As you can imagine, when interest rates start to rise, your borrowing power decreases, because servicing the mortgage becomes more expensive.

Let’s say Bo wants to buy a home with his partner Roe. Bo’s before-tax annual income is \$90,000 while Roe earns \$65,000, bringing Bo+Roe’s combined annual income to \$155,000. Their combined annual household living expenses are \$60,000 annually.

Based on an interest rate of 6.00% p.a. for a 30-year loan term, Bo+Roe should be able to borrow about \$688,120 (based on a serviceability buffer of 3%, which we’ll get to). However, based on an interest rate of 7.00% p.a. (a 100 basis point increase), they could only borrow \$627,530. This means their borrowing power effectively decreased by \$60,590, even though income and expenses are unchanged.

So how much would rate rises hurt your borrowing power, and how do banks assess home loan applications when interest rates can be subject to dramatic changes?

Work out exactly how much you can borrow with the Savings borrowing power calculator

How much do rate rises hurt your borrowing power?

Let’s stay with Bo and Roe. This is how much even small changes to the interest rate can impact borrowing power. The following table is based on a loan term of 30 years, and derived from Savings.com.au’s borrowing power calculator.

Interest rate

Maximum loan amount

Change

Base

6.00% p.a.

\$688,120

Unchanged

+1 basis point

6.01% p.a.

\$687,470

-\$650

+10 basis points

6.10% p.a.

\$681,640

-\$6,480

+100 basis points

7.00% p.a.

\$627,530

-\$60,590

+200 basis points

8.00% p.a.

\$575,360

-\$112,760

How does the serviceability buffer (and floor rate) fit in the picture?

In some countries, including the United States, 30-year fixed-rate home loans are commonplace, but in Australia, fixed terms typically don’t go beyond five years. That means over the course of a loan, the interest rate you pay can fluctuate dramatically.

Banks compensate for the risk of interest rate rises by using the serviceability buffer. When assessing a home loan application, they will add the serviceability buffer - currently 3% (300 basis points) - onto the advertised rate of the loan product, and judge whether the borrower could repay the loan at this higher rate. This is to stress test the borrower, ensuring they could afford substantial increases in their mortgage repayments should interest rates rise.

Many banks also have floor rates, which is a minimum rate loans are assessed against. Banks typically take the higher of the serviceability adjusted rate (advertised rate + 3% buffer) or the floor rate.

See more: Mortgage lending criteria

The indirect ways rate rises impact your borrowing power

Property prices

During periods of high interest rates, the maximum amount a bank will lend to you will typically be lower. If this is the case for you though, it also applies to others. Reduced borrowing power means reduced demand, which sometimes translates to property prices dropping. You might not be able to borrow as much as you want, but that might not matter if the property you’re after also drops in value.

As with most economic concepts though, this isn’t a guarantee. In 2023 for example, most analysts expected the rising cash rate would see property prices to continue to drop, after record declines throughout the second half of 2022. The cash rate did continue to rise, a full 100 basis points so far throughout the year, but property prices started to increase in March and kept going. CoreLogic have reported that by November, the market looks set to reach a new nominal high.

Economic conditions

Another thing to think about is that when the RBA lifts interest rates, it's usually because it thinks the economy is running too hot. Lifting the cash rate is designed to slow economic growth and reduce inflation. With the by-products of this sometimes including rising unemployment, or less work available if you are a sole trader, higher interest rates can reduce people’s income, which also curbs borrowing power.

Elevated cost of living

As we are seeing in 2023, higher interest rates are often a response to inflation running above target levels. At the end of 2022, Australia’s annual inflation rate was nearly at 8% annually. When the cost of the goods and services that make up your living expenses increase, without a comparable increase to your income, this can also reduce your borrowing power.

Buying a home or looking to refinance? The table below features home loans with some of the lowest interest rates on the market for owner occupiers.

Update resultsUpdate
LenderHome LoanInterest Rate Comparison Rate* Monthly Repayment Repayment type Rate Type Offset Redraw Ongoing Fees Upfront Fees Max LVR Lump Sum Repayment Additional Repayments Split Loan Option TagsFeaturesLinkCompare
5.69% p.a.
6.16% p.a.
\$2,319
Principal & Interest
Fixed
\$0
\$530
80%
Featured
• Available for purchase or refinance. 90% LVR
• Fast turnaround times. Can meet 30-day settlement
• No monthly or ongoing fees, split with low-rate variable loan
Disclosure
5.99% p.a.
5.90% p.a.
\$2,396
Principal & Interest
Variable
\$0
\$0
80%
Featured Apply in minutes
• No application or ongoing fees. Annual rate discount
• Unlimited redraws & additional repayments. LVR <80%
• A low-rate variable home loan from a 100% online lender. Backed by the Commonwealth Bank.
Disclosure
6.14% p.a.
6.16% p.a.
\$2,434
Principal & Interest
Variable
\$0
\$350
60%
• Estimate your borrowing power in as little as 1 minute
• Complete your application in as little as 15 minutes
Disclosure
Important Information and Comparison Rate Warning

Base criteria of: a \$400,000 loan amount, variable, fixed, principal and interest (P&I) home loans with an LVR (loan-to-value) ratio of at least 80%. However, the ‘Compare Home Loans’ table allows for calculations to be made on variables as selected and input by the user. Some products will be marked as promoted, featured or sponsored and may appear prominently in the tables regardless of their attributes. All products will list the LVR with the product and rate which are clearly published on the product provider’s website. Monthly repayments, once the base criteria are altered by the user, will be based on the selected products’ advertised rates and determined by the loan amount, repayment type, loan term and LVR as input by the user/you. *The Comparison rate is based on a \$150,000 loan over 25 years. Warning: this comparison rate is true only for this example and may not include all fees and charges. Different terms, fees or other loan amounts might result in a different comparison rate. Rates correct as of . View disclaimer.

Important Information and Comparison Rate Warning

Image by Ankush Minda on Unsplash

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