How your bank decides to loan you money
You will have read in the news that banks are tightening up on lending money to home buyers. Not so long ago it was easy to get a loan, now many first home buyers are wondering how they will ever secure the money to get into their own home.
There are, however, things you can do to make yourself more suitable for a bank loan. But don't leave these things until the last minute. If you think you may want to purchase a home in the future, think about these things now.
The bank uses three criteria to assess whether to give you a loan
There are three key criteria the bank will measure a potential borrower against;
- Serviceability
- Equity
- Character
Serviceability (sometimes called capacity).
Serviceability measures your ability to repay a loan. Basically, it is your income minus your expenses. This is why, when you apply for a loan, the bank asks you to complete an application form with records of your monthly earnings and monthly spending.
Each bank will have a slightly different mathematical formula to calculate serviceability, and slightly different requirements regarding the surplus funds you should have at the end of each month. However, in general terms, banks will expect you to have a monthly surplus of around $300 after all your expenses have been paid.
Two things will greatly affect your serviceability and therefore your chance of getting a loan.
The first is overspending. If you're thinking of asking the bank for a loan, begin to economise now so that you can show you're able to live on a minimal budget.
The second thing that will affect your ability to service a loan is existing debt. If you have debt, you will be making repayments. Those repayments will count against you being granted a loan; and that includes the debt from a student loan.
Remember the old rule - pay off debt as quickly as possible.
Equity (sometimes called Collateral).
Equity is a measure of your net worth. It's the value of what you own minus the value of what you owe.
In short, the bank wants to be sure that, if you can't repay your loan, you have enough value in your home so that, if they sell it, they can recoup the money you owe them. This is why part of the application form will include a measure of assets versus liabilities.
In recent times this became a problem for the bank (and for the person they loaned money to). You see, the banks were loaning 100% on the value of a home. That meant, if the housing market dipped and a mortgage holder couldn't repay their loan, the bank would sell the property but not recoup all their money. So, the person who borrowed the money is now without a home, and still owes money to the bank.
This is why there is so much talk about LVR; that is, your loan to value ratio. LVR is the amount you will owe on your house divided by the amount it is worth. LVR's vary from bank to bank but most will usually only loan up to 80% LVR. That means, if you want to buy a new home you will usually need at least 20% of the purchase price as a deposit.
It also makes it quite easy to work out how much you can afford to spend on a house - just multiply your deposit by five.
Character.
For many banks, your financial character is the most important criteria used to assess whether you qualify for loan or not. Banks will look at your financial track record to determine whether they think they can trust you to repay a loan.
They will take into account things like whether you have;
- previous defaults on any type of loan repayments,
- fines owing,
- a poor credit rating,
- a poor job history, or
- whether you are constantly going into unarranged overdraft.
This is why banks ask for three months' bank transactions before giving out a loan - it's to check how well you manage your finances.
This is an aspect of borrowing that many people underestimate. It's not just about having a deposit. The bank is more concerned about getting back the money it gives to you, and to prove that you will do that you need to have a good credit and banking record.
The challenge.
The challenge is simple; if you think you are going to want a bank loan sometime in the future, you need to be proactive now in ensuring you are an attractive client to the bank in these areas;
- Serviceability
- Equity, and
- Character.
The team at Futurisk would love to talk to you about all aspects of your personal finances. Click here to contact Futurisk.
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