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Absolute Beginner’s Guide to Borrowing Power in Australia

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In today’s world, borrowing money has become a common practice for individuals and businesses alike. From purchasing a home to starting a business, there are various reasons why people seek financial assistance. 

One crucial aspect of borrowing money is understanding your borrowing power. In this article, we will provide an absolute beginner’s guide to borrowing power in Australia, exploring its definition, relevance, and the factors that influence it.

What is Borrowing Power?

Borrowing power refers to an individual’s or entity’s ability to borrow money from financial institutions based on their financial circumstances. It is a measure of the amount a lender is willing to lend, considering factors such as income, expenses, credit history, and the value of any collateral. 

The concept of borrowing power has evolved over time as financial institutions have refined their lending practices to assess an applicant’s creditworthiness. Institutions and financial companies like Excellence Finance make use of it a lot.

Why is Borrowing Power Relevant?

Understanding your borrowing power is essential because it determines the amount of money you can borrow and the terms of the loan. Whether you are looking to buy a property, fund a business venture, or consolidate debt, your borrowing power directly influences your ability to achieve your financial goals. 

It plays a crucial role in determining the interest rate you receive, the loan repayment period, and the overall affordability of the loan.

Factors Affecting Borrowing Power

Several factors influence an individual’s borrowing power. These factors include:

  • Income

A stable and higher income increases your borrowing power as it demonstrates your ability to repay the loan.

  •  Expenses

Lower expenses relative to your income indicate a higher disposable income, positively impacting your borrowing power.

  • Credit History

A strong credit history with timely repayments and a good credit score enhances your borrowing power, as it reflects your reliability as a borrower.

  • Employment Stability

Lenders consider the stability of your employment or business income to assess your ability to meet repayment obligations.

  •  Existing Debts

High levels of existing debt can lower your borrowing power as it increases your overall debt-to-income ratio.

  • Collateral

Providing collateral, such as property or other valuable assets, can increase your borrowing power, as it provides security for the lender.

Borrowing Power in Action

To illustrate the impact of borrowing power, let’s look at the three types of borrowing power individuals can or may have:

  1. High Borrowing Power: An individual with a high income, minimal expenses, excellent credit history, and valuable collateral can enjoy several perks. They can secure larger loan amounts, negotiate lower interest rates, and benefit from flexible repayment terms. They have access to a wider range of loan products and lenders, providing them with greater financial flexibility.
  1. Average Borrowing Power: Those with average borrowing power typically meet the lender’s requirements but may not qualify for the most competitive loan terms. They can still secure loans for various purposes, but the loan amount may be more limited, and the interest rates and repayment terms may be less favourable compared to those with higher borrowing power.
  1. Low Borrowing Power: Individuals with limited income, high expenses, poor credit history, or little to no collateral may face challenges in borrowing money. They may have restricted access to loans, limited loan amounts, and higher interest rates due to the perceived higher risk by lenders.

Borrowing Power Examples

To provide a more relatable understanding of borrowing power, let’s delve into three scenarios that depict individuals with different borrowing power levels. These scenarios highlight the factors contributing to their borrowing power and how it affects their financial options.

Scenario 1: High Borrowing Power – The Hendersons

Meet the Hendersons, a financially stable family residing in a suburb of Melbourne. Mr Henderson, a successful surgeon, earns a substantial income, while Mrs Henderson manages her own thriving business. With minimal expenses due to their prudent budgeting and no outstanding debts, the Hendersons have an excellent credit history. Additionally, they own valuable property and have investments in stocks and bonds. As a result, their borrowing power is high.

The Hendersons enjoy several perks because of their high borrowing power. They can secure a substantial loan amount to purchase a larger home or invest in additional properties. Lenders offer them lower interest rates due to their reliable income and assets, which translates to significant savings over the loan term. The Hendersons also have the flexibility to choose from various loan products and lenders, giving them the freedom to negotiate the most favourable terms.

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Scenario 2: Average Borrowing Power – The Parkers

Let’s turn our attention to the Parkers, a middle-income family living in a modest suburb in Brisbane. Mr Parker works as an accountant, while Mrs Parker is a teacher. They meet the lender’s requirements but do not have the same financial advantages as the Henderson’s. Their income, while stable, falls within the average range, and their expenses are reasonable for a family of their size.

The Parkers have average borrowing power, which means they can secure loans for various purposes. However, the loan amounts they qualify for may be more limited compared to individuals with higher borrowing power. The interest rates and repayment terms offered to them may not be as favourable as those enjoyed by individuals with higher incomes and better credit histories. 

Nonetheless, the Parkers can still achieve their financial goals, such as purchasing a modest home or funding their children’s education, albeit with slightly less flexibility and potentially higher costs.

Scenario 3: Low Borrowing Power – The Thompsons

Lastly, let’s consider the Thompsons, a struggling family residing in a regional area of Australia. Mr Thompson recently lost his job, while Mrs Thompson works part-time in a local retail store. Their income is limited, and they struggle to cover their daily expenses. Unfortunately, the Thompsons also have a history of financial mismanagement, resulting in a poor credit score.

Due to their limited income, high expenses, and poor credit history, the Thompsons face significant challenges in borrowing money. Lenders perceive them as high-risk borrowers, which restricts their access to loans. When they do manage to secure a loan, the amount may be significantly limited, making it difficult to meet their financial needs. 

Additionally, the interest rates offered to them are higher, reflecting the perceived higher risk. Without valuable collateral to provide as security, the Thompsons find themselves in a disadvantaged position when it comes to borrowing money.

Conclusion

Understanding borrowing power is crucial when it comes to making informed financial decisions. Your borrowing power determines the amount of money you can borrow, the terms of the loan, and the overall affordability of your financial endeavours. 

Factors such as income, expenses, credit history, employment stability, existing debts, and collateral all contribute to your borrowing power. By comprehending this concept, you can effectively assess your financial capabilities and make informed borrowing choices that align with your goals and financial situation.
To gain a better understanding of your borrowing power, we encourage you to explore our Borrowing Power Calculator. This user-friendly tool will provide you with a personalised assessment of your borrowing power based on your unique financial circumstances. Armed with this knowledge, you can confidently approach lenders, negotiate favourable terms, and make well-informed decisions about your borrowing needs.

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