Whether you are building or renovating, unless you have the money readily available in your savings account, you will need to seek a loan from a bank or independent financial lender. But, before you sign on the dotted line of your house plan, you want to know exactly how much you can borrow from your bank to ensure you don’t run short. This loan figure will depend on your serviceability.
What is Serviceability?
Your home loan serviceability is the calculation the bank uses to determine whether you can make a payment on your loan after all of your income and expenses have been taken into consideration. Basically, they want to make sure that you don’t default on your mortgage and can make all the necessary payments without undue stress or bother.
If your monthly payment on your bank loan is $2,500 and your serviceability figure is well above this number, then you will have no issue. If it is less, then your loan will, in all likelihood, be refused.
What Income Will The Bank Accept?
Income can come from many sources. Financial lenders will focus on your salary or wages first and foremost, as well as income from rental properties and investments. They may also take into account any benefits you receive and income from self-employment.
Not all of these forms of income will be accepted at 100% of their face value. Lenders may only allow up to 75-80% of your investment income, as an example, as they will need to take into account the maintenance, management fees, account rental fluctuations, depreciation and re-letting expenses. More weight will be given to proven salary or wages over future unproven self-employment earnings, bonuses or commissions.
Exact Serviceability Figure Will Depend on the Lender
Although minimum serviceability rules and regulations are set by APRA (Australian Prudential Regulation Authority), each bank or building society will have their own standards and specific calculations. For the most part, lenders will use relatively similar calculations subtracting all expenses, loans and debts from your income before determining how much you have left over to pay your anticipated mortgage payment.
The number of dependents you have at home will affect your final loan figure. A buffer will also be applied to take into account changing interest rates. This may be as high as 9% or as little as 3%, but will ultimately depend on the financial institute. Don’t hesitate to shop around to determine the best lender when it comes to the actual loan amount and interest rates on offer.
Available credit can also impact your serviceability figure as lenders have to look at a worst-case-scenario situation. A balance of $0 on a credit card with a limit of $10,000 will still reduce your borrowing capacity as that loan can be accessed at any given time.
Different Serviceability Calculation Methods
There are three popular serviceability calculation methods used by lenders in Australia to determine how much you can borrow.
Net Surplus Ratio (NSR)
The Net Surplus Ratio focuses on the specific amount of money that is NOT used to pay debt and calculates it as a percentage of your after-tax income.
Debt Servicing Ratio (DSR)
The Debt Servicing Ratio takes a different approach and comes up with a percentage based on figures used to pay your debt including the home loan in question. As a guide, a healthy debt service ratio is between 30-35%.
Uncommitted Monthly Income (UMI)
The Uncommitted Monthly Income calculates all of your income once ALL of your expenses, including the loan, have been factored into the equation.
Can I Alter My Serviceability Calculation?
Your serviceability calculation will remain the same unless your income increases, your dependents leave home, or your expenses decrease. Of course, increasing your income or reducing your debts may not be practical in your situation.
A pay rise or an increase in investment income can boost your desirability to a lender. Note, if you were looking to take out a second job to improve your income, it might only be included in the serviceability calculation if you have held it for a period of twelve months or more. You can also look at combining loans and reducing your minimum monthly outgoings to reduce your regular expenses. Regardless of the exact calculation or the method your lender uses, reducing your expenses and increasing your income will certainly work in your favour every time.