As discussed in my recent article regarding Loan to Value Ratio (LVR), how much you can borrow is determined by two important factors: Your LVR and your Servicing Capacity. So this week I’m going to focus on the latter of these two. This is because when it comes to presenting a strong loan application it is not simply your income that your lender will consider. Instead it will be the all-important Servicing Capacity, or your actual ability to repay your loan, which will be key to your application’s success.
What is my Servicing Capacity?
Your Servicing Capacity is the amount of money that you can borrow based on how much you can afford to pay after all your income is allowed for, minus all of your current expenses and financial commitments. This amount is calculated by each lender via their own internal Servicing Calculator. Which means that how much you can ultimately borrow will vary greatly from lender to lender, sometimes by as much as $100,000! This is because the various financial institutions approach income and expenses (in particular) differently and each lender has their own unique formula to arrive at the Servicing Capacity figure.
To calculate your Servicing Capacity your lender will consider the following:
- Your Total Income:
This can consist of salary, wages, rental income, royalties, regular interest, Centrelink Payments, Family Benefits A & B (depending on the age of the children) etc. This income must be regular and ongoing as well as being evidenced by the appropriate documentation such as pay slips and bank statements. Examples of unallowable income can be Family Benefits paid as lump sums, a boarder renting a room or one off bonuses etc.
Some lenders (but not all) may discount or downwardly adjust income such as commissions, overtime, shift and other allowances under certain circumstances, unless it can be demonstrated that this is consistent income earned over an extended period of time.
- Your Total Expenses:
Car & Personal Loans– Lenders will require documentation showing your regular repayments on these loans, the applicable interest rates and how long the loans have before completion.
Credit Cards- Lenders will assume that all of your credit cards are maxed out or drawn to their full capacity, because in theory you can spend up to the total credit limits at any time. Therefore as well as gaining details of your current balances, they will want to know what your total credit limits are. They will then assume a minimum monthly payment of around 3% of your total combined credit card limit as an ongoing expense.
Existing Property Loans- Your lender will also want information about any repayments on other properties you may own, as well as the interest rates and how long the loans have before completion. If you have made extra payments and have re-draw capacity on the mortgages, then the limit on your loans, not the balances, is what the lenders will use to assess your repayments.
Living Expenses – In general most lenders will have automatic living expenses calculations based upon your circumstances, whether you are applying as a single, a couple, a family with children or group etc. This figure will increase for each additional dependent in a family.
Other Financial Commitments– These include items such as HECS debts, Store Loans, Hire Purchase Agreements, Furniture Rentals and Certegy Loans etc. These and any other regular expense commitments will also be taken into account to arrive at your Servicing Capacity.
- A Note On Savings
Demonstrating that you are able to save money and have a disciplined approach to doing so, has important benefits. This is because most lenders will want to see genuine savings of at least 5% of the purchase price of your property. Genuine savings is defined as regular deposits made over a period of 3 months or longer into a savings account in the name of the borrower. This can also be lump sum payments that have been put into a savings account but they must be held in the account for 3 months or longer.
An example of lump sum payments may be where parents gift the deposit, an inheritance is received or the proceeds from the sale of an asset forms part or all of the deposit etc. As a general rule, if you have an LVR of less than 85%, then genuine savings may not need to be demonstrated. Also when you have a deposit which is not genuine savings, this may not be a problem as there are specialist non-genuine savings lenders available.
From this brief rundown of the Servicing Capacity assessment process, it’s easy to see why the banks place so much emphasis on this key factor, because you must be able to show your lender that you can repay your loan. So if you are considering a property purchase, feel free to give one of our Mortgage Coaches a call to discuss your specific circumstances and potential Servicing Capacity position.
Until next time, watch those expenses,