The simple guide to lending criteria for home loans
When you apply for a home loan, there are things you can do you boost your chances of approval. Find out the policies and criteria banks have in place when assessing your application.
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Banks have a set of criteria by which they assess home loan applications. These criteria determine whether or not you'll be approved. Unfortunately for you, individual lenders don't often make these policies public, which means there can be some guesswork involved in knowing whether or not your application is likely to be approved.
However, there is a general framework most lenders lean on. Most lenders will ask the following questions when assessing your application – and being aware in advance, can help you tailor your application to suit their lending criteria.
The first detail banks will look at is exactly what sort of borrower you are. Lenders definitely have preferred borrowers, and there are some borrowers they're unlikely to approve.
You have to be at least 18 years of age in order to be approved for a home loan. In general, many banks are hesitant to lend to older borrowers, because they're worried about your income and capacity to repay the loan when you retire.
While there aren't exceptions for borrowers over 18, there are exceptions for borrowers over the age of 55. If you're an older borrower, you may have to do a bit of extra work to see your application approved. You'll have to provide a written exit plan to demonstrate your ability to repay your home loan, and lenders may only be willing to offer you a shorter loan term.
A lender will want to know whether or not you're a permanent resident of Australia. However, if you're not a permanent resident you're not necessarily excluded from borrowing.
If you're a non-resident who is the spouse or de facto partner of an Australian citizen, Australian permanent resident or New Zealand citizen, lenders will assess your application like any other resident's application.
If you're a non-resident, lenders may place limits on the amount you can borrow. You may need a larger deposit. In some cases, you may also have to seek approval from the Foreign Investment Review Board.
A lender will want to know if you're borrowing as an individual or a collective. In other words, you may be sourcing a home loan as a company or as the trustee of a trust. Lenders will allow companies and trustees to borrow, but will require specific documentation and are likely to have different lending criteria in place.
However, not all companies or groups are eligible for home loans. Clubs and associations cannot be approved for home loans, and neither can limited liability companies (LLCs).
Lenders will need to examine your work situation to determine that you have a steady source of income. The way your income is assessed will depend on your type of employment.
If you're a PAYG employee, meaning you receive a payslip with tax withheld, you should have a relatively easy time proving your income. However, there are a few things lenders will scrutinise.
- Length of employment. Lenders usually require that you've been employed in the same job for 12 months, or in the same industry for two years.
- Type of employment. Lenders will want to know if you're full-time, part-time or casual. If you're a casual or seasonal employee you could face greater challenges getting approved for a home loan, though some lenders are willing to consider this type of employment on a case-by-case basis.
If you're self-employed, you won't have PAYG payslips to prove your income. Instead, a lender will need alternative documentation to demonstrate your income. You'll have to apply for a special type of home loan known as a low documentation, or low doc, home loan.
You'll usually be asked to provide Business Activity Statements, tax returns or a letter for your accountant. While it's sometimes more difficult for self-employed borrowers to provide income documentation, there are lenders who specialise in providing loans to these borrowers.
The next thing lenders will want is a detailed view of your financial history, habits and overall position. In order to get that, they'll look at a few different factors.
Lenders will want to know that you have a steady source of income. As stated before, this is easy to demonstrate if you're a PAYG employee. You'll just provide your last three payslips so your lender can determine your average pay amount.
But even PAYG employees may have sources of income apart from their normal pay. Some of these will be accepted by lenders, and some won't. Some of the sources of income lenders will accept include:
- Rental income. A lender will generally accept up to 80% of the income you receive from an investment property.
- Overtime pay. You'll generally need to provide two years of payslips to demonstrate how much overtime you're likely to work.
- Centrelink benefits. Certain Centrelink benefits, such as child support payments, are accepted as income. You can find the full list here.
- Fringe benefits. Lenders may accept up to 80% of any fringe benefits you receive such as a stipend, a living allowance or car allowance.
- Share dividends. Some lenders, though not all, will accept a portion of share dividends as income.
Some lenders may accept other alternative forms of income on a case-by-case basis. Likewise, if you're self-employed you'll use different documents to demonstrate your income, as mentioned above.
Lenders assess your income to determine serviceability, or your ability to repay your home loan. Your income helps a lender calculate the size of a home loan payment you're likely to be able to manage.
Your credit score
Lenders will also want to look at your debt repayment history. They do this by looking at your credit history and credit score.
