Borrowing capacity has reduced by around 30% over the past year due to the impact of higher interest rates and the increased 3% interest rate buffer that banks must use to calculate your borrowing capacity. This was eloquently depicted in this chart by CBA in February 2023.
I wanted to explore the common strategies that people can use to safely maximise their borrowing capacity.
How to borrow safely
I’ve written several times that building wealth is a marathon not a sprint. Whilst it is good to avoid procrastinating and invest as much as possible, you should never take high risks.
When borrowing, it’s wise to plan for the worst but hope for the best. Look closely at your spending habits to ascertain how much you need to maintain a standard of living. Don’t rely (completely) on variable income such as bonuses. Test your ability to repay at higher interest rates – even if you think they are unlikely. And ensure you have adequate buffers in place to help you navigate any unforeseen changes in circumstances.
As a rule of thumb, if you are borrowing more than 6 to 8 times your total gross annual income, be careful. It could be a sign that you are borrowing too much. Consider the risks. You must have an exit strategy that you can implement if everything goes pear-shaped.
In my experience, it is unnecessary to borrow a huge amount to achieve your goals. People that do accumulate a lot of debt (i.e., what I would consider to be too much) usually do it because they are investing in the wrong properties. Property investing is a game of quality, not quantity. I would rather own one awesome, investment-grade property and have $1.5m of debt than a portfolio of 10 properties with $5.6 million of debt (I’m using an actual example of a portfolio that I saw recently). The former scenario will generate a lot higher risk-adjusted return over the next 20 to 30 years.
My overarching point is, be careful. Don’t overborrow.
Having said that, it is helpful to know what steps you can take to preserve and maximise your borrowing capacity. Here’s a few tips.
Consider using a charge card instead of a credit card
After many years (decades) of actively investing and using different banks, my wife and I ended up accumulating 7
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