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How Do Interest Rates Impact Your Borrowing Power?

Borrowing Power

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2022 has been a challenging year with regard to interest rates. The Reserve Bank has been increasing interest rates since May 2022. The rapid interest rate rises now mean you can borrow much less.

Your independent mortgage broker, What If We Finance, has consistently advised clients that interest rates and borrowing power are inversely related. This means as interest rates rise, your borrowing power falls. Conversely, as interest rates fall, borrowing power increases.

In 2020 the Reserve Bank decreased interest rate rises rapidly to record lows, which meant borrowing power increased significantly. Interestingly this saw housing prices rise quickly and to record levels and consumer spending also increased.

With the current interest rate rises borrowing power is falling. Mortgage Broker Melbourne What If We Finance says that as borrowing power falls and interest rates rise, consumers have less money to spend, leading to an economic slowdown. Historically interest rate cycles (peak to low) last 1.5 to 2.5 years.

If history repeats itself, we can expect interest rates to fall in 2024.

Rising interest rates and the corresponding fall in borrowing power mean it may get harder to buy a house unless you have a larger deposit or higher income.

How Does The Bank Calculate Borrowing Power?

Calculate borrowing

A bank will look at your income, existing liabilities (think credit cards, car loans, HECS/HELP debt, zip or after payment, for example), living expenses and number of dependents to calculate borrowing power. The bank will also look at current interest rates, and this will decide your borrowing power.

For example, assume a couple earns $70,000 and $60,000 each. They have 1 child, 1 credit card with a limit of $5,000, and monthly living expenses are $3,721. Given this scenario, we will illustrate borrowing power for various interest rates.

Interest RateBorrowing Power
2.50%$830,000
3.00%$796,000
3.50%$755,000
4.00%$717,000
4.50%$677,000
How does the bank cal borrowing power

The above scenario reflects the impact of the rising interest rate, and we see the above couple can afford to borrow approx. $160,000 less.

In addition, their monthly repayments have increased from $3,230 per month to $4,205 per month, assuming they borrowed $830,000. As we can see, the couple has less to spend on other items, and there are no 2 effects that will impact the economy:

  1. Consumers can borrow less, and as such, house prices may be impacted
  2. Consumers have less to spend, and economic activity will be impacted

Interest Rates And Borrowing Power

It is extremely important to have a competitive interest rate because it impacts borrowing power and your cash flow. Higher interest rates mean higher repayments and also impact your living standards.

At times of increasing interest rates, ensuring a competitive interest rate is extremely important as it may make housing more affordable. A lower interest rate will save you money if you have an existing home loan. This is where refinancing makes sense.

Your home loan broker can help you refinance your home loan or buy your home. Contact What if We Finance today to find out more.

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