Why a high income doesn’t always make you eligible for a big home loan

Intuitive Finance managing director Andrew Mirams explains why the banks won't lend you money despite your high salary.

Many medium- to high-income earners believe that when they apply for a home loan they will have no trouble getting it approved.

Unfortunately this isn't necessarily the case because lenders assess each applicant on a number of factors, including their ability to service the loan.

Now, serviceability is different to affordability, so this article will outline the principal differences between the two as well as how you can improve your chances of a bank saying "yes" to your application instead of "no".

Affordability vs serviceability

When applying for a home loan, a lender will assess whether each applicant has the necessary cash flow to pay, or service, the mortgage.

And just because someone has a reasonable income, it doesn't mean they will automatically be given the green light.

Therefore the term serviceability means the ability of a borrower to meet loan repayments.

This will be 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. In fact, why not go to a mortgage broker who can do all that work for you?

In assessing your application, banks will also apply certain calculations to your existing mortgage loans, rental income and any credit card debt. For example, your rental income may be reduced by 20% to 25% to allow for vacancies and your credit card debt will be assessed as though your cards were all up to their limits (not balances), etc.

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.

Why is affordability so much harder now?

In recent times, lenders have changed their calculations of living expenses, which is having an impact on affordability and loan serviceability criteria.

In the past, a fairly generic calculation was used to assess a borrower's living expenses, but given the hot property market in some cities this criteria is now assessed at a more individual level.

Interest rates also remain at historic lows, which has driven demand in some of our capital city markets.

Many borrowers are wondering how they can improve their borrowing capacity in light of this tighter lending environment.

This is partly due to property prices increasing significantly in Sydney and parts of Melbourne, meaning homebuyers and investors need to borrow more, but this can be riskier for lenders.

New Australian Prudential Regulation Authority (APRA) rules have also limited the flow of interest-only loans to 30% of total new residential mortgages.

How much can I borrow?

Just as lenders have differing serviceability criteria, they also have different calculations when it comes to how much they will lend you.

This was highlighted by a "secret shopper" experiment by APRA in 2016 where it presented "applicants" to different banks to assess how much they were willing to lend to each of them.

The insightful results showed that the most generous lenders were prepared to lend 50% more than the most conservative.

The outcome of the survey showed that banks were willing to lend at levels ranging from five to 6.5 times a borrower’s gross income.

With the lending environment more constrained recently, it's possible that owner-occupier borrowers may be approved for a loan of about four to five times their gross income.

However, a caveat to that is that the borrower would need to also produce a 20% deposit to keep their loan to value ratio (LVR) within the banks’ preferable or sweet spot range of 80/20 or below.

If your LVR is above this amount, you would also be liable for lenders mortgage insurance, which can impact your borrowing capacity as well.

How can I improve my borrowing capacity?

With home loan serviceability on the radar of lenders, borrowers should do everything they can to improve their borrowing capacity as well as their chances of being approved for their chosen loan product.

There are a number of ways that you can improve your attractiveness to banks which can include:

• Compare home loans. One of the easiest ways to improve your borrowing capacity is to shop around for the best deal for you. Consider a number of different options and perhaps look for a mortgage broker that specialises in your situation, e.g. self-employed home loans.
• Many borrowers don't understand that it's the total limits of their credit cards that are counted in serviceability calculations, so consider cancelling some of them or lowering the limits. Reducing the limits on your credit cards can have a positive impact on your borrowing power.
• Another option is to consolidate your debt so that you only have one payment per month and also only one portion of debt that is accruing interest. Ideally, you should try to pay down any of this type of "bad debt” – such as a car loan – before applying for a home loan.
• With loan serviceability criteria tightening up, it's also wise to document your finances – including all incomings and outgoings – so you can provide a thorough assessment of your regular living expenses. This is of particular importance for self-employed borrowers who can be faced with a more arduous loan serviceability assessment.
• Saving a larger deposit, or using other investments to finance a deposit via equity, can increase the amount that you can borrow as well as showing the lender that you have good money and investment habits.

Conclusion

While the lending environment is currently more difficult due to intervention by the government regulator, it doesn't mean that solid borrowers with good credit histories and robust income levels can't qualify for home loans.

Banks are still open for business and are willing to lend to borrowers with sound financial foundations.

Also, it's worth keeping in mind that the current lending restrictions are likely to be temporary, especially since the Sydney and Melbourne markets are already cooling, according to the latest data.

Andrew Mirams

Andrew Mirams is the Managing Director of Intuitive Finance. With over 27 years of experience in the mortgage broking industry, Andrew and his team cover all aspects of lending for a diverse range of applications – from first home buyer loans to property upgrader loans, property investor loans, expatriates and loans for self-employed.