Onar Serrano, home loan specialist from Lendary shares the intricacies of how banks calculate your ability to borrow.
“How much can I borrow?” is the number one question I get right after “what’s the best interest rate?” I find this question common amongst first time buyers, potential investors seeking their first investment property and buyers who have been out of the market for quite some time.
Post 2014, when lending practices were more closely scrutinised, the lending landscape in Australia became a lot more complex – albeit for the right reasons.
Many individuals query why banks offer differing borrowing capacities when most financial institutions are governed by APRA (Australian Prudential Regulation Authority).
Amongst other things, it is dependent on a bank’s “serviceability calculator” and the sensitivities applied on the inputs.
In Layman’s terms, serviceability refers to “one’s ability to afford their financial commitments after consideration of their revenue and total expenses (discretionary and non-discretionary)”. Put simply, it is your “repayment-ability calculator.”
Each bank’s serviceability calculator has three main elements, with each element possessing other sub-sectors. These are most commonly categorised by:
- Income
- Proposed & ongoing financial commitments
- Living expenses.
Income
Income is self-explanatory in its own right and could include salary earnings, dividend distributions and property rental income. With respect to other income types (for example dividend distributions) and rental income, banks will have differing sensitivities applied most commonly in the range of 70%-80% of the actual amount.
Proposed and Ongoing Financial Commitments
Proposed and ongoing financial commitments form the heart of where most deviation lies in terms of banks lending standards.
Regulatory changes have also seen banks assess serviceability based on an individual’s capacity to repay their debts as opposed to only meeting interest repayments. This has caused angst amongst individuals seeking funding and has inherently impacted the level of borrowings one can now seek.
In addition, each bank will apply to financial commitments what’s most commonly known as a “buffer rates” or “serviceability assessment rate” (SAR), which is a rate, applied regardless of the actual interest rate being afforded to an individual. These buffer rates differ between banks and are an important requirement of modern residential lending standards.
Some lenders will have a minimum serviceability assessment rate, of say, 5.5% or the actual interest rate plus 2.5%, whichever is higher. As example, if your interest rate being applied for is 3.10%, then a lender will add 2.5% and will assess your repayments at 5.6% (3.1% + 2.5%) with Principle & Interest repayments on the remaining term (after interest only period has expired). Some lenders will have an outright flat rate such as 8%. Though most lender follow the former nevertheless the serviceability assessment rates are a significant variable affecting your borrowing power.
Living Expenses
Finally living expenses is an area where historically, banks would assess individuals on the basis of a minimum required level of living expenses, relative to the number of individuals in a household. This methodology is now largely obsolete with lenders rigorously scrutinising actual living expenses via bank statements and or further confirmation & breakdown of expenses. Differing treatment of living expenses amongst banks has created a wider variance in relation to borrowing capacity correlated to the rigour applied in validating living costs.
In summary, the lending landscape of old has vastly transformed. The once simple and predominant comparison of interest rate is slowly waning with individuals seeking a middle ground between differing borrowing capacities and its commensurate interest rate.
To better understand your borrowing power, please take a look at Lendary to learn more.
