used to service debts. Lenders would not be willing to grant loans where the DSR is too high.

Uncommitted Monthly Income (UMI)

The UMI represents the total income left over after deducting all the relevant expenses and commitments.

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