With Australia having one of the highest levels of
household debt in the world, it’s unsurprising that lenders take a good hard look at your serviceability. In other words, your ability to meet your home loan repayments.
A common factor in determining how much you can borrow is to look at your loan-to-value ratio (LVR), which is how much deposit you have compared to the size of the loan. Lenders also determine your serviceability by scrutinising your expenses and liabilities compared to your income.
Home loan serviceability in the personal finance world means the amount in dollars required to pay for your home loan payment each month. If you cannot afford this, you will have difficulty meeting your mortgage repayments and may even be unable to keep up with other financial commitments like utilities and groceries.
How your serviceability is assessed
Different lenders have different criteria for this assessment, but Net Service Ratio (NSR) is a standard industry measure. NSR is a measure of the difference between after-tax income and expenses. It measures your ability to service the additional debt of a home loan after calculating your existing debts and living expenses.
Your serviceability tells lenders how likely you are to be able to pay off your debt based on your current income. If lenders know about your regular financial commitments and expenses, it gives them an accurate assessment of the amount of loan you can manage.
To calculate the NSR, lenders add up your after-tax income, including all sources like any rental income. They then subtract the amount of loan you have applied for, plus your existing expenses (like credit card liabilities and day-to-day living expenses). The proposed loan will be calculated a test rate, which is higher than the current rate you applied for. That means if you sign up for a $500,000 loan with an interest rate of 2.5% p.a., you’ll be assessed on your ability to pay off that same loan at a higher rate.
Living expenses are now calculated via a minimum benchmark known as the Household Expenditure Measure (HEM). Expenses like entertainment, groceries, utility bills, streaming services, subscriptions and insurance premiums are added up to assess whether you’re prone to spending above your means.
You’ll likely pass the serviceability test If there is a surplus after adding these declared and verified living expenses. Because lenders vary in their approaches to calculating NSR, don’t be surprised if you pass the test with one lender, but not another.
Why serviceability is so important
Utilise tools like the Yellow Brick Road “
How much can I borrow?” calculator, which can show some of the factors that influence a lender’s decision.
These tools highlight the
essential details a lender will ask for and scrutinise, because it’s the information they need to measure your ability to meet mortgage repayments under a proposed loan agreement, without finding yourself in financial hardship.
Emergencies happen. A job loss, unexpected bill, health scares on top of maintaining your mortgage repayments means that you want to ensure you’re not agreeing to a loan that leaves you with no wiggle room to continue saving. It’s for this reason that lenders like to add in an extra margin when calculating your loan serviceability.
The keys to increasing your serviceability
Your loan serviceability will vary from lender to lender and the specific assessment criteria they employ, however, there a few simple things you can do to put yourself in the best position when you submit your loan application to increase your serviceability.
Spend within your means: a lender is going to scrutinise your living expenses, so the earlier you get on top of your everyday expenses, the better. Luckily we have 7 simple savings hacks you can start today.
Increase your income: The most obvious way to increase your serviceability (though by no means the easiest) is to increase the amount of money you earn. You could do this by asking your employer for a raise, applying for a higher paying job, or even taking on a second job.
Reduce your expenses: Lenders will scrutinise your spending habits over the three months prior to applying for a home loan, so if you want to boost your borrowing power you’ll have to rein in any unnecessary purchases and show you can be responsible with your money.
Reduce debt: If you have any existing debt, try to pay it off as soon as possible. If you’re not sure where to start, identify which debt is accruing the most interest and tackle that one first.
Lower your credit limits: When determining your serviceability, lenders will usually calculate your minimum monthly repayment at 3% of your approved credit card limit. High credit limits don’t go over well, so try to reduce them where you can. And if you have any unused cards it’s a good idea to cancel them too.
Contact your qualified home loan experts to find out more about loan serviceability. We stay up to date with the latest loan application criteria used by lenders so we can advise you on the most suitable lenders for your personal situation.
