3 Main Factors That Determine How Much You Can Borrow From The Bank

Before you search for a nice home to buy for your own occupation or for investment purposes, it’s advisable to determine the maximum amount you can loan in order to identify the properties you can afford.

Essentially, the factors that affect your maximum loan quantum are household income, the debt servicing ratio (DSR) and the Loan-to-Value (LTV) ratio or margin of finance.

It’s an undeniable truth that individuals and households with a higher income can obtain greater financing than those with lesser earnings.

For example, Family A and Family B has a gross annual income of RM100,000 and RM200,000 respectively and each of them wants to take out a 30-year mortgage with an interest rate of 4.5%.

Based on PropertyGuru’s Affordability Calculator, Family A can loan up to RM493,403 and their maximum monthly repayments is RM2,500, while Family B can obtain as much as RM986,806 in financing and repay up to RM5,000 per month.

In the above illustration, it is assumed that both households will allocate 30% of their annual income to pay off the mortgage and they have no other existing financial obligations.

But what if they have other outstanding debts that needs to be repaid each month like car loans, credit card and student loans?

This is where the Debt Servicing Ratio (DSR) comes in. Basically, this is the yardstick used by banks to assess if a potential borrower would still have enough cash to pay off his monthly instalments after repaying his other commitments.

To calculate the DSR, a borrower’s total monthly debt obligation is divided by monthly net income then multiplied by 100 to convert it into percentage form.

For an easier explanation: the figure should not exceed 70% after including the new housing loan, otherwise the bank will likely reject your mortgage application.

But what is the DSR’s impact on the maximum amount that you can borrow?

To illustrate its effect, let’s assume that Family A and Family B have a gross annual household income of RM100,000 each.

But the former has an existing debt servicing ratio of 30% excluding the new loan, while the latter has a DSR of 50%.

In this illustration, even if both of them have the same level of income, Family A would be able to borrow a greater amount than family B.

However, it’s not advisable to depend on the 70% limit alone to see if you can really afford a mortgage because it doesn’t take into consideration all of the monthly expenses, according to financial experts.

To see if you can really service a loan without any hitch, compute your monthly expenses for necessities like food, utilities, clothes and transportation.

Then add the expected monthly instalment for your mortgage including interest and principal payment, plus real estate taxes and homeowners insurance.

The bottom line is that your net income should be higher than your projected overall expenses, with a remainder of at least 20% going to your savings or some form of long-term investment.

There should also be some cash left for flexible spending like dining out, vacation and entertainment.

But to avoid the hassle of calculating everything, financial advisers say that your monthly mortgage instalment including principal and interest payment along with property taxes and homeowners insurance should only account up to 28% of your monthly gross salary to prevent getting foreclosed in the event something bad happens, like getting laid off by your employer.

That means if you’re earning RM3,000 per month, your instalment should not go beyond RM840.

Another factor that affects the maximum mortgage amount is the loan-to-value (LTV) ratio or margin of finance.

Previously, home buyers can borrow up to 90% of a property’s gross price, excluding any rebates or special discounts and other freebies.

But now only firs-time buyers are eligible for the 90% LTV, while persons with two or more existing residential loans can only obtain a 70% margin of finance.

For instance, first-time buyers can get a mortgage of RM450,000 for a property valued at RM500,000, while those with two or more existing housing loans can only avail of RM350,000.

This means Family A would have to pay only RM50,000 from his own pocket, while Family B has to shoulder RM150,000.

Furthermore, Bank Negara Malaysia now requires financial institutions to use the net selling price instead of the gross value in computing the LTV because the former makes it easier for home buyers to obtain a greater amount at a higher margin of finance.

This rule is also in line with the central bank’s separate guideline that developers must fully divulge any discounts, rebates and add-ons they gave to the buyer.