What Is Debt Servicing And How Does It Affect Your Approval Chances?
Do You Pass The Debt Servicing Test?
Borrowing at the moment isn’t easy and a lot of this comes down to bank credit policy in this market and their appetite to lend. Credit policy varies across banks, however, in most respects, they remain very similar. This article helps to explain the importance of debt servicing when applying for your first home loan.
Debt Servicing Test Rates
A debt servicing test is a calculation to assess whether your financial situation would stand up to changes in situation during the term of your home loan. This could be increased home loan rates, a change in employment or something else that could impact your ability to maintain your loan payments.
Servicing test rates are currently around 7.1% at all the major banks which means you as a borrower need to prove that you can afford to borrow at that interest rate even though real rates are down in the low 4’s. At a high level, banks use that rate along with a general living allowance depending on the number of applicants to determine your fixed outgoings and therefore your capacity to borrow.
Borrowing Potential
In this current market, lending above 5-6 times your income is proving almost impossible.
In recent times, credit policy has been more broadly dictated by Reserve Bank Loan To Value Restrictions (LVR) and responsible lending codes. Responsible lending codes are guidelines for lenders to ensure that your lender does not put borrowers in a situation they can not afford.
Variations in bank interpretation of these rules allow banks to separate themselves from each other in small ways. However, none of them test these boundaries very much. Up until recently, the gap between the lowest test rate and the highest was over 1%. This is no longer the case now with the gap closing to around 0.7% and because of this, your ability to borrow won’t move too much across lenders.
New Build Exemption From LVR Restrictions
Construction and new build lending remains exempt from the RBNZ rules, allowing you as borrowers to do more with less deposit and allowing lenders to play with policy a bit more. Most major banks will go to 90% LVR on a progress payment. This doesn’t solve the servicing problem but it does mean that with a smaller deposit you can find yourself in a better quality home.
With changes in bank policy becoming more regular, having an adviser working for you is now more important than ever and could be the difference between an approval and a decline – or more importantly the difference between getting your own home or not.
What Can Be Done To Improve Your Approval Chances?
Getting a home loan approval is now not simply about how much deposit you can get together but your ability to service or maintain the mortgage payments. Therefore one's income, current debt levels and outgoing expenses are increasingly important in helping you get the 'Yes' from your lender.
1. Reduce your debt
Debt is a massive handbrake when it comes to it's effect on your borrowing potential. In fact, having around $10,000 worth of debt, can reduce your borrowing amount by around $40,000. For tips on how to reduce your debt, read our article here on how to Get On Top Of A Debt Mountain.
2. Manage your expenses were possible
Since the introduction of the CCCFA, the Banks have been taking a very close look at applicants' expenses to ensure that any proposed borrowing is not going to put them in a financially stretched position. While the CCCFA is due to change, expenses are still likely to be factored in to some degree when determining a borrowing amount.
3. Maintain a monthly surplus
When determining what borrowing a client can reasonably be expected to be able to afford, the Banks set a required Monthly Surplus. The Monthly Surplus is calculated from your combined monthly income minus expenses confirmed from bank statements, then minus the proposed home loan payments (using the service rate mentioned above).
By maintaining a consistent monthly surplus you are indicating to the Bank that you are financially able to afford the mortgage payments with money left over should the unexpected expenses arise.
