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What Is Home Loan Serviceability?

How much can you afford to borrow for a home loan? To an extent that depends on your serviceability.

There are a number of factors that a financial institution will take into account if you want to borrow money to purchase a property. One thing they will consider is the amount of deposit that you have, which (depending how much you want to borrow) will dictate the loan to value (LVR) ratio. You can read more about what is an LVR, here.

Another thing the financial intuition will consider is your serviceability. “Serviceability” is essentially the calculation of whether a borrower can afford the repayments on a loan, after other expenses and income are taken into account.

Thus is you intend to borrow an amount that will require you to pay back $3,000 per month – but after tax and other expenses are taken into account you have only $2,000 per month left over – your serviceability is not looking too good! Try our home loan repayments calculator to get an idea of what size home loan might be affordable for you.

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What is home loan serviceability?

Home loan serviceability is something that the Australian Prudential Regulation Authority (APRA) keeps a close eye on in relation to the lending practices of our financial institutions.

During a speech to the Macquarie University Financial Risk Day conference, APRA  General Manager, Industry Analysis, Heidi Richards, said that assessment of loan serviceability is not only a legal obligation for lenders under responsible lending rules; it is also an important, prudent risk management practice.

“Most banks calculate serviceability on a loan application by aggregating all sources of income (including rent on properties the borrower owns) and subtracting living expenses, interest and principal payments on the new debt and servicing costs of any other debt the borrower may have,” she said.

“The resulting number is called the net income surplus, or NIS. For most banks, the crux of the lending decision is whether or not the NIS is positive (although some add additional buffers). This is a simplification, as clearly banks also take into account qualitative factors including whether the borrower is an established customer or not, any past default history, industry of employment and location of the collateral.”

How much will a bank lend you?

APRA recently conducted a form of shadow-shopping, inventing four hypothetical “case studies” and requesting financial institutions to assess these hypothetical people and determine how much they would be willing to lend them. According to APRA this approach was approach was insightful, because it allowed them, for the first time, to benchmark lending policies in a consistent way.

So how much might a bank lend you? According to the APRA survey, it was not uncommon to find the most generous ADI was prepared to lend 50 per cent more than the most conservative. We found this disparity was particularly the case for investor borrowers, but even for owner-occupiers they saw ADIs willing to lend at levels ranging from 5x to 6.5x gross income.

Thus, 4 – 5 times your gross income is what you might reasonably expect to be able to borrow.

Not all income is the same though

APRA did note that financial institutions tend not to treat all forms of income in the same way. So while your PAYG income might be taken at face value, investment income or commissions or other forms of less certain income might not be able to command such a high level of borrowing.

“All ADIs are now applying at least minimum haircuts on uncertain income sources, and some have gone further to apply larger discounts to rental or other income,” said Ms Richards.

Banks apply a buffer

In addition to looking at your current income and expenses to determine whether you can afford a home loan now, financial institutions will add an interest rate buffer to their assessment – commonly 2 or 3 percent. That is, could you still afford the home loan if interest rates were to rise by three percent.

This is a very sensible thing to do because home loan interest rates will almost certainly rise (and fall) during the course of your home loan.

Before you take out a home loan make sure that you have a terrific budget in place, so that you’re in control of your expenses. You can try our budgeting calculator here.

We also have plenty of articles on how to save money, such as this one, and this one. And of course make sure that you compare home loans carefully before you sign up for anything.

You can view a snapshot of the current low rate variable home loans available to the market below in our comparison table, or you can try this tool for yourself and refine it to your requirements. This table has been sorted by comparison rate (lowest to highest). Please note that this table features products that are based on a loan amount of $750,000 with a LVR of 80%, under a first home buyer profile in NSW, with links direct to the providers’ website.

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