Home Loan Serviceability: Meeting Lender Requirements

Home Loan Serviceability requirements of lenders is one of the most difficult barriers to overcome when attempting to obtain a mortgage to fund the purchase of your dream home.  

Serviceability refers to your ability to meet the monthly home loan repayments based on your income, expenses, and nature of existing debts.  

This article will guide you through the essential steps to undertake to help you to meet lender home loan serviceability requirements and secure your home loan. 

Understanding Home Loan Serviceability 

Home loan serviceability is a measure used by lenders to determine whether you can afford to repay on an ongoing basis, the required monthly mortgage loan repayments. Lenders assess your financial situation to ensure that you will not face undue hardship in making these regular loan repayments. 

Key Components of Serviceability 

1. Income: Your gross and net income, including salary, bonuses, rental income, and other sources. 
2. Expenses: Your living expenses, including utilities, groceries, transportation, and discretionary spending. 
3. Debts: Any existing debts, such as credit card balances, personal loans, and other financial obligations. 
4. Loan Amount: The principal amount you wish to borrow. 
5. Interest Rate: The rate at which interest will be charged on the loan amount. 

Key Factors Affecting Lender’s Home Loan Serviceability Calculations 

1. Assessment Buffer

Lenders apply an assessment buffer to determine if you can handle future interest rate hikes. The typical buffer ranges from 2% to 3% above the prevailing interest rate for home loans. A higher buffer reduces your borrowing power as it assumes higher future costs. 

• Example: If your current interest rate is 6%, a 3% buffer means the lender will assess your ability to repay as if the rate were 9% It applies to your existing home or investment loans even you are still paying 3.99% on fixed rate. Higher buffer significantly lowers the amount you can borrow. Monthly repayments for $500,000 loan at 6% over 30 years would be $2,998. Applying buffer 3%, lender asses your repayments at 9% which equal to a $4,023 monthly repayment. Applying a 2% buffer generates monthly repayments of $3,668. The difference between these two buffers is $355 per month, which is equal to the monthly repayments for a supplementary loan of $55,000 at 6% over 25 years. 

2. Overtime & Bonus Income

Different lenders assess overtime and bonus income differently, which can impact your borrowing capacity: 

• Some lenders take the average of the last 2 years and shave it (reduce it by a percentage). 
• Others might use the most recent year’s income but reduce it by up to 20% or more. 
• Some lenders consider 100% of your bonus, depending on how consistent and reliable they deem the income. 

3. Existing Commitments & Repayments

Lenders will look at any existing debts or financial commitments you have (e.g., personal loans, credit cards, car loans, etc.) and factor these into your borrowing capacity. The more repayments you have, the less you will be able to borrow. 

4. Rental Income

If you’re an investor, rental income from your properties will be a key factor. But it’s important to note that lenders shave rental income by varying percentages: 

• Some lenders apply a 75% reduction (e.g., 25% of rental income is ignored). 
• Others apply an 80% or even 90% reduction, depending on the lender’s policy. 

This difference treatment of rental income can have a significant impact on your borrowing capacity. 

5. Negative Gearing

Negative gearing allows investors to offset the losses from their investment properties against their taxable income. However, not all lenders treat negative gearing the same way: 

• Some lenders may not consider negative gearing at all, impacting your borrowing power. 
• Others may “shave” the benefit, meaning they reduce the positive effect of negative gearing on your borrowing capacity. 
• The interest rate applied to the negative gearing calculation can also influence the result, so understanding each lender’s approach is crucial. 

6. Living Expenses

While all lenders use a basic Household Expenditure Measure (HEM) for standard living expenses, some lenders include additional costs or categories, such as childcare, education, or private health insurance. This can impact your overall borrowing capacity. 

Certain lenders might absorb some additional living expenses into their HEM calculation, which could lead to a higher borrowing capacity compared to lenders who don’t. 

Early Steps to Help Meet Lender Home Loan Serviceability Requirements 

  1. Improve Your Income 

One of the most straightforward ways to enhance your future home loan serviceability is to increase your income. Consider the following strategies: 

• Seek a higher-paying job or ask for a raise in your current position. 
• Take on additional work or freelance projects to supplement your income. 
• Identify and leverage any other sources of income, such as rental properties or investments. 

2. Reduce Your Expenses

Lowering your living expenses can significantly improve your home loan serviceability. Implementing a budget can help you identify areas where you can cut costs: 

• Track your monthly expenses to pinpoint unnecessary spending. 
• Reduce discretionary expenses, such as dining out, entertainment, and subscriptions. 
• Shop around for better deals on utilities, insurance, and other recurring expenses. 

3. Manage and Reduce Debts

Lenders will scrutinize your existing debts when assessing your home loan serviceability. Take steps to manage and reduce your debt load: 

• Pay down high-interest debts, such as credit card balances and personal loans, as quickly as possible. 
• Consolidate multiple debts into a single loan with a lower interest rate. 
• Avoid taking on new debts or making large purchases before applying for a home loan. 

4. Save for a Larger Deposit

A larger deposit reduces the amount you need to borrow, thus improving your serviceability: 

• Aim to save at least 20% of the property’s purchase price as a deposit. 
• Consider utilizing government schemes and grants that can assist in saving for a deposit. 
• Open a high-interest savings account to grow your deposit faster. 

5. Maintain a Good Credit Score

A strong credit score can positively impact your serviceability assessment. Ensure your credit report remains in good standing: 

• Pay all your bills and debts on time to avoid late payment marks on your credit report. 
• Keep your credit card balances low and avoid maxing out your cards. 
• Regularly check your credit report for any inaccuracies and dispute any errors promptly. 

