If you have ever been told you can borrow less than expected, even though when you ran the numbers in a spreadsheet and worked out you still have a substantial amount of funds left over, then you’re not alone!
This is due to the “3% buffer“
It is one of the most important and most misunderstood parts of how most lenders assess your home loan. In today’s rate environment, it actually makes huge difference to how much you can actually borrow.
What is the 3% buffer?
When a lender assesses your loan, they do not use the actual interest rate that you will be paying, but rather they add a buffer of currently 3% on top of your loan rate to make sure you can still afford the loan if rates go up in the future.
So if your actual rate is 6.00% the bank assesses you at 9.00% (brutal right?) this is known as your assessment rate.
Why do lenders do this?
This rule comes from regulators like Australian Prudential Regulation Authority (APRA). The goals are to:
- Protect borrowers from interest rate rises
- Reduce the risk of mortgage stress
- Keep the financial system stable
- Avoid what happened in another country that I don’t want to name
It might feel harsh, but it has been designed to stop people from over extending especially when rates are low like during COVID times.
How it affects your borrowing power
The higher the assessment rate, the higher your “stressed tested” repayments are, this means:
- Your monthly commitments look bigger on paper
- Your surplus income looks smaller
- Your borrowing capacity drops
In most cases, the 3% buffer can reduce borrowing power by tens to even hundreds of thousands of dollars.
When interest rates rise, the buffer stacks on top, for example:
- A few years ago 2.50% + 3% buffer = 5.50% assessment rate
- Now 6.00% + 3% buffer = 9.00% assessment rate
That is a huge jump, even if your actual repayments are still manageable.
Can the buffer be reduced?
To put it bluntly, No.
The 3% buffer is a general standard across lenders and is guided by APRA, however there are a few specialist non-bank lenders that may utilise a smaller buffer based on strict conditions. You just need to know where to look OR utilise a broker (such as us, shameless plug).
Another strategy is navigate the 3% buffer is to:
- Find lenders with more favourable servicing models
- Structure your loan differently
- Use different income shading policies (specifically around income allowances, bonuses, rental, OT, etc.)
- Optimise existing debts to improve your position
So while the buffer itself doesn’t change, the outcome may change.
Final thoughts
The 3% buffer is one of the biggest gotcha factors in home loan success.
If your borrowing capacity feels lower than expected, it is not always your income but rather it is how the lender is assessing your loan behind the scenes.
If you want a clear picture of what you can actually borrow (and ways to improve it), it’s worth understanding the mechanisms and which levers to pull before making any big decisions.
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