You know you can afford it, so why did the bank say no?
Loan servicing is not as simple as you might think, and can vary dramatically from one lender to the next. Most lenders have some form of borrowing capacity calculator available on their website – the unfortunate truth is that these generic calculators are highly inaccurate!
There are many techniques applied in order to determine your borrowing power. Firstly, you will likely list your actual expenses – however the lender will default to using their own minimum standards for this.
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General living expenses
You might have minimal living costs and your actual living expenses may be lower than average, however the banks will allocate a minimum living expense to your application. This covers everything from your food, utility bills, petrol, and general day to day living expenses. If you’re thinking ‘I take home $3,000 per month after tax and have no ongoing liabilities –therefore, I should be able to get a mortgage based on a repayment of $3,000’ – then you may find yourself a little disappointed when you complete your application.
To give you an example, it could be as much as $1,200 – $1,400 for a single adult that the bank has assigned as your minimum cost of living – so suddenly you’re only left with $1,800 to service a home loan. That is going to make a dramatic difference in what you can borrow, and is often not even known by most property hunters! There are also different living expenses for couples, children and families – each lender is different.
Interest rate buffers
To make this harder for you to work out your true borrowing power, lenders generally include a buffer on the interest rate of anywhere from 1-2%, or more. So for example: the rate you receive from the lender is 5.5% – they are actually using a rate of 7.5% in their servicing calculations. Whilst this does complicate things, this is actually a good model! This means they’ve already made some allowances for fluctuations on mortgage rates, or just simply fluctuations in your month to month living expenses.
Having a buffer does mean you can borrow a little less, but also means that you are far less likely to run in to issues in the future. This buffer is also applied to most interest only loans – you may only be paying $1,000/month on your interest only loan – but when working out your capacity the bank is highly likely buffering this as if you were paying the loan off as principal and interest over 25 years – so suddenly the $1,000 you’re actually paying is closer to $1,600 in the lenders servicing calculator.
‘I have a credit card, but I never use it’
That’s great to see you’re not falling into the credit card trap, but from the lenders point of view, you can max that credit card out at the drop of a hat – so they will use the limit of the credit card to calculate your liability. Most lenders use around 2-3% of the limit as the assigned monthly liability, so a $10,000 limit with a $0 balance, is a $300/month potential liability. If you’re having issues with your borrowing capacity, try reducing your credit card limit, or – closing it down altogether.
Do you have any deductions?
Another sticking point that comes up all too often – be mindful of any deductions on your payslips – including salary sacrifice. If it’s for personal use such as mortgage repayments and living costs, with a letter from your employer to verify you probably won’t have too many issues. But if it’s something more sticky, like a vehicle lease that you’ve forgotten about, deductions for work related expenses, or even a HECS/HELP education debt, then this needs to be taken in to account in working out your borrowing capacity.
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There are many tricks and niche servicing policies throughout various lenders – like the ability to add $5,000+ to your income if you are supplied with a company car – or servicing other debts at actual repayment (ie, not adding the 1-2% buffer I mentioned earlier) – so it pays to know what each lenders niche’s are. This area is a little more specialised and so I’d always recommend taking guidance from your mortgage broker around this – after all it is our job to know!