In the last couple of years, lending criteria has become far more stringent mainly due to the regulatory pressure from APRA and ASIC who are the two regulators of banks and lenders. These changes include how lenders calculators or what they call serviceability calculators are used to determine your borrowing capacity. Lenders have had to increase the assessment rate and increase the living expenses they allocate to borrowers in that calculator.

How a lender uses a serviceability calculator

When a lender assesses your ability to obtain a home loan, they don’t assess the repayments on the new loan at the current actual interest rate. They assess it at what they call an assessment rate, which is currently at least 2% higher than the actual interest rate.

The general assessment rate of most lenders is around 7.25% and what that means is that on a loan of $500,000, the actual repayment at an interest rate of 4%, which is the minimum current rate if you’re looking at investment and unoccupied properties, the repayment on that would be $2,387 per month.

At the assessment rate of 7.25% the monthly repayment that the lenders will use in their calculator is approximately $3,411 per month. Understandably this is quite a bit higher than the actual repayment and the reason why lenders are required to do this is to account for any possible interest rate rises in the future. Lenders are required to test the affordability of the loan for the borrower should the rates increase.

How a lender calculates Living Expenses

The other factor I mentioned is living expenses. Lenders have a minimum living expense amount, which is based on what they call the household expenditure measure or HEM. When you apply for a loan, you will be required to declare your living expenses.

If the living expenses you declare are less than the minimum HEM amount, then the bank uses the HEM. The HEM amount has gone up substantially in the last 18 months to two years and the combination of both the increase in minimum living expenses plus the increase in assessment rate has had an effect on the borrowing capacity of recent loan applicants.

Do all lenders follow the same lending criteria?

Generally, the major lenders all lend and consider lending criteria in roughly the same way but there are some exceptions. There are some small lenders who tend to be a little bit more generous in terms of borrowing capacity and use a lower assessment rate.

The other thing that has also changed in recent years is the way lenders consider other forms of income such as overtime and bonuses. Generally, most lenders will only accept 80% of that income, but there are some exceptions to that. In answer to the question about whether there’s another lender that will lend the money, it is possible.

There are some lenders that are a bit more flexible in policy for example, if you work in emergency services, such as police, ambulance, fire and you earn overtime, there are some lenders that will consider 100% of that over time, whereas most lenders will only consider 80%. In addition, the way lenders will calculate overtime can vary between lenders as well.

There are a few exceptions that could allow you to borrow more from particular lenders. Some lenders will look at the overtime that you earn in the last financial year and compare it to the annualised year to date overtime in the current financial year and use a lower figure. Whereas some lenders will just use figures off the annualised overtime in this current financial year. Some lenders will consider annual bonuses and look at the last two years and take the lower of the last two years. Some may just look at the current year or take an average.

Another example is lending criteria pertaining to the self-employed applicants. The vast majority of lenders will look at the last two years tax returns and may use an average or may use the lower amount plus 20% if there’s more than a 20% difference in the profit between the two years.

There are some lenders in certain circumstances that will just go off the most recent tax return. An example of when this is useful is you might have had a business that’s only been in operation for two or three years. It’s common to see the first year of operation typically produce lower profits because you’re starting out compared to the second-years tax return which may reflect more favourable figures. There are lenders that can just use the most recent tax returns which helps to increase your borrowing power.

How will a lender calculate my affordability if I have more than one investment?

This is a situation that I’m encountering more frequently, determining affordability for clients who have a couple of investment properties and are looking to buy another investment property. On an average income these days at most major lenders, you pretty much max out at two, maybe three investment properties.

In these particular circumstances, there are some lenders that are a bit more generous because of the way they consider existing mortgage debts in their calculations. As a rule of thumb, most lenders will look at your mortgage and assess it at the assessment rate of 7.25% using principal on interest repayments.

Even if your existing investment loans have interest-only repayments, most lenders when you make a new loan application will consider those existing interest-only loans as principal on interest loans. This means that the repayment amount they put into their calculator or the commitment they put into their calculator is much higher than what you’re actually paying.

Lenders will factor in the fact that that the interest-only loan will eventually turn into a principal on interest loan. Some lenders will treat existing debts a little bit differently which results in your borrowing capacity being higher with those lenders.

To answer the question of “Your bank says you can’t afford the loan, or you don’t have sufficient borrowing capacity” it is worth speaking to a broker just to double check whether there are other lenders that can consider your situation a little less conservatively and who may be able to help you qualify for the loan you need.

Every lender will have a variation in policy and finding the right lender can potentially increase your borrowing capacity.