What do banks look for when considering a home loan application?
Lenders generally focus on your income and how you make it, the property you are buying and its value, your savings and spending habits, your credit history and what you own or owe.
The four C's of credit:
These can be summed up in the four C’s of credit:
- Capacity or your ability to repay the loan. Do you have a stable jonb and a steady income? How long have you been in your job? Do you have other debts or obligations?
- Character or your willingness to repay the loan? Have you had a loan before? Do you genrally pay your bills on time?
- Collateral or do you have assets the bank can sell to get their money back if you don’t pay?
- Capital or assets. Do you have other assets, such as a savings account, car, or shares that you could use to repay the debt?
So what does this mean in practice for home loan borrowers?
1. Income
Your income and how you earn it will affect how much money you’ll be able to borrow. And this will vary greatly between lenders. Often this will determine which lender is appropriate more than rate will.
Not all income is created equal. The best is regular ordinary time salary as evidenced by a number of consecutive payslips. Each bank has its own approach to assessing additional pay such as commissions, bonuses, overtime, shift allowance and other loadings.
Overseas salary will often be severely discounted or ignored depending on the currency in which it is earned.
If you get a portion of your pay in shares, these are likely to be heavily discounted.
Many Government benefits may not be counted as relevant income.
Self employed and business owners will generally face greater scrutiny, to ensure the income is sustainable. The best result will be achieved with two consecutive tax returns with steady to slightly increasing income.
Be aware that your creative accountant will usually seek to reduce taxable income to minimize your tax bill – its just in the DNA. This may backfire when it comes to demonstrating to a lender that you’re good for a loan.
Rental income and related expenses will also be treated differently and can have a huge impact on which lender is appropriate for you.
Income from share investments will usually be ignored unless received over a period of many years.
2. Employment history
A consistent employment record is important.
Don’t change jobs just before you want to get a home loan.
Probation is a no-no for many lenders.
Casual positions and second jobs often are disregarded or significantly discounted by lenders. And don’t expect your side hustle to get treated like a steady wage.
3. Savings.
A demonstrated history of saving from your income is an important element in demonstrating that you’re good for a loan.
Firstly, because it shows that you are able to manage your money, and secondly, because the more savings you have, the lower proportion of the purchase price you will need to borrow.
4. Deposit
Regardless of how much income you have, each lender will have an upper limit as to how much of the value of the property they will lend. This ratio is called the Loan to Value ratio (LVR or LTV).
The lower rates are often only available to those borrowing less than 80% of the value of the property, but it can be possible to go as high as 95%. And with a parental guarantee to 100% or even more.
5. Spending habits
Lenders will usually closely examine your bank and credit statements for a period of up to six months to get an insight into your spending habits and to ensure you aren’t exceeding your limits or making late payments.
They will look for regular transfers or payments which might indicate a debt or other fixed commitment. And they will look to see if you are regularly spending less than you earn consistent with the savings you are claiming.
No matter how frugal you might be most lenders have adopted a floor on the living expenses they will accept. This floor is based on how many people are in your household, where you live and how much you earn.
6. Credit score
All lenders will review your credit file to look at your history of credit usage and repayment behaviour.
The are some red flags which will limit your options and potentially lead to a dcline. Court judgements, bankruptcies, and defaults are obvious. But more innocent ones such as multiple enquiries (often just shopping around or chasing sign on bonuses for credit cards) or credit with some types of lenders, can lead to questions or even a decline.
Some lenders use a computer algorithm to filter applications, so your application might be auto declined and not even get looked at by a human if too many of these red flags are present.
Unlike the USA, your credit score (as shown on many websites) is not used as hard and fast indicator. Many lenders use their own algorithm.
But your credit score is a useful indicator to self assess. Your credit score is a number derived form your credit file, that attempts to identify how likely you are to default, and is typically measured on a scale of 0 to 1,200 or 0 to 1,000. Each of the three main bureaus has their own scale and methodology.
Generally speaking, the higher your score, the more desirable a customer you are. Paying your bills on time and making regular progress in paying down debts result in a higher credit score, while bankruptcies, defaults, unpaid debts and multiple unsuccessful loan applications will result in a lower one.
7. Assets and liabilities
What you own and what you owe is another key determinant in whether you will qualify for a loan and for how much.
Your assets can include cars, superannuation and any properties you may own already.
Liabilities, on the other hand, can include credit card debts, personal loans, car loans or other home loans.
When it comes to credit cards, it’s the limit that matters not how much you actually owe. So consider getting rid of the ones you don’t really need.
Be very careful about using your cash to pay for your car or repay your car loan early – the impact on the total cost of your loan might be the opposite of what you expect.
8. HECS/HELP
Although, HECS/HELP is a liability, it is treated differently to other debts – mostly because it is.
What matters here is not the balance on your account, but the impact it has on your take home pay.
So making additional payments won’t make any difference unless it results in the total balance being cleared. This cash flow will usually be better directed to increasing your deposit.
9. Debt to Income Ratio
The total amount of debt (other than HECS/HELP) that you have relative your income is becoming increasingly important when it to comes to how much you can borrow.
This will have a big impact on people with investment properties which generate rent to service the loan but still add to the total debt burden.
Debt multiples of up to six will get little scrutiny even if they may not be prudent as a borrower. Nine times is likely to be an upper limit for most.
Get Professional help
There is a lot more to this than meets the casual eye. A good broker will help you cut through the clutter to get to what matters for you. Using a broker doesn't cost you more than going direct to your bank, but will save you time and hassle, be more convenient and is likely to save you significant sums over the life of your loan.
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Vince Scully
Founder and Chief Sherpa
With over 25 years in Financial Services from consulting to management, Vince Scully is the go-to guy for wealth management and financial advice. Vince founded the Calliva Group; a fund manager, product issuer, advisor and lender to Government and private clients. Vince is an advisor to the Wealth Management Industry, and prior to his role as CEO at Calliva, a senior member of Macquarie bank’s infrastructure team.
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