6. Provide Accurate and Comprehensive Documentation

Lenders require accurate documentation to assess your financial situation. Be well-prepared to provide the following: 

• Recent pay slips. 
• Six months of Bank statements showing your income and expenses. 
• Details of any existing debts, including six months of loan statements and repayment schedules. 
• Tax returns and financial statements if you are self-employed. 

7. Seek Professional Advice

Navigating the complexities of home loan serviceability can be challenging. Consider seeking early advice from a mortgage broker or financial advisor: 

• A mortgage broker can help you find the best loan products that match your current financial situation. 
• A financial advisor can provide personalized strategies to improve your serviceability. 
• Both professionals can assist in preparing your application to effectively meet lender home loan serviceability requirements. 

Failure to Satisfy Lenders Home Loan Serviceability Requirements 

If your home loan application is declined due to home loan serviceability issues, it typically means that the bank believes you don’t have enough income or financial capacity to comfortably service the loan (i.e., repay the loan and meet all associated costs).  

Addressing serviceability issues can be crucial for improving future chances of loan approval.  

Here are some lender concerns and steps individuals might consider adopting to address these issues and successfully obtain a home loan: 

Concerns: 

1. Income Insufficiency: The primary concern is that the borrower’s income is too low or irregular to meet the repayments for the requested loan. 
2. High Debt-to-Income (DTI) Ratio: If the borrower already has significant existing debt (such as personal loans, credit card debt, etc.), it could negatively affect the serviceability assessment. 
3. Living Expenses: Banks factor in living expenses, and if they are high compared to income, it can affect the approval of the loan. 
4. Inconsistent Income: For self-employed individuals or those with variable incomes, banks may have difficulty assessing long-term income stability. 
5. Credit History: A poor credit history, including missed payments or defaults, can affect serviceability by increasing the risk perceived by the lender. 
6. Future Financial Stress: If there are uncertainties about future income (e.g., expected job loss, pending changes in the economy), the bank may decline the loan, fearing that the borrower may struggle to repay the loan in the future. 

Steps to adopt: 

1. Increase Your Income: 

• Secure a Higher-Paying Job or a Side Hustle: Look for additional sources of income or seek opportunities to increase your primary income (e.g., negotiating a raise, starting a side business). 
• Rental Income: If you have a property that could generate rental income, this may improve your serviceability. 

2. Reduce Existing Debt: 

• Pay Off Debts: Reducing or eliminating existing debt can improve your Debt-to-Income (DTI) ratio. Start by paying off high-interest debts like credit cards or personal loans. 

• Consolidate Debt: Consider consolidating multiple debts into a single, lower-interest loan to reduce your overall monthly repayments. 

3. Lower Your Living Expenses: 

• Create a Budget:  Scrutinize your spending and look for areas where you can reduce costs, such as cutting out non-essential subscriptions or limiting discretionary spending. 

• Minimize Big Expenses: If possible, reduce major ongoing costs, like leasing a car or moving to a more affordable accommodation, to free up more funds for loan repayment. 

4. Increase Your Deposit: 

• Save a Larger Deposit: A larger deposit can reduce the loan-to-value (LTV) ratio, which may ease concerns about serviceability by reducing the loan amount you need to borrow. 

5. Seek a Co-Applicant or Guarantor: 

• Apply with a Co-Applicant: If you have a spouse, partner, or family member with a higher income, applying together can improve the overall serviceability of the loan. 

• Get a Guarantor: A guarantor can increase the likelihood of loan approval by providing additional security to the lender. 

6. Consider a Longer Loan Term: 

• Select a 30-Year Loan Term: By extending the loan term, monthly repayments may be lower, improving serviceability. However, this will result in more interest paid overtime. 

7. Reduce Your Loan Amount: 

• Apply for a Smaller Loan: Consider applying for a loan amount that is more manageable within your current financial situation. 

8. Review Your Credit Score: 

• Check Your Credit Report: Ensure there are no errors on your credit report that might be affecting your score. If there are mistakes, dispute them with the relevant credit bureaus. 

• Improve Your Credit Score: Pay off any overdue debts, reduce credit card balances, and avoid taking on new debt to improve your credit score before reapplying. 

9. Provide Strong Supporting Documentation: 

• Provide Proof of Additional Income: If you have additional income sources (e.g., bonuses, rental income, or part-time work), be sure to include this information in your application. 
• Show Savings History: Demonstrating a history of saving can show the bank you’re financially responsible and capable of handling the mortgage. 

10. Work with a Mortgage Broker: 

• Seek Expert Advice: A mortgage broker can help identify lenders that may have more flexible serviceability criteria, or they might suggest loan products better suited to your financial situation. 

11. Reassess Your Loan Structure: 

• Consider Interest-Only Loans: Some lenders offer interest-only loans for an initial period, which may lower monthly repayments. However, this approach comes with long-term risks and should be carefully considered. 

12. Explore Alternative Lenders: 

• Non-Banking Lenders: Some non-bank lenders may have more relaxed home loan serviceability assessments, though they might come with higher interest rates. 

Conclusion 

Meeting lender home loan serviceability requirements is crucial in securing a loan to finance your dream home.

By understanding the key components of serviceability and taking proactive steps to improve your financial situation, you can enhance your chances of loan approval.  

Remember to maintain a good credit score, reduce your debts, and provide accurate documentation. Seeking professional advice from your local mortgage broker can also provide valuable insights and support on your journey to homeownership. 

Should your initial application for a home loan be rejected on serviceability grounds, contact us here at Oz Lend, and we will provide help to assist you to address the issues involved.