Your borrowing power is how much money you’re able to borrow without putting too much pressure on your finances. This guide will take you through how to work out your own borrowing power and how lenders determine your borrowing limits when you apply.
Why is it important to understand your borrowing power?
When you apply for a type of credit such as a car loan this will be listed on your credit report. It will be listed whether it was approved or not. If there are several enquiries for credit on your credit report it can be a red flag to lenders and can stop you from being approved for loans.
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. It's important to compare a lot of different offers but you don’t want to apply for too many different loans. You also don’t want your credit history damaged by any rejections you receive.
Calculate your car loan borrowing power
You can use the calculator below to get an idea of your borrowing power.
How do lenders determine your borrowing power?
Most lenders use a formula called the Household Expenditure Method (HEM) to determine 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 generally 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.
Compare your car loan options
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A low rate loan to finance new vehicles or cars up to two years old. Borrow up to $75,000.
Elizabeth Barry is Finder's global fintech editor. She has written about finance for over five years and has been featured in a range of publications and media including Seven News, the ABC, Mamamia, Dynamic Business and Financy. Elizabeth has a Bachelor of Communications and a Master of Creative Writing from the University of Technology Sydney. In 2017, she received the Highly Commended award for Best New Journalist at The Lizzies. Elizabeth has found writing about innovations in financial services to be her passion (which has surprised no one more than herself).
You'll receive a fixed rate from 5.69% p.a. A larger loan of $5,000 or more to help you buy a new or used car. 5-hour pre approval available and no ongoing fees. Note: Product only available to residents of Victoria.
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