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It’s one of the first questions any borrower wants answered: “How much can I borrow?”
The answer will always be dependent on your ‘serviceability’.
Home loan serviceability is a lender’s formal assessment of a borrower’s ability to meet their mortgage repayments.
It is a measure of whether you have the financial capacity to comfortably make the required monthly or periodic payments on a home loan for the length of the loan.
When you apply for a home loan or pre-approval, a lender will assess your income (the money you make), your expenses (the money you spend), and your existing debts (the money you owe). This helps them figure out if you can comfortably pay back the loan without running into trouble.
Lenders will look at your financial situation and the loan you wish to take out, then carry out some calculations to ensure you can meet the required repayments, both now and as interest rates change over the course of the loan.
How do lenders determine my loan serviceability?
They run a ‘Serviceability Assessment’ which involves the lender assessing several factors about your personal finances to determine your serviceability levels:
- Income: Lenders will evaluate your income, including your salary, wages, rental income, and any other sources of income. They want to ensure that you have a steady and sufficient income to cover the loan repayments.
- Expenses: Your living expenses, including groceries, utilities, transportation costs, and other bills, are taken into account. Lenders want to determine if you’ll have enough money left over after meeting your regular expenses to cover the loan payments.
- Debts and Liabilities: Existing debts, such as credit card balances, personal loans, and other financial obligations, are considered. These can impact your ability to take on additional debt.
- Interest Rates: Lenders will also consider the interest rate on the loan. Higher interest rates will result in higher monthly repayments, which may affect your serviceability.
- Loan Term: The length of the loan term, typically 15, 20, or 30 years, can also influence serviceability. Longer loan terms often result in lower monthly payments but higher overall interest costs.
- Credit History: Your credit score and credit history are important factors. A good credit history can improve your chances of loan approval and favourable terms.
- Loan-to-Value Ratio (LTV): Lenders will assess the ratio of the loan amount to the appraised value of the property. I.e. the loan amount divided by the assets value x 100 gives you the LTV percentage. A lower LTV ratio generally indicates a lower risk for the lender. A higher LTV may require you to take out loan insurance.
- Future Financial Projections: Some lenders may also consider your future financial prospects, such as expected salary increases or changes in your financial situation.
- Loan Serviceability Buffer Rate: Before coming up with a final determination, most lenders will assess your serviceability by adding a ‘buffer’ – or a safety margin. This is applied on top of your loan interest rate to ensure that you are able to continue to make your repayments if interest rates increase. For example: if you are applying for a home loan with a 5% interest rate, you will be assessed on your ability to make repayments with an interest rate of 8%.
Serviceability Matters
Mark Bouris says that understanding serviceability is particularly important in a competitive property market:
“In a booming market, every buyer has to play to their strengths.”
“In this market, you have to become knowledgeable on some key areas: not only the real estate market that you’re looking to purchase in but with lending formulas for home loans and also your own personal finances and budgets.”
“You need to measure personal affordability and your ability to pay off the loan, known as loan serviceability.”
“One of the oldest rules in the book is that an appropriately-priced property should be valued at around five times your annual income.”
“This assumes a 20 percent deposit and it means that if you and your partner bring in $120,000, the sweet spot is a house price of $600,000. Admittedly in some areas of Australia, particularly In Sydney, this rule of thumb has become somewhat outdated.”
“The question of loan serviceability varies from lender to lender and often hinges on monthly household expenses such as food, clothing, entertainment, and so on. Your lender will help you determine this, according to your personal situation.”
“You can use online calculators to see your borrowing power, like our calculator, and every property buyer should use one to self-assess their situation. However, lenders might calculate your loan serviceability differently and where one may approve you, another won’t.”
“This can confuse borrowers. In an environment of having to stretch your income to cover a larger loan, first-home buyers should make at least one visit to a mortgage broker. Information is power, and brokers have the information.”
Every Lender is Different
Lenders may consider additional factors and use their own criteria to assess home loan serviceability. Therefore, it’s advisable to chat with a mortgage broker who has experience with the different serviceability criteria that various lenders utilise. Brokers negotiate loans with a number of lenders on their panel, so they’re prepared with knowledge that could help you avoid wasted time in applying to lenders whose serviceability criteria doesn’t align with your circumstances.
You should also be mindful that loan serviceability is not just about the current interest rate and repayment amount on your home loan. It’s also important to consider how comfortable you will feel with repayments if the interest rates increase in the future.
By understanding what factors lenders consider when assessing home loan serviceability, and by doing your own financial calculations, you can be better prepared to secure the loan you need!
If you would like to understand more about serviceability and be empowered with the knowledge you need to maximise your borrowing capability, reach out to us today and we will put you in touch with one of our experienced home loan experts.
