You may have heard the words serviceability and/or borrowing capacity in relation to a loan application or in the media lately. Serviceability and borrowing capacity are the same thing. They both mean the ability of a borrower to meet loan repayments, based upon the loan amount, the borrower’s income, expenses and other commitments. Having knowledge about how banks calculate servicing means you can prepare yourself and get into a more favourable financial position before applying for a loan.
Every bank has its own serviceability calculator and its own set of policies on what income can be used and how they calculate existing financial commitments which is why it is helpful to use a broker who will be aware of all the bank’s policies and will know which lender to recommend based on your circumstances.
I apologise in advance for the long story here but there are just so many factors. Hopefully it will help if you are about to apply for a loan and it will give you some insight into the life of a broker!
There are such a wide variety of income sources these days and each lender has a different take on what income they will accept for the purpose of serviceability. Income can include regular salary, overtime, a fully-maintained company car, shift allowance, bonuses and commissions.
In some industries where overtime is an integral part of income such as police, fire services and nursing, most lenders will take 100% of shift allowance & overtime but other industries, lenders may only take between 70% - 80%. You will need to evidence it is a permanent/ongoing part of the employment and not a ‘once off’ overtime scenario.
With regards to commission & bonus income, most banks will need you to evidence consistent bonus over a 2 year period for you to be able to use bonus income in servicing. Once this has been established, most will take 80% of the average of the last 2 years and some will take 90% of the lesser of the last 2 years. If there is a big variance between the last 2 years i.e. more than 20% then they will likely take the lower of the 2 years.
If you have a fully maintained company car, some lenders will add up to $5K to your salary. If you get a car allowance, this is also added to your salary but some lenders will only add 80% of the allowance.
If you do any salary sacrificing the lender will want further information on what the salary sacrificing is for and if it is voluntary or not. For example, if you salary sacrifice into your superfund this is usually voluntary which means we can add it back into your salary for servicing. Be prepared on this one though, the bank will generally ask for a letter from your employer to explain the salary sacrificing and to state whether it is voluntary or not.
Some Centrelink income can be used in servicing. Family Tax Benefit Parts A and B are considered in most cases where the children are under the age of 13. The Aged Pension is allowed by some lenders however Newstart or any of the study allowances are not acceptable.
Investment income from interest & dividends are only accepted if you can evidence the income over a 2 year period. The income will be averaged and shaded to 80%, however not all lenders accept this type of income.
Rental income is usually shaded to 80%. This allows for property management fees and other costs as well as any potential vacancy periods. Some lenders only accept 65% but most will accept 80%.
Credit cards have a really big affect on your borrowing capacity, even if you don’t owe anything on them. For the purpose of calculating your borrowing capacity the bank will assume you are at your credit card limit. Repayments on credit cards are generally 3% of the limit but this is going to increase in the very near future. For example, if you have a credit card limit of $20,000, the repayment allowed for in servicing will be $600/month. If you don’t use your credit card I would recommend closing it or reducing the limit before you apply for a loan.
Existing personal loans, car loans and leases the bank will ask you to declare the outstanding balance as well as the monthly repayments. Most banks will now ask you to evidence this by asking for your most recent bank statement.
If you already have a home or investment loan the banks take a conservative approach to the repayments on these existing debts. Generally speaking, for existing investment loans they will take the limit and calculate the repayment over a 25 year term, P & I (even if you are paying interest only), at a ‘benchmark’ or ‘assessment’ rate which is usually around 2.5% higher than the standard variable rate. This has quite a drastic effect on servicing. For example, if you are paying interest only on a $500,000 loan at an interest rate of 4.5% your actual repayment will be $1875/month but the bank will use $3614/month (25 year term, P & I at 7.25%) which is almost double. You can now see why people who have multiple investment properties find it almost impossible to get loans now.
On the topic of existing property investors, many receive tax benefits if their property is negatively geared. Some lenders will not consider this when calculating serviceability or some will but only apply 50% of the benefit. These changes happened recently with the crack down on investor lending.
Just like in the existing investment property scenario, your new loan will also be assessed at the assessment rate. So even if the rate you are signing up for is 3.90%, the bank will be calculating your ability to repay at 7.25% - 8% depending on the lender.
The banks have all recently changed the way they look at living expenses too. Some will determine minimum living expenses by postcode or by how much your salary is and some still use HEM (Household Expenditure Measure detailed by the Australian Bureau of Statistics) as their base line. When you declare your monthly living expenses most banks will now verify this from your bank statement so please take some time to calculate this when asked as the banks will go through these with a fine tooth comb! Also worth noting that if you like to have a punt, you may want to set up a separate account to do this as banks do not like seeing ‘SportsBet’ on your bank statement.
Hopefully this has given you some insight as to how much the lenders vary with calculating borrowing capacity and also into the value a good broker can add. If you’re are curious as to your own borrowing capacity please don’t hesitate to get in touch.