The Gap Between What You Think You Can Borrow and What the Bank Will Lend
Most buyers estimate their borrowing capacity by working backwards from a purchase price they have in mind. The bank does the opposite — it runs every number through a serviceability formula, and the result is often lower (sometimes much lower) than buyers expect.
Use our Borrowing Power Calculator to get a starting estimate, then read on to understand what's driving the number.
The Core Formula: What Every Lender Calculates
At its most basic, a lender calculates your maximum loan by working out your net monthly income, subtracting your monthly living expenses and existing debt repayments, and then determining the largest mortgage payment you could service at their assessment rate.
That assessment rate is the critical factor most buyers don't know about.
The 3% Serviceability Buffer
APRA requires all Australian lenders to assess your ability to service a loan at 3 percentage points above the actual loan rate. If the current rate is 6.25%, the bank assesses you at 9.25%.
This buffer exists to ensure you can still repay the loan if rates rise. It has a dramatic effect on borrowing power — the same income that qualifies you for a $650,000 loan at the actual rate may only support a $520,000 loan at the assessment rate.
The buffer is not negotiable. It applies across all APRA-regulated lenders (banks, building societies, credit unions). Some non-bank lenders operate outside APRA oversight and apply a lower buffer — but these lenders typically charge higher rates, which often offsets the borrowing benefit.
What Counts as Income?
Lenders count the following income types, though they shade some more conservatively than others:
- PAYG salary and wages: 100% of base salary. Overtime and allowances: usually 80% if consistent over 2+ years.
- Self-employed income: Typically the lower of the last two years' average net profit, with some lenders adding back depreciation and one-off expenses. Two full tax returns plus notices of assessment are required.
- Rental income: 70–80% of gross rent to account for vacancies and outgoings.
- Government payments (FTB, parenting payments): Some lenders include these; others don't. Child support received is usually included at 100% if documented.
- Investment income (dividends, distributions): Typically 80% of the last two years' average.
The HEM: The Expenses Benchmark That Determines Your Floor
Even if you claim to spend very little, lenders will apply the Household Expenditure Measure (HEM) as a floor for your living expenses. HEM is a benchmark developed by the Melbourne Institute — it represents the median expenditure for a household of your type based on ABS data.
A single person HEM in a capital city is roughly $2,000–$2,400/month. A couple with two children might be $3,800–$4,500/month. Lenders use HEM or your declared expenses, whichever is higher. Declaring unrealistically low expenses doesn't help your borrowing capacity — the lender will override your figure with HEM.
Existing Debts and Liabilities
Every existing debt reduces your borrowing power dollar-for-dollar against your serviceability. Key items lenders assess:
- Credit card limits: Banks typically apply 3–3.8% of the total credit limit per month as an assumed repayment — regardless of your actual balance. A $20,000 credit limit costs you $600–$760/month in assumed repayments.
- Car loans and personal loans: Actual monthly repayment is included.
- HECS-HELP debt: Your annual compulsory HECS repayment rate is included as a monthly liability.
- Buy now, pay later: Most major lenders now include BNPL limits as a liability.
- Existing mortgages: Assessed at the buffer rate, same as your new loan.
Dependants: Each Child Reduces Capacity
Each dependent child reduces your borrowing power by roughly $30,000–$50,000 depending on the lender and the child's age, because they increase your assumed living expenses under HEM. A couple with three children may borrow $100,000–$150,000 less than a couple with no children on the same income.
Practical Ways to Increase Your Borrowing Power
If your estimated borrowing capacity falls short of your target purchase price, here are levers you can pull:
- Cancel unused credit cards. Reducing your total credit limits — even on cards you don't use — directly increases borrowing capacity.
- Pay down personal loans before applying. Clearing a $300/month loan repayment can increase your borrowing power by $50,000–$80,000 at current rates.
- Fix your repayment period. A 30-year loan has lower monthly repayments than a 25-year loan — lenders assess based on the monthly figure, so a longer term can increase capacity (though you'll pay more interest overall).
- Apply with a co-borrower. Adding a partner or guarantor with stable income significantly increases assessed capacity.
- Choose a lender with more generous treatment of your income type. If you're self-employed or have rental income, some lenders are materially more generous than others. A mortgage broker can identify who will treat your income most favourably.
Check what your repayments will look like with our Mortgage Repayment Calculator and model affordability with the Home Loan Affordability Calculator.
For a deeper understanding of how lenders assess risk and structure home loans, these Australian mortgage and home loan books on Amazon AU are worth having on your shelf before you sit across from a bank.