The official cash rate continues to lift again this month. This is the highest the rate has been since July 2013 when it was 2.75%.

The increase will impact any homeowner with a variable-rate or split home loan, or anyone considering taking out a new loan. But it isn’t only repayments that will be impacted. The increasing cash rate also impacts borrowing power. But what is borrowing power and how much does an increase in cash rate and its flow-on effect to interest rates impact it?

Borrowing power is the amount of money a lender is willing to let you borrow to purchase property. This is also sometimes referred to as your borrowing capacity. The way it is calculated varies depending on the lender, but in general it takes into consideration your income, assets, liabilities, credit health, debts, deposit amount and the value of the property.

Lenders are also expected to apply at least a three percentage points interest rate serviceability buffer (according to the Australian Prudential Regulation Authority’s guidelines). This means the lender will add at least three percentage points to the current interest rate to calculate repayments and ensure you will be able to meet them, hedging against future rate rises (for example a 3% p.a. Interest rate would be raised to 6% p.a. With the serviceability buffer).

When you speak to your Construction Home Loan Specialist, we calculate your borrowing power across the criteria of a number of lenders to give you an idea of how much you could borrow and therefore the top value of properties you may want to consider in your search.

When interest rates rise, your borrowing power is likely to decrease. This is because the repayments will increase and if your income isn’t also increasing, your ability to service that loan will drop. Let’s have a look at how borrowing capacity can be impacted as interest rates rise.

In this example, Nancy earns $110,000 per year pre-tax with no dependents, debts or credit card and the average Australian annual expenses of $16,500. For a loan term of 30 years, her borrowing capacity would change depending on the interest rate as follows:

3.0% p.a. - $830,000

3.5% p.a. - $784,000

4.0% p.a. - $741,000

4.5% p.a. - $702,000

5.0% p.a. - $666,000

5.5% p.a. - $632,000

6.0% p.a. - $602,000

As you can see, an increase of just half a percentage point makes a huge difference in Nancy’s borrowing power. If the lender passed on the RBA’s full increase in cash rate in its interest rates, which was by half a percentage point last month, and Nancy had been considering a loan at 4% p.a., the interest rate would have increased to 4.5% p.a. and her borrowing power would have dropped from $741,000 to $702,000 - decreasing her potential bid by $39,000. 

Pre-approval is when a lender indicates they are satisfied you meet their criteria to borrow a specified amount. This is very helpful in refining your property search and bidding with confidence. However, something to keep in mind is that pre-approvals are conditional. If your circumstances change or interest rates increase, it could impact your pre-approval. While one increase in the cash rate is unlikely to void your pre-approval, if the cash rate increased three times during the period of your pre-approval (which is usually up to around three months), you may find the amount the lender is willing to lend you has decreased.

Because of this, it is a good idea to get pre-approval when you are likely to choose your new home and signing your building contract rather than waiting until the end of the pre-approval period. If there have been delays and you are not at this stage until later in your pre-approval period, speak to our Construction home loan specialists to find out if it could have been impacted.

The important thing to keep in mind is that increasing interest rates do not mean doom and gloom. We have a panel of over 60 lenders and can find the right one for your needs. There are still competitive deals available, and we can help optimise your borrowing power through a number of steps and matching you with the right lender.

Let our team of Construction Loan Specialists help you with anything finance related, every step of the way. You have nothing to loose! Our construction loan expertise and service comes at no cost to you. Learn more and make an enquiry.