What’s the difference between borrowing capacity and affordability?

So you want to buy your first home? Maybe your second or even an investment property?

Well here is a tip from a friend for free:

Just because the bank says you can borrow a certain amount doesn’t mean you should!

When it comes to borrowing money, many people confuse their borrowing capacity with their affordability.

So what exactly is the difference?

Borrowing Capacity

Banks and lenders calculate how much you can borrow from them based on an ‘assessment rate’, along with other lending criteria such incoming wages, rental income(s), financial dependents as well as existing loan commitments and debts.

Affordability

Your affordability is about you and your family’s lifestyle, choices and future plans. Are you going to start a family, buy a car, are you children moving into higher education?

The choices you make and how you spend your money will differ from person to person therefore the cost of living that the bank uses to determine your borrowing capacity rarely ever matches your actual spending pattern.

In short, the projection of what you are able to borrow might not actually be something you can afford to pay off in the real world.

When you take on debt, you have a responsibility to you (and your family) to know your numbers so you don’t get in over your head.

My tip? PLAN!

Before you take on a mortgage or any other large debt consider the following:

1) Know your numbers. Current and projected cashflow before new debt needs to be factored in
2) Understand the difference between disposable income and planned events
3) Crunch the numbers of what the loan repayments will be with your current disposable household income
4) Be familiar with interest rates. A small increase can cut deep into a personal budget

Borrowing money is generally the easy part, it’s paying it off is where some people run into trouble.

Be smart and only take on debt that you know or expect to have the capacity to service now.

7Wealth Pty Ltd ABN 44 609 210 246, is an Authorised Representative of AMP Financial Planning Pty Limited ABN 89 051 208 327 Australian Financial Services Licence 232706 and Australian Credit Licence 232706
This blog contains information that is general in nature. It does not take into account the objectives, financial situation or needs of any particular person. You need to consider your financial situation and needs before making any decisions based on this information. If you decide to purchase or vary a financial product, your financial adviser, and other companies within the AMP Group may receive fees and other benefits. The fees will be a dollar amount and/ or a percentage of either the premium you pay or the value of your investment. Please contact us if you want more information.