It’s a quiet Saturday night. You’ve ordered Uber Eats for dinner, have a Netflix original series playing on your television and are scouring the internet for a new outfit that you’re going to purchase with Afterpay.
This scenario doesn’t sound out of the ordinary, does it? But tighter lending conditions across Australia mean that seemingly harmless spending on your Saturday night could actually affect your ability to secure a home loan.
So, what do banks look at when you apply for a home loan?
1. Income and expenses
Banks assess a borrower’s income, other loans and living expenses to calculate how much money can be put towards home loan repayments.
In the current market, lenders are looking much harder at borrowers’ expenses by analysing credit card statements, transaction accounts and any recurring spending patterns.
In the first instance, you’ll most likely be asked to detail expenses like childcare, education, insurances, phone and internet bills, groceries, medical costs, entertainment, recreation, travel and transport.
So, if your bank account is filled with Uber Eats orders, overdue Afterpay bills, Netflix subscriptions, take away coffees and smashed avo brunches, perhaps it’s time to tidy up your spending habits.
It can be daunting to actually tally up your spending, but it can also be incredibly beneficial. Knowing your income and outgoing costs can help you curb unnecessary spending as well as give you a realistic understanding of your financial position. This will help when it comes time to apply for a home loan.
2. Loan to Value Ratio
Loan to value ratio (LVR) is how lenders describe the amount you need to borrow to buy a property. To calculate the LVR, divide the loan amount by the value of the property then multiply by 100 to get a percentage. Banks and financial institutions use this as a measure of whether you can secure the loan.
When borrowers request a loan for an amount that’s near the appraised value and therefore has a high LVR, lenders consider there to be a greater chance of the loan going into default.
“In general, home loan applicants with an LVR over 80% are considered to be riskier to lenders.”
In general, home loan applicants with an LVR over 80% are considered to be riskier to lenders. However, with the introduction of the First Home Loan Deposit Scheme, first home buyers can access a mortgage with as little as a 5 per cent deposit.
To find out more about the scheme, read What is the first home buyers grant?
3. Liabilities
Liability refers to the money you owe. This can include car loans, personal loans, HECS/HELP debt, tax liabilities, credit cards and store cards. Even if your balance on a credit card is nil, the banks still want to know about it.
A lender will be hesitant to take on a customer who is juggling multiple streams of debt at once.
Before thinking about a deposit, you should start devoting more money to paying off any existing debts or consider consolidating them to simplify your financial burden.
4. Credit history
Now the banks know how much you owe, they’ll be able to delve deeper into your credit history. Your financial and personal information is recorded on a credit report, and lenders can use this data to calculate a credit rating.
The credit rating helps them to determine whether to lend to you and if so, how much they will approve. Your rating can increase and decrease over time depending on your circumstances and financial information.
If you’ve missed payments, defaulted on a loan or failed to pay off a mounting credit card bill, this can negatively affect your rating and therefore your ability to secure a mortgage.
5. Assets
Not only do lenders want to know what you owe, they want to know what you own. Assets like property, savings accounts, vehicles, investments and shares, and other household items like boats, tools, furniture and electrical goods can all be included in your loan application.
Although you may not realise, these items often tally up to a significant amount and can add to your net worth.
6. Employment history
Lenders like to see secure employment when assessing a home loan application. Most lenders won’t approve a home loan application if the borrower is still on probation, so ensure you have proof of your employment history.
It’s important to have at least six to twelve months in a job, receiving regular income.
7. Significant changes in finances
Do you expect any significant change to your financial situation over the next three years? It’s important to outline any foreseeable shift in circumstances, whether that be extended leave, retirement, full time study, medical treatment or your next business venture.
These changes can range from a temporary decrease in income to an anticipated large expenditure.
8. Credit card limits
Even if you’re a conservative spender, be aware of your credit card limits when applying for a home loan. Lenders will look at the maximum spending limit on every credit card you own and factor this into your potential expenses.
You may never actually spend the maximum amount, but the fact that it’s accessible means it’s a possibility the banks have to consider. With this in mind, it can be a good idea to reduce any unnecessary credit card limits before applying for a home loan.
More on What Banks Look at When You Apply For a Home Loan
What does the bank check when applying for home loan?
Aussie banks take a deep dive into your finances to assess your suitability for a home loan. Here’s what they typically scrutinise:
- Income and Expenses: They’ll verify your income with payslips, tax returns, and assess your spending habits through bank statements. Regular income and manageable expenses show you can comfortably afford repayments.
- Savings and Deposit: Banks want to see evidence of a genuine deposit, typically a minimum percentage of the property value. This demonstrates your financial commitment and reduces the amount they lend, lowering their risk.
- Debts and Liabilities: Existing debts like credit cards, personal loans, or other loans are factored in. High debt levels can restrict the loan amount you qualify for, as they impact your capacity for repayments.
- Credit History: Your credit report reveals your past borrowing and repayment behavior. Defaults, missed payments, or a high credit card utilization can raise red flags, indicating a potential risk of delinquency on the home loan.
- Property Valuation: An independent valuation of the property ensures the loan amount aligns with the property’s true value. This protects the bank in case of future repossession.
How do banks decide on home loans?
Based on this information, banks use a risk assessment process to determine your eligibility and loan terms.
Factors like your income stability, debt-to-income ratio, credit score, and the property’s value all influence the interest rate you’re offered and the maximum loan amount you can borrow.
What are red flags on bank statements?
While your bank statements might seem like a simple record of transactions, they play a crucial role in shaping your home loan approval chances. Here are some red flags that could send warning signs to lenders:
- Large, frequent unexplained deposits: These could indicate undeclared income, making it difficult to verify your true financial picture.
- Regular overdrafts: A consistent pattern of overdrafts suggests difficulty managing finances, raising concerns about handling loan repayments.
- Missed loan or bill payments: A history of defaults on other loans or bills is a red flag for potential repayment issues with the home loan.
- Excessive gambling transactions: Frequent gambling expenses can raise concerns about responsible financial management.
By understanding what banks look for and avoiding these red flags, you can strengthen your home loan application and increase your chances of securing a loan that fits your needs.
