Whether you’re a first-time home buyer or a seasoned property investor, knowing how much loan you can borrow can make a world of difference. This is known as your home loan borrowing power, and it plays a critical role in determining the interest rate and monthly payments.
In simple terms, the higher your home loan borrowing power, the better your options. Fortunately, the borrowing power doesn’t follow a one-and-done scenario. There are numerous effective ways to increase it and avail better options.
1. Improve Your Credit Score
One of the first things lenders consider when you apply for a mortgage is your credit score. It is a three-digit number, typically between 300 and 850, representing your creditworthiness and the likelihood of making payments without defaulting.
You can get free credit reports from three major credit reporting agencies, including Experian, Equifax, and Illions, once every 12 months upon request. Take a closer look at your financial standing and check for any mistakes or inaccuracies.
Take the following steps to improve your credit score:
- Reduce credit card balances
- Avoid opening new accounts or acquiring new debts
- Pay bills on time
Align your credit score with the requirements of your chosen loan type. For instance, you need a credit score of at least 680 to qualify for a conventional mortgage, whereas FHA and VA lenders might accept lower credit scores.
2. Reduce Your Expenses
In addition to your credit score, lenders look at your current day-to-day expenses. This includes:
- Utilities
- Rent
- Transportation
- Entertainment
- Healthcare costs
- Childcare costs
- Monthly subscriptions
Cancel that streaming platform subscription and take a closer look at your fuel costs. It may not seem like a lot, but cutting down on even minor expenses can make a significant difference.
To effectively reduce expenses, first consider how much can I borrow? Use a home loan borrowing calculator, which gives an accurate mortgage estimate depending on your current expenses, debts, down payment, and loan term. Knowing how much you can borrow beforehand will provide you with a clear pathway to long-term financial stability.
3. Pay Down Existing Debts
Paying down existing debts can not only increase your credit score but also reduce your debt-to-income (DTI) ratio. In simple terms, your DTI measures how much of your monthly gross (before-tax) income goes toward existing debts. Lenders use the debt-to-income ratio (DTI) to determine whether you can afford another payment.
To calculate your DTI, add the total amount of your debts (credit cards, existing mortgage, student loans) and divide that number by your gross monthly income. Most lenders follow the 28/36 rule, where no more than 36% of your monthly income should go to debt payments.
One of the easiest ways to reduce your DTI is to lower your credit card limits. Mortgage experts also recommend refinancing any loans to a lower interest rate.
4. Consider a Co-Borrower
An overlooked way to improve borrowing power is to bring a co-borrower, such as a spouse or a family member, into the agreement. As the name indicates, a co-borrower is a joint applicant and is responsible for the payments.
The combined income of you and your co-borrower can help you acquire better mortgage terms, such as flexible repayment terms and lower interest rates.