Buying a home is a big decision – it often involves committing to repaying a large debt over a long period of time.

The exact size of that debt depends on how much you borrow from the bank. And that amount is ultimately limited to how much they believe you are capable of repaying.

The banks calculate your borrowing limit based on your household income, your expenses, your reason for buying the property, the size of your deposit, your credit history, and an analysis of the property itself. And many provide free online calculators to show you what that limit would likely be.

These tools are helpful because they enable you to limit your property search to homes you can realistically buy. But they can also encourage you to stretch your budget to an uncomfortable place, as banks will generally offer you more money than you can afford to repay.

Use our handy home loan calculator to help you work out your estimated loan amount, monthly repayments and upfront costs.

man browsing laptop and holding phone in hand

Online calculators are useful tools but may encourage you to stretch your budget to an uncomfortable place. Picture: Getty

What affects your borrowing power? 

While each lender will have slightly different lending criteria, most will follow a fairly similar process to determine how much they’re willing to lend you.

1. Your household income and expenses

Before deciding on a loan application, banks are legally obliged to take “reasonable steps to verify the consumer’s financial situation”. Since the Hayne Royal Commission, this has typically been understood to mean verifying a borrower’s income and expenditure by physically checking their bank statements.

Your income and expenses will form the backbone of your bank’s assessment of your creditworthiness, though they’ll show an interest in your employment status, too. Freelancers and contractors often deemed higher risk.

2. Your credit history

This one’s a no-brainer, really. The purpose of the bank assessing your financial health is to determine whether you’ll be able to service the monthly repayments, and a credit check goes straight to the heart of that matter, by telling banks whether you’ve paid bills on time in the past.

3. The size of your deposit

Most lenders will offer loans to borrowers with deposits as low as 5% of the property’s lender-assessed value but will charge extra fees for those with less than 20%. More on that later.

4. Your reason for buying the property

Banks treat owner-occupiers and investors differently, with the latter currently charged higher rates.

5. An analysis of the property

In addition to analysing your personal finances, banks will take a good look at the property to determine how much they’re willing to lend you.

Everything from the property’s condition and location to its floor plan and fit-out will affect their valuation of it – and their valuation will affect how much you’re able to borrow.

brighton home with pool

58 Hanby St, Brighton, Vic 3186 is a beautiful Atkinson Pontifex-built entertainer penthouse. Picture: realestate.com.au/buy

How to calculate what you can afford 

When it comes to working out what you can afford to borrow – as opposed to what a bank will lend you – there are two key rules to remember.

1. Avoid borrowing more than 80% of the property’s value

First, you should think twice about borrowing more than 80% of the property’s lender-assessed value. This is because banks will consider you high risk if you have a loan to value ratio (LVR) of over 80%, and will require you to pay for lenders mortgage insurance (LMI) as a result.

Typically capitalised into your overall mortgage, this insurance enables banks to make a claim in the event that you default on your loan and the property sells for less than the value of the mortgage.

The exact amount of LMI you will need to pay depends on the size of your deposit, the size of the loan, and your reasons for buying, but it can often run into the tens of thousands.

As of writing, a homeowner hoping to buy a $500,000 property with a $80,000 deposit would likely need to pay $8,280 in LMI, according to our mortgage calculator, which based its calculations on a principal and interest loan with an interest rate of 3.69% and a loan term of 25 years.

And so, borrowing more than 80% of the property’s lender-assessed value could result in you paying much more for your home than taking the time to save a larger deposit.

Three-bedroom house in St Kilda

124 Argyle Street, St Kilda, Vic 3182 is a naturally lit three-bedroom house with a leafy north facing rear courtyard. Picture: realestate.com.au/buy

2. Keep your monthly repayments below 30% of household income

There’s no universal definition of mortgage stress, but most analysts believe it begins to creep in when your monthly repayments exceed 30% of your pre-tax income.

When you move past that point, keeping on top of your repayments typically comes at the expense of your quality of life. You might be forced into buying cheaper groceries, socialising less with your friends, and giving up luxuries that you once deemed essential.

And so, before you set your heart on buying a specific property, make sure you estimate your monthly repayments with our free mortgage calculator.

Remember there are hidden costs to buying a home

The price tag is only the beginning of the story when it comes to paying for a home.

In addition to the purchase price, there are a few hidden costs to look out for. For example, buyers must shell out for conveyancing and legal fees: stamp duty; a building and pest inspection; mortgage registration, loan application and transfer fees; and council and utility rates.

Most states, however, offer first-home buyers significant grants and stamp duty concessions to help them get a foot on the property ladder.

141 Errol Street, North Melbourne, VIC

The true cost of a home is more than the purchase price. Picture: realestate.com.au/buy

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What you should look out for  

The interest rate and loan principal aren’t the only features worth seeking out when you’re searching for a home loan. Each offering will come with its own set of fees and charges, so it’s important to read through all the terms and conditions before deciding which loan is right for you. Here’s what you need to weigh up:

1. Establishment fees

Most lenders will charge you a fee to set up your mortgage.

2. Service fees

Each lender will charge you different ongoing fees to cover the cost of servicing your loan

3. Special feature fees

Loans with lots of features, such as offset and redraw facilities, typically attract more fees and come with variable interest rates. And so, borrowers must weigh up the greater flexibility these features offer against their additional expense

4. Additional repayment fees

Some lenders charge borrowers for making additional repayments, or place restrictions on the total amount of additional repayments a borrower can make.

Ask for help

Ultimately, how much you should borrow is dependent on your financial situation and personal goals. And while the information above will serve as a helpful guide, it’s no replacement for seeking professional advice.

two people taking notes near laptops

Financial advisors and mortgage brokers are good sources of advice when trying to figure out how much money you can borrow. Picture: Unsplash

Seek help from a financial advisor or mortgage broker and provide them with as accurate a picture of your current finances as possible. Doing so will set you well on your way to finding a suitable mortgage.