There are a few different credit providers that can give you a credit score. Credit scores from bureau Experian range from 0 to 1,000 and credit scores from credit bureau Equifax range from 0 to 1,200. You can check your credit score and full credit report for free with finder here.
If you have had some rough patches in your credit history, there are still lenders who may be able to help. Some lenders specialise in helping borrowers with bad credit and offer home loans to borrowers who've had defaults, writs, judgements and even discharged bankrupts.
Lenders will assess your monthly expenses to determine your disposable income, or the income that's not currently devoted to bills, household necessities, groceries and discretionary spending. To calculate this, lenders tend to use one of two methods, either the Household Expenditure Method or the Henderson Poverty Index. The Household Expenditure Method calculates the median spend for basics necessities and discretionary items, while the Henderson Poverty Index is based on a survey of Australian families and assumes a family of two adults and two children.
You can head here to find out more about how your living expenses are calculated.
A lender will also take into account any assets you have. This includes vehicles you own, any shares you have, your superannuation and any other properties you might own.
Your liabilities include any debts you might have. This could be credit cards, personal loans, car loans or HECS or HELP debts.
When assessing your credit card debt, it's important to note that lenders will look at the combined credit limit of all your cards rather than what you owe on them. So if you have a card you don't use, it pays to cancel it or reduce the limit.
Lenders want to see that you've saved a deposit because it demonstrates your financial discipline. You will require at least a 5% deposit, except in some special circumstances.
If you have less than a 20% deposit, you'll have to pay for lenders mortgage insurance (LMI), an insurance policy that covers your lender in the event you default. This expense can add tens of thousands of dollars to the cost of your home loan.
Parts of your deposit can come from sources like gifts, financial windfalls or inheritances, but most lenders will want to see at least 5% coming from genuine savings. Genuine savings are funds you've held in your account for at least three months.
However, there are ways to get a home loan without a deposit. One way is to use a guarantor.
A guarantor is a close family member, usually a parent, who offers their home as security for your home loan. This security serves as a deposit, eliminating the need for you to save one yourself. However, this means your parents' home is at risk should you default on your home loan.
There is also one Australian lender that offers a home loan using a parental loan as a deposit. The parental loan is then managed and repaid through the lender.
However, in all other cases you'll need to save a deposit yourself, and you'll need at least 5%.
The type of home loan and the size of the loan amount also affect how the lender assesses you. This includes:
- The amount you wish to borrow must not exceed the loan's maximum loan-to-value ratio (LVR). In other words, you'll need to have a minimum deposit saved, with a common amount being 20% of the property's purchase price
- Your proposed borrowing amount must fit between the minimum and maximum loan limits imposed by the lender
- You must use the financing from the loan for the purpose it is designed for, such as using an investment home loan to purchase an investment property
Determining your borrowing power with an estimate calculator can also give you a better idea of how much you can borrow.
Next, lenders will want to know the kind of property you're buying. The property will be used as security for the home loan, meaning that if you default on the home loan, your lender will sell the property to recoup the money they've lent you. Because of this, banks scrutinise the type of property you're considering.
- Its location. Some lenders have restrictions on which postcodes they will lend in. Some rural areas, undesirable areas or areas of oversupply may face restrictions.
- Its nature. Your lender will want to know if you're buying a house or a unit. Lenders often have more stringent criteria when it comes to lending for units. They'll also want to know that the property has running water and electricity, is zoned for residential use and that it can be accessed without driving through someone else's property.
- Its size. The property size is usually relevant only to units. Most lenders will not lend for units under 50 square metres. However, land size is relevant to rural properties. If a property sits on more than ten hectares, some lenders will not consider it. Some lenders will consider land sizes up to 100 hectares as hobby farms, but anything above 100 hectares is generally considered income-producing.
- Its title. The property will need to have a freehold or strata title without encumbrances. In the event you default on your home loan, your lender will want to be able to sell the property without restrictions.
- Its use. If you're buying a rural property, it must be not be used for commercial farming.
Lastly, a lender will want to know why you're purchasing the property. The reason you're buying your property will dictate the type of loan you're eligible for, and often the amount you can borrow.
- To live in. If you're buying as an owner-occupier, you're likely to face fewer restrictions and get offered a home loan with a lower interest rate.
- As an investment. While investors face tighter lending criteria and are often saddled with higher interest rates, they are sometimes able to borrow larger amounts because lenders assume rental income will help them service their home loan.
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