Get a car loan that works for you by finding out your borrowing limits.
Your borrowing power refers to how much money you’re able to borrow without putting too much pressure on your cash flow and without being rejected by the lender. Before taking out any kind of loan you need to have an idea of what your borrowing power is.
Why is it important to understand your borrowing power?
When you enquire about a personal loan such as a car loan, this enquiry is recorded on your credit report even if you decide not to take it or you are declined. If lenders see more of these enquiries on your credit report, you may be seen as a higher risk, making it more likely that your application will be denied.
Understanding your borrowing power can help you limit the number of applications and enquiries you need to make as you’re only applying for loans that you can afford. You want to compare a lot of different offers but you don’t want to make an excessive amount of enquiries for credit. You also don’t want your credit history damaged by any rejections you receive.
A selection of car loans you can compare
How lenders determine your borrowing power
Once you know your own borrowing power you’ll be able to limit your chances of being rejected for a loan. To be sure though, it helps to know how lenders are calculating your loan borrowing power.
Lenders essentially take your monthly living costs, weigh them against your monthly income and then see whether you can fit in the loan repayments. However, it gets more complicated when you start factoring in multiple incomes, credit cards, other debts, the cost of owning and running a car, dependants and the difficulty of knowing how much any given borrower can tighten their belt.
For this reason, most lenders use a formula called the Household Expenditure Method (HEM) to work out your borrowing power. This is the closest thing to a one-size-fits-all approach to calculating these factors. It involves dividing all household expenses into one of three groups: the essential (food, utilities, etc), the discretionary (entertainment, childcare, restaurants) and the luxury (vacations, household staff). The HEM is determined by looking at the median spending on essentials by Australian households, and the 25th percentile spending on discretionaries.
These two values are added together to get the HEM, a number that changes and is updated each year. The number is adjusted in a particular way depending on your location, whether you’re part of a single or partner household and whether there are any children.
- The lender will ask you what your monthly expenditure is, and then look at the HEM. The higher of the two sums is used as your monthly expenditure when determining your borrowing power.
- The HEM is based on the Australian Bureau of Statistics spending data. It is regularly updated based on the more recent information.
Not all lenders use the HEM. Some have their own formulas or use similar alternatives like the older Henderson Poverty Index (HPI).
How to work out your monthly expenditures
You will be required to provide your monthly expenditures to your lender when you apply, despite them making their own calculations as well. For car loans, most lenders will typically want you to give them a single figure, but some might want a more detailed cost breakdown.
- Consider how much you spend on essentials. This includes housing, food, utilities, transport and other things you can’t live without.
- Factor in how much you tend to spend on discretionary costs and luxuries each month. Resist the urge to exclude these from your calculations. An ideal loan won’t require you to make significant lifestyle adjustments, although this isn’t always possible.
- Remember to consider the cost of owning and maintaining a car. There are numerous one-off expenses as well as ongoing costs. These include vehicle registration, licensing, compulsory insurance, additional insurance, petrol, repair and maintenance costs and countless others. However, do not include these in your monthly expenditures unless you already have and are paying for a different car, because your lender will factor them in for you. Do bear this in mind, however, and leave yourself some financial leeway for the costs.
Calculate your borrowing power
Use the borrowing power calculator below to find out how much you’re able to borrow. This will help you to avoid rejections and black marks on your credit file from lenders by being aware of what your price range is.
Find car loans to compare
Now that you know what to expect from lenders and what kind of borrowing power you have, you’re ready to compare car loans. Remember to use calculators first to avoid being rejected for a loan and to keep your credit history clean.
Start browsing car loans to find one you can drive away with without having multiple enquiries listed on your credit report.
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