When it comes to securing a home loan, there is a certain criteria your lender will look at to determine what you can afford and how much they can lend you. It can be easy to overlook borrowing money, and you could be getting into situations where you borrow more than you can afford to repay. It’s vital to financially manage whatever you borrow effectively and do the research before applying for a home loan. By running your own numbers, you can avoid falling into “bad debt”.
How Lenders Assess Your Loan Eligibility
When seeing how much you can borrow, most lenders will need your records of income, assets and debts. This includes any dwellings, land, vehicles, and household goods you own. They’ll also need credit card statements, your debt on personal loans and a credit check if they require. All these factors enable them to determine how much your borrowing power can be – that is, how much money they can lend you with certainty that you will be able to pay the amount back. It also gives them the ability to decide whether you’re a high or low-level risk to the bank.
To determine if you can borrow, a lender generally looks at these criteria points:
- Loan serviceability – can you afford to repay the loan without any financial hardship?
- Financial information verification – is all information you’ve submitted true and accurate?
- Credit history – are you able to manage your finances well over time?
- Loan to value ratio (LVR) – is the property you want to buy worth more than the amount you’re borrowing?
Lenders usually apply a higher interest rate to your loan repayments when assessing your ability to repay. This ensures that if rates do rise, you’ll still be able to make repayments without any difficult financial hardship.
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Do All Lenders Assess Loans using the same process?
All lenders must follow the Consumer Credit Code, under the Australian Securities and Investments Commission (ASIC) regulations. Under this code, lenders must ensure that you or any other borrower can repay the loan that you’re given. Lenders also have to disclose your rights and responsibilities under their credit arrangement prior to signing a loan contract. They must also truthfully reveal all contract information, including specific clauses on interest rates, fees, and commissions.
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Can You Borrow More Than You Can Afford?
In a lending review, ASIC found mortgage broker home loans had bigger LVRs than lender direct loans. The ASIC review also found a high number of loans were equal to the Household Expenditure Measure (HEM) benchmark. As a result, some borrowers were just within their financial means and had little residual income should anything financially unexpected occur.
A home loan survey also found that a quarter of respondents presented ‘mostly factual’ answers on their home loan application. The most common underestimation given in a loan application was living costs. Other understated expenses included debts. Some loan applicants also admitted to overstating income or assets, which accounted for 15% of misrepresentations.
If information is inaccurate on your home loan application, then it is technically possible to borrow more than what you can afford. However, this can lead to your inability to make repayments off your home loan if you do. Giving accurate information to the best of your ability and considering your financial circumstances is crucial to avoid that
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How can you avoid borrowing more than you should?
Write down your income and all your expenditures first
Be realistic and write down exactly what you spend on a monthly basis – include eating out, buying coffee and lunch, groceries, car costs, school fees and insurances, as well as entertainment costs. You should also leave some spend aside for emergency needs that can come up. Deduct these expenses from your income to calculate residual income – can you afford to repay your mortgage with what’s left?
Estimate your home loan repayments
You can use our easy home loan repayments calculator to gauge what your actual home loan repayments will be per month. Be sure to add an extra 2 to 3% to the repayments to allow for any increases and to see if you can still afford the mortgage if rates rise.
Factor in other home buying costs
When buying a home, many of us only think about the surface costs such as the purchase price and home loan repayments. However, there are more costs that come with buying a home. These added costs include council rates, water use, emergency services, stamp duty and conveyancing fees. These can add thousands per year to the cost of home ownership, so be sure to keep them top of mind when planning.
What should you try to avoid?
Don’t borrow when you’re already in debt
If you have another big loan elsewhere and are struggling to pay it off, you shouldn’t borrow more. Focus on solving that one debt before it snowballs and you find yourself unable to pay off your mortgage. A simple calculation to see if your debt is excessive is to do the debt-to-income test, which compares your monthly gross income to your monthly debt payments. Anything over 43% is a sign that you should avoid new debt.
Don’t borrow money without ready the fine print on your contract
The interest rates or repayment terms on your contract may be less favourable than you assume. For example, there may only be minimal hardship help available, or the lender may have the right to seize your property after a certain amount of days. You will need to read the fine print carefully and take your time to understand the agreement. Ask questions to your lender, or contact a professional such as a conveyancer or accountant to look into it for you.
Don’t borrow more than you can afford to repay
It goes without saying, but this still gets thousands of Australians into trouble and debt each year. Be absolutely sure that you’ll be able to pay off all the repayments in full. This means having income certainty, and flexibility to cut back on your budget if need be. Taking on a home loan is one of the biggest loans you’ll undertake during your lifetime, so borrowing less than you can afford is the most effective way to ensure you can still pay off your debt.
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Words by Joanne Ly
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