Have you ever had a rude shock using an online mortgage calculator? You plug your numbers in and everything looks great! You contact a potential lender feeling confident, then feel deflated when they all but laugh down the phone at you. It turns out that you’re miles off borrowing what the calculator told you that you could afford. So what’s happened? Most likely you’ve discovered firsthand the difference between ‘borrowing capacity’ and ‘affordability’, the gulf many would-be buyers are discovering.

So what is the difference between borrowing capacity and affordability, and how are they both calculated?

What is borrowing power?

Put simply, borrowing power (or borrowing capacity) is based on the amount of money you have coming into your house. The bank calculates (or gets you to calculate) how much money is coming in, and they use this to calculate how much they will lend you. This can include salaries, wages and other earnings, as well as things like business income, rental investment income etc. The confusing part for borrowers is that while you earn the same amount, different lenders will offer you different amounts based on their own calculations. This means that some will offer you more than others. Lenders will also consider your current existing debt as well as the number of financial dependents you have.

Something to know here is that the bank will make assumptions as to how much your dependents cost you. This number may be nowhere near your actual costs, but it’s part of the formula. This is close to a ‘one size fits all’ calculation. For something more customised to your circumstances, they will calculate the affordability.

How is affordability calculated?

Affordability is the part of the equation actually based on your lifestyle and expenses. This can be affected by any of the financial decisions you make, including how much you spend on your car, on your hobbies, on holidays, or on your children or pets. Your insurance premiums and professional membership costs, including social clubs, will likely also be considered. This is where what you actually spend is compared against what the bank’s algorithm assumed you would be spending.

Of course, there’s also a big difference between back of the envelope calculations and the actual scrutiny the bank will subject you to. If you’re serious about applying for a loan, be sure to go through old receipts and bank statements to make sure that your numbers are accurate. While they’ll take your word for income and expenses in the initial stages, they will eventually check that against the reality of your finances.

How can I use this information?

Most free online calculators will tell you what your borrowing capacity is, but not what your affordability is. This means that if you’re just managing to scrape into your ideal borrowing range according to an online calculator, you might not quite be there yet. The online calculator will give you an idea of the upper-end of what you can borrow, but only an individual lender can determine what they will lend you. As lenders have different requirements and thresholds, each one may give you a different amount.

If you are struggling to meet lender’s thresholds, your time may be best spent going to talk to a broker to assess a variety of options at once. If nothing else, they might be able to tell you what needs to change in your circumstances to become eligible for a home loan. For example, if you’re in a single income household, the second partner earning a small amount (such as $10,000 or $20,000 a year) can make a bigger difference than the primary earner earning that much extra. This is to do with risk distribution, as it’s less risky for the bank to lend to you if you’re both responsible for money coming into the household.

Buying a house is a complicated process. If you haven’t been through it before, there’s a lot to learn. Don’t be afraid to read as much as you can, and to talk to as many people as you can to get a feel for the process. It’s a steep learning curve, but it’s always easier to do the reading upfront rather than learning lessons the hard way. It’s also easier to have the conversations with people who can help you upfront, rather than assuming that you’re getting closer to being able to borrow without knowing what else you may need to do.