Capacity refers to the borrower’s ability to service the loan. This is also known as serviceability. In simplified terms it relates to the surplus cash available after meeting all current personal expenses and other commitments. It assesses the borrower’s ability to repay the loan. The more surplus cash-flow that is available, the higher the potential loan amount.
The majority of lenders assess serviceability by calculating the repayments on the total borrowings at a benchmark rate that is usually one to two per cent higher than the actual lending interest rate at the time. This figure is compared to the income available after tax and after making an allowance for living expenses based on the number of adults and children.
Included in income is an allowance for the net rental income from property. The percentage of gross rental income allowed to arrive at the net rental income varies from lender to lender, but is generally between 70 per cent and 80 per cent.
A number of lenders are now allowing the tax savings from negative gearing to be taken into account when calculating net available income. There can be large variations in maximum borrowings between lenders, especially when an investor has a number of investment properties where the borrowings are tax deductible. These variations are in accordance with lenders’ benchmark rates, percentage of gross rent allowed to calculate net rent and whether a lender will allow for tax savings from negative gearing.