Establishing your borrowing capacity can be approached in a number of ways and is a relatively quick and simple process using a good mortgage calculator

For example, most mortgage calculators will allow you to enter your net income and your current liabilities such as a car loan or credit card debt and will then quickly give you an idea as to the amount you can borrow. In the same calculation you will see your monthly instalment amount for the proposed mortgage which will enable you to determine what surplus income will continue to be available to meet your general cost of living expenses and the repayments on any other debts you may have. Although a mortgage calculator can give you a guide to your borrowing capacity there are other things that a lender will take into consideration when you apply for a loan. For example the number of dependent children you have will impact on your borrowing capacity.

You can play around with the mortgage calculator, in that if you feel the monthly repayment is too high you can increase the loan term from the standard 25 years to 30 years (being the maximum generally available in today’s market). By increasing the loan term you reduce the monthly repayment amount. A number of borrowers choose to make interest only payments in the first 5 years of their loan to reduce their monthly commitments while they are getting themselves established. You must remember however that by taking an initial interest only period you increase the amount of the principal and interest instalments when they kick in because the loan is being amortised over the remainder of term only.

With the mortgage calculator you can also compare the difference in your monthly outgoings under your existing situation (for example your new mortgage, a car loan and current monthly credit card repayments) with the repayments that would apply if you combined all your personal debt into your home mortgage. You will invariably improve your cash flow by doing this as the interest rate on car and credit card loans is usually higher than home loan rates. However you should also realise that by including say your car loan with you’re your home mortgage you are in effect now paying the car off over 25 or 30 years as opposed to perhaps a 5 year personal loan or lease with nominal residual. If you decide to sell the car after 3 years you will not have built up the same equity in it as you would have under the shorter term financing.

If you are considering a refinance the mortgage calculator has a feature which enables you to compare the interest rates of your existing lender with those of a new proposed lender. It will show you the amount of interest you will pay under each loan. The comparison mortgage calculator is quite sophisticated in that it has provision for a number of variables. For example you may compare your existing loan which may have an initial fixed rate term for 3 years @ 8.20% reverting to a 7.75% variable rate at the end of that 3 year period with a proposed loan which may have an initial 5 year fixed period @ 7.95% reverting to a 7.65% variable rate for the remainder loan term. The mortgage calculator will calculate the fixed interest payable for the first 3 or 5 years plus the interest for the remaining term at the variable rate and give you the total interest amount that you will pay for the full loan term on each mortgage. The mortgage calculator will also often summarise this in graph form and advise the amount you will save or lose by staying with your existing lender.

When using the mortgage calculator one should remember that it is only interest rates that are being compared. You may have special features that you wish to include within your mortgage for which you are prepared to pay a small premium in interest rate.

In fact, you may well be better off with a lender who charges a marginally higher interest rate but also offers a 100% offset account with your loan. Such a feature allows you to place any surplus funds you have in your offset account and with 100% offset these funds earn you the same rate of interest as that which you are paying on your mortgage.

In other words if you have a loan of $250,000 and a $50,000 balance in your offset account your monthly interest is calculated on $200,000 only.

Example:

Mortgage: $250,000 paying 8% (interest only) = $20,000 p.a.

Offset:$50,000 earning @ 8% = $4000 p.a.

Nett result:$200,000 @ 8% (interest only) = you pay $16,000 p.a

Compare this with $250,000 at a lower rate of interest, again on an interest only basis for simplicity:

$250,000 @ 7.75% = $19,375

$250,000 @ 7.50% = $18,750

$250,000 @ 7.00% = $17,500

In reality you would need to have an interest rate of 6.40% (that’s 1.6% below the mortgage loan with 100% offset) to have an equivalent rate of the offset package.

In Australia, a mortgage calculator is a good resource and you should certainly check them out to be confident that you are on the right track in relation to your estimates on borrowing capacity.