Calculating your home loan based on rental payments

Considering purchasing a property but curious how your rental payments may factor in to how much you’ll be approved for? Or perhaps you live at home and don’t pay rent – did you know the banks will still factor in ‘notional rent’?

Your rental payments, or lack of, make up a key component of how a lender will assess your borrowing power for your home loan. Let’s explore how you may be able to determine how much you can borrow for a home loan based on your rental payments and current living situation.

Why your rental payments don’t mean you can afford that loan

If you’re considering purchasing property, the thought of “well I can afford this in rent so surely I can afford that in mortgage repayments” has probably crossed your mind. However, this is a common misconception, as there are a lot more factors banks take into consideration that impact your borrowing power.

Firstly, there are additional expenses you will need to afford for when you own property, including council rates and other utilities, stamp duty, insurance and more. But the primary reason rental payments don’t equal mortgage repayments is because lenders will test your ability to repay a mortgage based on a higher interest rate than is being offered, also known as the serviceability floor.

Currently, we’re in the lowest home loan interest-rate period in decades, but it’s unlikely rates starting with a 1 will be around for the next 20-30 years of your mortgage. Lenders are required by APRA to ensure borrowers can afford to repay the loan at either 2.5 per cent more than the current ongoing interest rate, or the ‘floor’ rate set by the bank – whichever is higher.

As of writing this, the floor rate for Commonwealth Bank sits at around 5.25 per cent. So, assuming this was the higher rate for the serviceability assessment, thelender would test your ability to afford mortgage repayments with an interest rate of 5.25 per cent.

For example, a would-be borrower is paying the median weekly rental price in Sydney of $582 (CoreLogic rental rates). For simplicity’s sake, let’s multiply this by 4 weeks to get one month’s rent at $2,328. This borrower wants a 30-year, $500,000 home loan and sees a lender offering rates of 2.5 per cent. The monthly repayments on this mortgage at this rate would be $1,976

The borrower assumes it’s a done deal, and as it’s lower than their rent they can afford the mortgage repayments. However, when you factor in a floor rate of 5.25 per cent, the monthly mortgage payments the borrower’s income is being tested against are $2,761. This is $433 a month more expensive than their current rent payments.

Rental payments and getting a home loan

When you apply for a home loan the lender will assess a few things to determine your borrowing power, including your income, any dependents, your expenses, and liabilities. All of which are examined to calculate how much you may be able to afford in regular repayments.

But for would-be buyers, there are generally two camps they sit in: living with family or long-term renters. The rent they pay, or lack-thereof, is factored into the lender’s assessment.

• Living rent free and getting a home loan

You may be wondering how rental payments could factor into your home loan application if you’re living with friends or family to save for a property. After all, if you’re not paying rent, why should it matter?

Even if you live rent free in a property, the lender will still factor in an assumed rental payment into your loan application. This is called ‘notional rent’, and under responsible lending laws the banks must factor in an amount that a borrower could pay as rent.

Notional rent is generally around $650 a month, or $7,800 a year. This helps to protect borrowers in case of financial emergencies, such as being approved for a property that is still being built and having a falling out with your family, so you no longer live rent free. Anything you can afford to repay above that notional rent the lender may let you borrow.

Living with friends or family and paying no rent while saving for a property is arguably one of the easiest ways to save up a deposit quickly. Not only may it help you save faster but it might put you in a stronger position financially to purchase your next investment. This is because you are paying far fewer expenses than a borrower renting and saving up for a property, which increases your borrowing power.

• Renting and saving for a home to live in

Realistically, not everyone can afford to not pay rent and buy property. For the majority of Aussies, renting and saving up for a home is the reality. If you’re planning on living in the property as an owner-occupier, the lender understands that you will no longer be paying rent. This means that the money you spend on rent is put back into the ‘income’ category of your application

To calculate your potential borrowing power on a home loan based on rental payments, simply multiply your weekly rental payments by 52. Then, use RateCity’s Borrowing Power Calculator to discover how much you may be approved to borrow from lenders across the market.

• Renting and saving for an investment

Purchasing property for the purpose of investment while renting, also known as ‘rentvesting’ has increased in popularity in recent years. It offers borrowers, particularly young Australians in capital cities, the flexibility of being able to get a foot on the property ladder in a suburb they can afford, while continuing to rent in the ideal suburb they want to live in.

If you’re considering rentvesting, you may be wondering how your rental payments will factor into the home loan application. Unlike a renter-turned-owner-occupier, it will not be counted as ‘income’ as you’ll continue to pay rent while servicing a mortgage.

Instead, the home loan lender will consider the following:

• Your current rental payments
• The estimated rental yield on the purchased property
• Your capacity to service the mortgage payments

The lender will need to assess that you can afford both your mortgage payments and your current rental payments. Your current rental payments will be considered an expense and factored into your borrowing power. The estimated rental yield is calculated by the lender, which has an algorithm to estimate this income, including CPI. The lender will then work out for your application what your expenses are less the estimated new rent (and other factors, like negative gearing) to determine your borrowing capacity.

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