Mortgage serviceability can feel like a frustrating hurdle to clear. But it’s an important safeguard against borrowing too much, particularly in the current interest rate landscape.
It’s in the best interests of all parties involved if your mortgage is chugging along with regular repayments being made.
Borrowing an amount you don’t have a hope in hell of repaying can mean heartache for you, and can land your lender and broker in hot water.
Enter mortgage serviceability.
Before approving your loan application your lender will take a good look at your finances to see if you can meet repayments.
We’ll break down just what to expect with a mortgage serviceability test, and how you can improve your chances of gaining home loan approval.
What is mortgage serviceability?
Lenders and brokers have a duty of care to ensure you’re not provided with a loan that’s beyond your means.
In fact, the National Consumer Credit Protection Act (2009) is in place to ensure lenders and brokers are following responsible lending practices (here’s that hot water we were talking about earlier).
While this protects consumers from landing in financial dire straits, (which doesn’t have anything to do with getting money for nothin’, unfortunately) … it means that lenders and brokers are serious about checking serviceability, which can create some strict hoops for you to jump through.
So how is serviceability calculated?
Your serviceability is calculated by looking at your income and subtracting your expenses and debt repayments (including your new home loan repayment amount).
We then need to work out what portion of your monthly income can go toward repayments. This is called your debt service ratio.
It’s also important to calculate your debt-to-income ratio, which is a measurement used to compare your total debt to your gross household income.
Your credit card limit will also be taken into account and you may need to prove that you have the means to pay off the limit within three years, even if the balance is $0.
Finally, a serviceability buffer is applied to the current interest rate to see if you’ll be able to continue repayments should interest rates rise.
In 2021, the Australian Prudential Regulation Authority (APRA) raised the serviceability buffer from 2.5% to 3%.
This buffer amount has been the topic of much discussion, with some arguing it’s making it tough for people to pass the assessment and refinance to a lower-rate loan. But APRA is remaining firm at 3% given the current state of interest rates.
How to increase your serviceability
Here are our top tips for increasing your serviceability score and improving your chances of home loan approval:
– Pay down your debts to improve your debt-to-income ratio.
– Reduce your expenses by cutting out non-essentials and looking for better deals on utilities.
– Reduce your credit limits or cancel credit cards you’re not using, if appropriate.
– Increase your income by starting a side hustle, asking for a raise, landing a higher-paying job, or even a second one (which we fully acknowledge is not possible for many families).
Other ways you can increase your chances of home loan approval:
– Improve your credit score. Lenders will delve into your credit history to see if you’re good at making repayments.
– Look at spending habits. Lavish overspending on non-essentials could raise a lender’s eyebrows.
– Make savings. Showing that you can put away money on a regular basis will look good on your application.
How much can you safely borrow?
Buying a home is an exciting prospect, but you don’t want to stretch yourself beyond your means.
This is especially important given the recent RBA interest rate hikes over the past year.
But we’re here to help you crunch the numbers and find a loan that will work for you, not against you.
If you’d like to find out your borrowing power and what loan options are available, give us a bell.
What is the difference between serviceability and borrowing capacity?
When it comes to borrowing for a loan, there are two important factors to consider: borrowing capacity and serviceability.
Borrowing capacity refers to the amount you can borrow at a specific point in time, primarily based on your capital, including savings and equity. It reflects your financial resources available for lending purposes.
On the other hand, serviceability refers to the amount of loan you can comfortably repay, taking into account your income and expenses. It assesses whether you have the financial means to meet the loan repayments without straining your budget.
While these two factors are interconnected, it’s worth noting that they can vary significantly. In some cases, your borrowing capacity and serviceability may align closely, but in other situations, there can be notable differences between the two figures.
