How Australian Banks Assess Borrowing Power

When you apply for a home loan in Australia, the bank doesn't just look at your income and multiply it by some factor. They run a systematic serviceability assessment — and understanding exactly how it works can help you maximise your borrowing capacity and avoid surprises at approval time.

Step 1: Calculate gross income

Lenders assess different income types differently. Base salary is taken at 100%. Overtime and bonuses are typically averaged over 2 years and taken at 80%. Rental income is usually shaded to 80% to account for vacancies and costs. Self-employed income requires 2 years of tax returns and is averaged. Government benefits vary by lender and benefit type.

For a couple buying together, both incomes are combined. This is one of the most powerful ways to increase borrowing power — a combined household income of $180,000 is assessed very differently to two separate $90,000 incomes applying individually.

Step 2: Apply the assessment rate

APRA requires lenders to test your repayments at the loan rate plus a minimum 3% buffer. At a current market rate of 6.5%, the assessment rate is 9.5%. This is not a rate you'll ever actually pay — it's a hypothetical stress test to ensure you can service the loan if rates rise significantly.

The monthly repayment is calculated at the assessment rate for the full loan term (typically 30 years). This figure is then tested against your income and expenses.

Step 3: The HEM expense benchmark

The Household Expenditure Measure (HEM) is a minimum living expense floor. Lenders compare your declared monthly living expenses against the HEM benchmark for your income band and household size. If your declared expenses are below HEM, the lender uses HEM instead.

Post-ASIC scrutiny (following the Royal Commission into banking), lenders have become much stricter about verifying actual expenses against bank statements. Understating expenses is not only ineffective — it can result in application rejection and potential responsible lending breaches.

Step 4: Existing debt commitments

All existing monthly debt payments are deducted from available serviceability. This includes car loans, personal loans, HECS/HELP repayments, and credit card minimums. Importantly, lenders typically assess credit card commitments at 3% of the total credit limit per month — regardless of what you actually owe. A $20,000 credit card limit adds $600/month to your assessed commitments even if the balance is zero.

Step 5: Net surplus ratio (NSR)

After all commitments, the lender checks that a positive net surplus remains. The formula: Monthly income − mortgage repayment (at assessment rate) − living expenses (HEM floor) − existing debts = net surplus. This must be positive for the loan to pass serviceability.

Step 6: Debt-to-income ratio check

APRA guidance flags loans where total debt exceeds 6× gross annual income. Most lenders treat DTI above 6× as a risk flag requiring additional justification, credit committee approval, or both. Some lenders will decline outright above this threshold.

Example: A $750,000 loan on $120,000 income is a DTI of 6.25× — already above the APRA threshold. To bring this under 6×, the borrower needs either a larger deposit (smaller loan), a higher income, or a co-borrower.

What lenders also consider

Beyond the numerical serviceability assessment, lenders evaluate:

• Employment stability: Permanent employment is preferred. New jobs (less than 3 months) and probation periods can delay applications.
• Credit history: Defaults, late payments, and multiple recent applications (indicating "rate shopping") reduce lending appetite.
• LVR (Loan-to-Value Ratio): Above 80% requires LMI. Above 90%, lender options narrow significantly. Above 95%, very few lenders will approve.
• Property type: Small apartments (under 40sqm), unusual locations, and non-standard construction can reduce loan-to-value limits.

Why different lenders give different results

While all lenders must comply with APRA's minimum standards, they apply different policies on top. Some use higher or lower HEM benchmarks. Some shade rental income at 70% rather than 80%. Some are more flexible on DTI for high-income borrowers. Some have profession-specific policies (doctors and lawyers often get LMI waivers at 90% LVR).

This is why a mortgage broker — who has access to 40+ lenders — can often find approval where a single bank declines. The mathematics of serviceability are the same, but the policy overlays vary significantly.

Sources: APRA Prudential Practice Guide APG 223 (Residential Mortgage Lending), ASIC Regulatory Guide 209 (Credit Licensing), ABS Household Expenditure Survey.