When you apply for a home loan, a lender will take many factors into consideration when deciding whether or not to approve your application. One factor is serviceability, which means your ability to afford the loan repayments after considering all of your income, expenses and liabilities.
What is mortgage serviceability?
Serviceability is your ability to pay, or service, your home loan repayments each month. Lenders calculate your serviceability to ensure you can afford the mortgage and to determine how much of a home loan debt you can manage.
Each lender has its own way of calculating serviceability, and different criteria when it comes to the serviceability standards. Lender A could look at your income and expenses and decide to lend you a maximum of $480,000. Lender B could use those same figures and lend you $500,000.
Lenders don’t often make their exact serviceability standards public, but they do tend to calculate serviceability in a similar way.
Calculate your serviceability
While every lender determines your serviceability slightly differently, you can get a general idea of your borrowing power with our borrowing power calculator.
To use the calculator, enter your income from all sources. Then enter any other loans you have, the total limit of all your credit cards and your number of dependants.
How do lenders calculate serviceability?
In general, lenders calculate serviceability by adding together your income from all sources, subtracting your expenses and debt liabilities and adding in the monthly mortgage payment.
Income can come from a variety of sources beyond your job. Lenders will take into account income from:
- Salary and wages
- Rental property income
- Investments and dividends
- Centrelink benefits
- Self-employed income
Some types of income will not be included in full in lenders’ calculations. Rental income, for instance, is assumed to fluctuate, as an investment property could go untenanted for a period of time. Likewise, investments such as shares have the potential to fluctuate in value, or even to depreciate.
Because of this, most lenders will only accept up to 80% of gross rental income or other investments when assessing your total income.
Lenders also build a buffer into their calculations. While you may be able to service a home loan of a certain size at current interest rates, lenders want to know that you’ll continue to be able to service this debt should rates rise substantially.
Following APRA guidelines, lenders add an interest rate buffer of at least 3.00% to serviceability calculations. Let's say you want to borrow $500,000 and the loan's interest rate is 2.20%. The your monthly repayments would equal $1,898.
But your lender has to apply a 3.00% buffer on top. That's rate of 5.20%. Your monthly repayments now equal $2,745.
This is the figure your lender uses to see if you can afford the repayments.
Affordability vs serviceability
Andrew Mirams is the managing director of Intuitive Finance and has around three decades of experience in the mortgage industry. He explains the difference between able to "afford" a home loan and being able to "service" the loan.
"The term serviceability means the ability of a borrower to meet loan repayments. Just because someone has a reasonable income, it doesn't mean they will automatically be given the green light.Your loan application is assessed on a number of contributing factors, including:
- Income, which can include your salary, rental income and investments.
- Living expenses, which can be higher for high income earners who tend to live more lavish lifestyles. That is, their expenses rise up to meet their income!
- Debt expenses and other commitments such as credit card limits or personal loans.
This assessment is known as the 'debt service ratio' and is a borrower's monthly debt expenses as a proportion of monthly income. This helps lenders evaluate whether they can afford the loan.
Each lender has its own assessment method; that's why it pays to shop around for the bank that is best suited to your individual financial circumstances.Conversely, the term affordability refers to a borrower's capability to pay off the home loan.
Lenders will consider whether an applicant can continue to live the lifestyle they do now while making mortgage repayments. If not, then the loan application may not be approved.
How can I improve my borrowing power?
There are two main ways to increase your borrowing capacity: you can either increase your income or decrease your expenses.
Increasing income can often be influenced by factors beyond your control. You can ask your employer for a pay rise, invest in assets that will provide regular income or take on a second job, but some of these strategies may not be practical for you.
However, you have far more control over your expenses. You can decrease the liabilities you have by committing yourself to paying down your existing debt. Work out a budget to tackle reducing your debt. You can also close out credit or loan accounts you don’t use. Even if you don’t owe money on them, the credit limit on these products can eat into your borrowing power.
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