Serviceability

mortgage-denial.jpgYour ability to make loan repayments, called serviceability, is crucial when you're talking to your bank or other financial institution.

To calculate your serviceability, financial institutions consider your debt-to-service ratio - the amount of your proposed loan added to any other existing loans and your nett income.

It's important to understand how your serviceability is calculated so you know where you stand when applying for loans, especially when you're accumulating a multi-property portfolio.

INCOME

Each lender has its own system, however you're likely to be asked about your:

  • total regular wage/salary from one or more jobs, or your business if you're self-employed;
  • commissions and bonuses; and
  • rental income from investment properties.

LIABILITIES

This is all the debt you have that will limit your serviceability:

CREDIT CARDS. Banks calculate the total spending limits on your credit cards, not how much you use them. Generally they assess this with a repayment of three percent of the total card limit.

For example, if you have a credit card with a $10,000 limit but you pay the whole amount owing every month, your lender will still calculate your repayments at $300 per month. So unless you need a high credit card limit, minimising it will increase your loan serviceability.

OTHER LOANS. Other property mortgages, personal loans, etc.
CHILDREN. They cost money (as every parent knows!), so they're taken into account.

ALL LENDERS AREN'T ALIKE

Different lenders can assess your serviceability differently.

BENCHMARK RATE. Each lender uses a different minimum rate to calculate your debt. Although this is usually around two percent higher than the standard variable rate, the higher a lender's benchmark rate the less borrowing capacity you have with that lender.

CURRENT DEBT REPAYMENT. Your serviceability is affected by the rates that your lender assumes you're paying to service your debts with other financial institutions. It might be the standard variable rate or the lender's own benchmark rate, which can be quite different.

RENTAL INCOME. Lenders discount rental income to allow for periods when the property is vacant, but the amount of that discount varies from lender to lender.

INCOME CALCULATION. Lenders use different methods to calculate your income if you're employed or self-employed, have additional part-time work, and have regular overtime, bonuses or other extras.

ADDED INTEREST

It isn't by accident that banks have an enviable track record when it comes to making profits!

They are very conservative in every aspect of your loan application. For instance, they add about two percent to their current interest rate in calculating your serviceability for a standard 'variable rate' loan.

Although wages and salaries generally mirror interest rates over the long term, your bank wants to be sure that you'd be able to make the repayments on your loan if interest rates increase faster than your income in the short term.

This isn't as common with short and medium-term fixed-rate loans, but it might apply for a long-term fixed-rate loan.

OVER-EXPOSURE

This means your risk to your lender, based on your serviceability for all of your loans.

If you have more than one loan from the same lender, then your exposure is higher than if you use different lenders. Two loans with the same lender isn't uncommon, and you might get a third if you have a solid track record with that lender, but to try for more would be pushing your luck.

Having too many loans with one lender can lead to problems if you then approach other lenders. When they check your existing commitments they might regard you as over-exposed with your other lender, and therefore risky to them too.

Another reason to spread your exposure is that the Australian Prudential Regulatory Authority has made banks tighten their lending criteria since the global financial crisis.

MORTGAGE BROKERS

A mortgage broker is good way to find multiple lenders to spread your exposure.

Mortgage brokers:

  • have access to a range of lenders and loans;
  • recommend the best lenders to suit your circumstances;
  • know which loans have the features you want, such as offset, redraw, variable and/or fixed rates, etc.;
  • can offer special deals from lenders wanting to get extra business;
  • can help to obtain a loan if banks regard you as too risky, for example if you're self-employed, a first home buyer, or have a poor credit rating;
  • can often get your loan approved quicker than a bank by chasing it up; and
  • generally provide excellent customer service because they're less bureaucratic than large banks.

CROSS-COLLATERALISING

When you take put a loan to buy a property, your bank usually requires the title of another property (or properties if you haven't paid back enough of one loan to satisfy the bank's loan-to-value ratio) as security in case you default.

It's important to check whether the loan agreement allows your bank to use money from the sale of any of your properties to pay back other loans. This can stop you from using the sale proceeds as you see fit, for example to obtain more property loans.

Many banks want to control the type of loan regardless of your overall situation with them. Loan establishment fees can also be higher.

Cross-collateralisation can also cause problems accessing equity in your other properties, especially when the property market is transitioning between growth and contraction. If one of your properties has enjoyed a capital gain and others have dropped, then the net effect on your portfolio may be nil or even negative. But if your properties are cross-collateralised, then you mightn't be able to use the extra equity in the property that increased in value.

HOW TO IMPROVE YOUR SERVICEABILITY

To summarise, here are some ways to maximise your borrowing power:

  • Increase your income.
  • Reduce the total of your credit card limits.
  • Pay off personal loans.
  • Use a mortgage broker to spread your exposure across multiple lenders.
  • Use lenders in order from the strictest to the easiest.
  • Avoid cross-collateralising

 

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