How are home loans assessed?

When you make a home loan application, you will come across the term “serviceability.” It is important to understand this if you want to learn how to get approved for a home loan.  

Serviceability is one of the key factors that a lender will consider when you apply for a loan or for a home loan pre-approval. 

Here, we examine how serviceability is calculated and what steps you can take to improve your assessment. 

What is serviceability?

Simply speaking, ‘serviceability’ refers to a borrower’s ability to make the repayments on their prospective home loan. If you are wondering “how much can I borrow”, the answer is going to depend upon the size of loan that you can service i.e. repay. 

Your serviceability is calculated to ensure you can afford to take on a mortgage, and to work out how big a home loan you can manage. 

Your serviceability result will depend upon the size of your proposed loan, your income, and how much you have left after paying for all your liabilities and living expenses. 

How is serviceability calculated?

Lenders loans.com.au calculate serviceability by adding up your income from all sources, subtracting your expenses and debts and then adding on your proposed monthly mortgage payment to see if you have enough to pay plus some left over if rates go up. 

What is classified as income?

Income can include your salary, overtime payments, bonuses and sales commissions, as well as fringe benefits like a company car or expense account. 

In some jobs like nursing, policing, and fire fighting, overtime is a key part of your income and will be considered in full for serviceability calculations. 

For other jobs, where overtime is less reliable, only a portion of your overtime income is likely to be used to calculate your income.  

Types of income

Types of income include: 

• Salary and employment income (including from second jobs) 
• Property rental income 
• Overtime payments 
• Centrelink benefits (including Family Tax Benefits Parts A and B) 
• Commissions 

Not all types of income are considered in full. For instance, with rental income, for a standard single residential tenancy, depending on the lender 70% to 90% of the gross rental income toward serviceability. The reason for this is that rental income often fluctuates and there are also costs associated with owning a rental property such as maintenance, management fees and re-letting fees when a tenant vacates. 

Liabilities

On the other side of the equation are your liabilities. 

These mainly relate to existing debts including home loans, credit cards, personal or investment loans, car loans and HELP debt. 

Liabilities also include your rent and any child maintenance payments.   

The higher your existing liabilities, the less you will be able to borrow for a new loan. 

You will need to provide account statements for your debts in order to confirm your monthly repayments. 

With credit cards, an assumption will be made about the interest payments you would be liable for if you draw down the available limit. 

Similarly, a line of credit will be taken into account as if it were fully drawn down, even if it isn’t. 

One step you can take to increase the amount you can borrow is to reduce your credit limit(s) to the lowest amount possible and cancel unused cards. 

Buffer

In calculating repayments for a new loan, lenders will add a margin or buffer to the variable rate, to arrive at what is known as the ‘assessment rate’. 

This is because interest rates could rise in the future and we need to know that you could afford to meet repayments if they were higher than today. 

Financial industry regulators insist that lenders have a duty of care to ensure that a borrower can meet loan repayments. 

What is the Household Expenditure Measure (HEM)

The HEM is a benchmark that many lenders, including loans.com.au, use to estimate a borrower’s annual living expenses.  

This is a vital step in working out how much you can afford to borrow. 

Developed by economic research group the Melbourne Institute, the HEM is based on more than 600 items in the Australian Bureau of Statistics Household Expenditure Survey.  

The HEM is calculated based upon the typical sum that a borrower in your family situation spends on absolute basics (food, utilities, transport, clothing) and that a borrower spends on voluntary or “discretionary” purchases like alcohol, eating out and childcare.  

Luxury expenses, such as overseas holidays, are excluded from calculations because you could easily cut them out if you have to. Rent or mortgage payments are also not included in the HEM because they will be replaced when you buy a home. 

What types of living expenses will be considered in a home loan application?

Living expenses that you will be required to estimate when you apply for a loan with loans.com.au include: 

• Education 
• Childcare 
• Private Health cover 
• General living expenses such as (groceries, clothing, utilities, phone/mobile, internet, motor vehicle/transport, rates, home and car insurance).