Obtaining a Home Loan or Refinancing in 2020
Promoted by Yarra South Finance
Life is busy, and the restrictions imposed in response to the coronavirus pandemic can add additional pressure, therefore understanding what is happening with respect to obtaining finance these days can be challenging. You may also recall headlines about the Financial Services Royal Commission (which concluded with Commissioner Kenneth Hayne’s Report in February 2019) and read articles about borrowers in hardship who did not understand the large loans they signed up to. In response to Commissioner Hayne’s Report, and, more recently, taking into consideration COVID-19, lenders are taking their lending obligations far more seriously and the bar to obtaining finance is considerably higher than it was a few years ago.
Tests used by lenders when assessing loan applications
When assessing a loan application, lenders consider the following key questions in order to determine whether to approve a loan:
- Does the loan fit lender policy?
- What is the Loan to Value Ratio (LVR)?
- Can you service the loan?
1. Lender Policy
Policies differ from lender to lender. For example, not all lenders offer construction loans or bridging finance, only some lenders provide finance to Australian expatriates living overseas, and while most lenders consider 80% of rental income for loan servicing purposes, others consider less. More importantly for those in the legal profession, some lenders waive Lenders Mortgage Insurance (LMI) when borrowing up to 90% of a property’s value (see 2 below for a further explanation).
Policies have become tighter since the Financial Services Royal Commission, and even more so recently as a result of the pandemic (some lenders have reduced their debt to income ratio threshold), however a good finance broker is familiar with the ins and outs of lender policy and can, in most cases, help you find a lender product to suit your circumstances.
2. Loan to Value Ratio (LVR)
The LVR describes the size of the loan you take out, compared to the value of the property being secured, expressed as a percentage. A lower LVR is seen as a lower risk to the lender. The calculation is expressed as follows: Loan Amount ÷ Valuation x 100 = LVR.
For example, if the property you wish to purchase (or refinance) is valued by the lender at $1,000,000 and you wish to borrow $800,000, the LVR will be 80%. The majority of lenders require a LVR of 80% or below, however they may consider a LVR above 80% with Lender’s Mortgage Insurance (LMI). LMI is payable by the borrower at the time of property settlement and serves to protect the lender if a borrower is unable to meet their loan repayments and the property has to be sold.
As mentioned above, some lenders offer waiver of LMI for legal professionals, namely barristers and solicitors holding a current practising certificate and judicial officers holding a letter of appointment; therefore if your LVR is above 80% and below 90%, and you meet the requisite minimum income threshold, no LMI will be payable (a considerable saving).
3. Can you service the loan?
After determining the LVR, the lender will then assess whether you can afford the loan repayments in relation to the amount you wish to borrow. In order to do this, the lender will scrutinise your financial circumstances in detail. Loan assessors will look at your income, living expenses, assets, liabilities (other loans) and credit card limits, and each lender uses their own calculator to determine serviceability. What may service with one lender, may not service with another.
When determining whether you can service a loan, note that lenders consider your credit card limit - or combined credit card limit if you have more than one card – not the fact that you may pay off your credit card each month. In fact, for every $1,000 of your credit card limit, your ability to borrow funds for your new home or investment property could be reduced by as much as $5,000.
An increased focus on living expenses by lenders
Since the Financial Services Royal Commission, lenders have significantly improved their processes to ensure that they meet their responsible lending obligations - which require lenders to show that they have taken into account a borrower’s circumstances and ability to repay a loan. These improvements have led to greater scrutiny of living expenses. A living expense is anything you spend your money on, for instance, morning coffees, groceries, utility bills, to name a few. When seeking a loan, your finance broker or chosen lender will ask you to fill out a detailed questionnaire with 13 expense categories (such as child care, personal care, groceries, insurance etc).
The living expense information is then required to be verified by your finance broker or lender against your bank statements and credit card statements (you will be required to provide at least 3 months of your most recent bank statements and credit card statements among other documentation as part of your application). If you are considering taking out a loan, understanding your household living expenses will improve your chances of getting a loan application approved efficiently and expediently.
Low interest rates and floor rates
While meeting the loan servicing test can be more challenging these days, the flip side is that we are in a low interest rate environment and in mid-2019, a number of lenders announced changes to their loan serviceability assessment rates. Interest rate floors were reduced to around 5.5% (from over 7%) therefore increasing the borrowing capacity for many home loan applicants. By way of explanation, the concept of an interest rate floor was introduced in 2014 so that when assessing loan applications, lenders use a higher rate of around 5.5% (despite interest rates being as low as 2.29%) in order to ensure that should interest rates rise, the borrower will still be able to make loan repayments.
Why use a Finance Broker?
Given the complexities involved in obtaining finance these days, it is worthwhile building a relationship with a finance broker that you can trust, and who understands the various lender policies. Finance brokers now write approximately 60% of all home loans in Australia and can help you to save time and money as they assist you with finding a loan which is most appropriate for your circumstances.
About the Author
This article provides general information only and has been prepared without taking into account your objectives, financial situation or needs. We recommend that you consider whether it is appropriate for your circumstances and your full financial needs and requirements will need to be assessed prior to any offer or acceptance of a loan product. It does not constitute legal, tax or financial advice and you should always seek professional advice in relation to your individual circumstances. Subject to lenders terms and conditions, fees and charges and eligibility criteria apply.
Credit Representative 504748 is authorised under Australian Credit Licence 389328.