HOW MUCH CAN I BORROW ?
Before you can invest in property, you need money – pretty simple, right? But, when it comes to borrowing money from the bank, simple can start to feel pretty damn complicated.
You may have saved a 25 per cent deposit. You may only spend a small portion of your credit card limit each month and pay it back in full. You may even be living with your parents on a rent-free basis.
On the other hand, you may also be self-employed, or you may have only just started working at your current job within the last year. Your credit card limit may be five figures, or you may have a few different cards.
When it comes to assessing how much they will lend you, banks look at more than just your income, deposit size and actual expenses. They assess a number of variables to determine whether you can pay back the loan in full – even if you move out and start paying rent, max out your credit card or stop getting work.
It is important to know how much you can borrow before you start filling out loan applications. Excessive bank-hopping – that is, going from bank to bank applying for loans until you get approved – will damage your credit rating and limit the likelihood of getting any loan at all.
So, how can you find out how much banks will lend you? By understanding the way lenders assess your borrowing capacity, it is possible to present your best self when applying for finance. But, before you approach any bank, it pays to speak with the experts first.
And before you do this, you need to take a good hard look at your finances, your credit history and the state of your paperwork in order to prepare.
HOW DOES THE BANK ASSESS BORROWING CAPACITY?
In general terms, lenders will aggregate all sources of income and then subtract living expenses, monthly repayments on the new debt and monthly repayments on any existing debt. This will calculate the borrower’s Net Income Surplus (NIS) – in other words, whatever money the borrower has left after making repayments and paying other living expenses.
While most lenders take the same sort of approach in determining serviceability, the way income and expenses are treated can vary somewhat across institutions.
Not all forms of income are treated equally by lenders. If you are self-employed or working on a casual or contract basis, most lenders will treat your income as being more subject to variance than that of those who are permanent, full-time wage earners.
The amount of time you have worked in your role may also affect the way lenders assess your income.
Uncertain income sources – such as investment income, rental income, commissions and bonuses – will likely be given a “haircut” by most lenders. This means they may only use a certain percentage of what you actually earn when calculating your NIS. The percentage used varies across financial institutions.
The same thing applies to Centrelink income such as Family Tax Benefit.
Generally speaking, most lenders will load up your expenses in the following way. Each will have a minimum benchmark based on the Household Expenditure Measure (HEM). This means that even if you are living with your parents, rent-free, and your actual expenses are below the HEM, the banks will use still use their minimum expense benchmark to calculate your NIS.
Having dependants increases this benchmark – again, actual expenses don’t factor if they fall below the bank’s minimum standard.
CREDIT CARD LIMITS
You may only spend $1,000 or so each month on your card and then pay it back in full, but if your limit is $10,000 – that is what the banks will use to assess your serviceability. In their eyes, that $10,000 is available to be spent and paid back with interest, regardless of whether you intend to use it or not.
When lenders calculate your NIS, not only do they discount your income and load up your expenses, they also increase the interest rate on repayments. This interest rate “buffer” is in place to make sure you can still service the loan when rates rise.
On top of this “assessment rate” many some banks will calculate your NIS as if you were making both principal and interest repayments, even if you are actually paying interest on the loan.
Banks apply the above-mentioned assessment buffers to any existing home loan debt you may have. So, even if you are only paying interest repayments at 4.5 percent on your loan, the lender may assess your serviceability based on if you were paying both interest and principal repayments at 6.5 per cent, for example.
LOAN TO VALUE RATIOS
Your loan to value ratio (LVR) can affect the amount of money that banks are willing to lend you. If you are borrowing at an LVR of more than 80 per cent, most lenders will require Lender’s mortgage insurance to cover any potential default. This insurance protects the lender, not the borrower, however, the cost is transferred to the borrower in excess fees. This added cost may affect your serviceability.
In addition to this, many mortgage insurance providers require a higher NIS than what the lender may accept. For instance, hypothetically speaking, a lender may accept a loan application with a NIS of one dollar per month, but the mortgage insurer used won’t provide cover unless the NIS is $30 or higher (this figure is just for illustration purposes and not based on expected real life figures!).
HOW MUCH CAN I BORROW?
Early in 2016, in an address to the Macquarie University Financial Risk day conference, the General Manager of APRA, Heidi Richards, said:
“Mortgage lending at four times gross income is relatively common, at one-third of all new housing loans. Lending at six times or more of gross income is much smaller but still material – nearly 10 per cent.”
This suggests, as a rule of thumb, borrowers may reasonably expect to be able to borrow four to five times their gross income.
EVERYONE’S APPLICATION IS DIFFERENT
For instance, let’s say borrower 1 and borrower 2 (B1 and B2) both earn $80,000 a year. B1 is employed on a contract basis and has to reapply for his job at the end of his 12-month contract. In contrast, B2 is employed on a permanent full-time basis and has worked in the same job for the past three years.
In the banks’ eyes, B2 has a more secure form of income, so he is more likely to be able to borrow up to five times his income.
On the other hand, B2 is divorced with three children for whom he pays child support. B1 is single with no children. In the eyes of the bank, B2 has a much larger living expense. This reduces his NIS, reducing the amount the bank is subsequently willing to lend.
Now, B1 and B2 are on more equal footing.
In addition to assessing your serviceability, banks will also look at your credit history to determine the level of risk in lending you money. Your credit file shows every line of finance you have ever been approved for, including home loans, personal loans, car loans, and even mobile phone plans.
Your credit file also shows every time you have applied for a loan – even if unsuccessfully. If you have a large number of loan enquiries on your credit file, your lender will ask you to account for each of them. The more hits on your file, the worse it looks to the lender.
If you shop around for finance, applying unsuccessfully for loans at several banks, you are painting an unfavourable image of yourself to other lenders who may have approved your loan application otherwise. This is exactly why you should arm yourself with some expert knowledge before approaching lenders individually.
WHAT YOU CAN DO TO PREPARE?
Tim says, it is important to be in control of your paperwork and have all income and expense statements in easy reach. This will enable you to have the most accurate picture of your monthly finances and prevent you from leaving anything out by mistake.
He says, it also helps to be able to demonstrate a good savings history. Lenders like to see those who can show a regular savings pattern on their bank statements. For many, this may mean “managing their statements” so that account usage patterns demonstrate consistency and financial control. Ie, don’t just go and withdraw $300 every day for a week – plan how much you need for the week before taking money out.
Checking your credit file before approaching a lender or broker is also a good idea. There are several websites that allow you to delve into your file – but, beware, they aren’t all free. Some require an ongoing paid subscription, so make sure you read the terms and conditions.
WHO CAN HELP YOU?
Once you have all of your paperwork in order and you know what you want to achieve with your investing, it helps to speak with a broker who is an expert in helping property investors build the sort of success you are after. A good broker should be able to find the best lender for your needs and find out how much you are able to borrow.
Beyond this, your broker should be part of an overall team of professionals who are skilled in building high performing property portfolios. The right success team will be able to help you strategically align your actions with your goals, and prevent you from making the wrong choices on your investing journey.