In today's article, we are going to give you a simplified breakdown of what the banks will often look for when assessing a potential client's capacity to obtain a home loan. Our recommended brokers have provided us with the information to help educate on what you need to know.
In order to understand how home loans work, you need to understand your business partner in a property purchase - the bank.
The bank doesn't just wake up one day and say yep let's go and buy a house for someone. They are making a business decision to go into a transaction together as partners. There is a benefit to both parties. Eventually you (the purchaser) will own the property and along that journey they will make money from the interest. There is a mutual agreement that you are both getting something out of it. There is an assessment process within the banks to ensure that the person/s they are partnering with in this transaction are suitable to maintain a lasting relationship. Sure if you don't want the bank to make money then just save up and buy the property outright. But the majority of us need a bank to cover the majority of the cost, so we venture for a home loan.
There are 2 fundamental components the banks are going to look at for any home loan; your deposit and your serviceability. However, you will also want to learn about some other factors like, LVR, LMI and Valuations to fully understand the how the lending partnership works.
Serviceability
To put it simply, this is your ability to service the loan (to pay it off). Most people understand this component the best, however, they don't get the nitty gritty. Just because someone has been paying $500 a week rent for 10 years, doesn't mean the banks will approve a loan that equals repayments of $500 a week. There is a lot more factors they look at. After all a home loan is normally a 30 year agreement.
Phil Verheijen (Mortgage Broker & Director of Professional Lending Solutions) has stated "the easiest way to understand how the banks look at serviceability is; your income, minus your liabilities & expenses. The lenders need to ensure you can meet the repayments on the loan whilst maintaining a comfortable lifestyle". He went on to explain "they will factor in your everyday living expenses based on your current spending habits - and yes they will look at your bank records to see how often you order Uber eats".
Things that may negatively affect your serviceability include:
Dependants
Car Loans
Personal Loans
Credit Cards
Any other debts
Bad credit
Inconsistent income - can include, short term self-employed, casual or probationary periods
Once you've run your numbers and the banks are happy with your serviceability. They will often give you what's commonly referred to as a BC - a potential Borrowing Capacity. This is unfortunately, where a lot of people get over excited because your BC is not a always a true representation on your potential purchase price. This is where a thing called LVR comes into the picture.
LVR
The catch is that, even if you are deemed to be able to service the loan (your BC), the banks won't lend you 100% of the purchase price, because that would mean they would be putting themselves at risk.
The lenders will only give a percentage of the purchase price - for example, they will give a client 80% of the purchase price, this is leaving room to move, in case the clients completely default on their repayments and the lender needs to sell the property, the lender will be able to sell the property for a minimum of 80% of the purchase price and still walk away with what they invested.
This is what we call in layman's term a buffer. The percentage figure is known as LVR, or Loan to Value Ratio, eg. 80% loan to the value of the property. Normally the maximum a bank will lend you will be 95% of the value of the property.
Deposit
In every business transaction there is an element of risk involved. The deposit is the banks way of mitigating that risk. The deposit portion covers the difference in the Loan to Value ratio. The bigger the deposit, the lower the risk is to the lender.
So the bank will give you 80% of the value of the property, that's great, but that means you have to come up with the other 20% (or 5% if its a 95% lend - you get the drift).
There are 2 main ways you can cover the deposit;
1. Savings - Obviously this is pretty basic. In most cases the lenders want to see that you can save up for a deposit over time, which they will deem as "Genuine Savings". For first home buyers, some of the lenders will actually factor in 6 months worth of rental history to represent genuine savings. This is where you may be able to get into a home with as little as $10-15k deposit + a good rental history. Some lenders will also factor in the First Home Owner Grant towards your deposit. This can significantly increase your potential purchase price.
That's is why it is fundamental to have a knowledgeable independent mortgage broker who specialises in first home buyers as some banks won't accept this and others will. This changes regularly.
2. Use a Guarantor - In some cases, particularly for first home buyers, you can get someone to go guarantor on a property by covering your deposit. Most times this will come from a family member who will use a portion of their equity in their home to cover the deposit. The Guarantor can be paid out over time and then released off the title on the loan. This is a much trickier process. But again with the right type of mortgage broker, they can make it work easily.
LMI
So, what happens when you go over 80% LVR? The banks will normally charge a fee called LMI or Lenders Mortgage Insurance. This is an insurance fee that will be added to your loan. The higher the % the bank invests into the property the more risk the bank takes, therefore they get insurance to cover the difference. LMI is not always a bad thing, in some cases, it may mean you can put in less deposit but borrow more, for a small fee. Would you prefer to wait 12 months to save up a bigger deposit (whilst house prices are increasing at the same rate)? Or add a small fee to the loan that would be paid off over the term. LMI can be your friend.
Valuations
Ok great, so you have the deposit sorted, your serviceability stacks up and you are approved for a loan. Before you can purchase the property, the bank needs to assess what they are investing in. This is done through an independent bank Valuation. Banks will normally have a panel of independent Valuers which they will send out to assess the property, on their terms, before they will give you the loan. Bank Valuations are normally pretty conservative and based on comparable sales, with a "glass half empty" view.
NOTE - Bank valuations are very different to Real Estate Appraisals. It is not abnormal for bank valuations to be 3-5% less than the asking price. You can often get varying results from different valuers, as it is based on their opinion. Again this is why it pays to have a good mortgage broker in your corner as they can often order multiple valuations to ensure you get the fair value for your new property.
Hopefully this gives you a good understanding of the basics when it comes to getting a home loan. If there is anything else you wish to know about home loans. Please get in touch with us and we will direct you to our recommended brokers who would be happy to give you all the details you need.
Please note: in this article we are providing general public information on an understanding on home loans. Your personal circumstances have not been taken into account. This is not finance or financial advice and should not be considered as such. Please contact a licensed mortgage broker if you wish to get more information on finance for home loans.