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With Australia having one of the highest levels of household debt in the world, it’s unsurprising that lenders take a good hard look at your serviceability. In other words, your ability to meet your home loan repayments.
A common factor in determining how much you can borrow is to look at your loan-to-value ratio (LVR), which is how much deposit you have compared to the size of the loan. Lenders also determine your serviceability by scrutinising your expenses and liabilities compared to your income.
Calculating your serviceability
Although each lender has its own criteria for calculating serviceability, Net Service Ratio (NSR) is a standard measure. NSR measures your after-tax ability to service additional debt after allowing for existing debts and living expenses.
Your serviceability gives lenders an idea of your financial risk, in terms of repaying the debt based on your current income. If they know your regular commitments and expenses, such as debts and living expenses, it tells them something about how big a loan you can manage.
To calculate the Net Service Ratio, after-tax income is added up, incorporating any rental income. Then the proposed loan is deducted. Also deducted are your existing financial commitments, including other mortgages, credit card liabilities (usually calculated at 3%-4% of the monthly card balance), and finally your living expenses (non-financial) are calculated. The proposed loan and your existing mortgages are usually calculated at a test rate, which is higher than the current rate.
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Previously living expenses were estimated, but this has been replaced with a minimum benchmark known as the Household Expenditure Measure (HEM). Expenses like entertainment, groceries, utility bills, subscriptions and insurance premiums are collated as a measure of whether you’re prone to spending above your means.
If there is a surplus after adding these declared and verified living expenses, you might pass the serviceability test. Because each lender has a slightly different approach, you might pass with one lender but not the next.
- Useful reading: Why Living Expenses are Suddenly in the Spotlight
Income refers predominately to what you earn from your job each month, but it can also include money that comes in from other sources. For example, you might have rental income, receive child support or get a work bonus. Some income such as rent and shares are prone to fluctuation so the lender will usually use a reduced proportion in the assessment of total income.
How important is serviceability?
If you have a go at the Yellow Brick Road “How much can I borrow?” calculator, you can see some of the factors that influence a lender’s decision.
These are all essential details for a lender to know because it helps them to measure your ability to pay your mortgage comfortably without ending up in financial hardship. When it comes to an emergency like job loss or paying an unexpected bill, maintaining your mortgage repayments will be that much harder. It’s for this reason that lenders like to add in an extra margin when calculating your loan serviceability.
By increasing your borrowing power, you not only boost your chances of getting your loan approved, but also open the way to getting a better loan product with fewer fees and a lower interest rate.
Contact your qualified Yellow Brick Road mortgage broker to find out more about loan serviceability. We’re across the latest loan application criteria used by lenders so we can advise which lenders are a good fit, taking into account your overall financial picture.