What is home loan serviceability and how is it calculated?

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on July 26, 2021
What is home loan serviceability and how is it calculated?

Updated by Alex Brewster 26 July 2021.

If you’ve been thinking about buying a home, you’ve probably come across the term ‘loan serviceability’.

On this page:

How much money you can afford to borrow for a home loan depends on a few things, like the size of your deposit and the value of the property you want to buy.

Another factor lenders will consider when determining how much you can afford to borrow is your serviceability.

Serviceability generally refers to a borrower’s ability to repay a loan based on their income and expenses.


Buying a home or looking to refinance? The table below features home loans with some of the lowest interest rates on the market for owner occupiers. 

Lender

Variable
More details
UNLIMITED REDRAWS
  • Fast turnaround times, can meet 30-day settlement
  • For purchase and refinance, min 20% deposit
  • No ongoing or monthly fees, add offset for 0.10%
UNLIMITED REDRAWS

Smart Booster Home Loan Discounted Variable - 2yr (LVR < 80%)

  • Fast turnaround times, can meet 30-day settlement
  • For purchase and refinance, min 20% deposit
  • No ongoing or monthly fees, add offset for 0.10%
Variable
More details
REFINANCE ONLY
  • A low-rate variable home loan from a 100% online lender. Backed by the Commonwealth Bank.
REFINANCE ONLY

Variable Rate Home Loan – Refinance Only

  • A low-rate variable home loan from a 100% online lender. Backed by the Commonwealth Bank.
Variable
More details
AN EASY DIGITAL APPLICATION
  • No ongoing fees - None!
  • Unlimited additional repayments
  • Easy online application, find out if you're approved quick!
  • Redraw- Access your additional payments if you need them
  • Use the app to get loan insights to help you pay off your home loan faster
AN EASY DIGITAL APPLICATION

Neat Variable Home Loan (Principal and Interest) (LVR < 60%)

  • No ongoing fees - None!
  • Unlimited additional repayments
  • Easy online application, find out if you're approved quick!
  • Redraw- Access your additional payments if you need them
  • Use the app to get loan insights to help you pay off your home loan faster
Variable
More details
NO ONGOING FEES
  • No ongoing fees - None!
  • Unlimited additional repayments
  • Easy online application, find out if you're approved quick!
  • Redraw- Access your additional payments if you need them
  • Use the app to get loan insights to help you pay off your home loan faster
NO ONGOING FEES

Yard PAYG Home Loan (Principal and Interest) LVR ≤ 80%

  • No ongoing fees - None!
  • Unlimited additional repayments
  • Easy online application, find out if you're approved quick!
  • Redraw- Access your additional payments if you need them
  • Use the app to get loan insights to help you pay off your home loan faster

Base criteria of: a $400,000 loan amount, variable, fixed, principal and interest (P&I) home loans with an LVR (loan-to-value) ratio of at least 80%. However, the ‘Compare Home Loans’ table allows for calculations to be made on variables as selected and input by the user. All products will list the LVR with the product and rate which are clearly published on the Product Provider’s web site. Monthly repayments, once the base criteria are altered by the user, will be based on the selected products’ advertised rates and determined by the loan amount, repayment type, loan term and LVR as input by the user/you. *The Comparison rate is based on a $150,000 loan over 25 years. Warning: this comparison rate is true only for this example and may not include all fees and charges. Different terms, fees or other loan amounts might result in a different comparison rate. Rates correct as of August 7, 2022. View disclaimer.


What is loan serviceability?

Lenders are legally obligated to make sure that borrowers can afford to repay a loan under responsible lending rules.

The Australian Prudential Regulation Authority (APRA) keeps a watchful eye over financial institutions to make sure they are complying with responsible lending practices and putting checks and balances in place to ensure people aren’t jumping into massive home loans they can’t afford.

This is where loan serviceability comes into the picture.

‘Loan serviceability’ is essentially a calculation of your ability to meet your home loan repayments according to the size of the loan and your income and expenses.

Lenders have a few different methods of calculating your loan serviceability (we’ll talk more about this later), but all are required to add what’s known as a ‘buffer rate’ to the home loan interest rate they are offering after taking into account a borrowers' income and expenses.

This buffer essentially allows for the fact that interest rates can rise over a loan term, so the lender will want to ensure the borrower can still meet the repayments should interest rates rise.

Before July 2019, APRA required financial institutions to assess all borrowers against their capacity to repay a loan at 7% p.a. Given that interest rates are unlikely to return to those levels any time soon, this was amended - lenders now only have to add a 2.5% buffer on their current interest rates to review whether a borrower can afford to repay a loan if interest rates were to rise by this much.


How lenders calculate your loan serviceability

Many lenders calculate a borrower’s serviceability by adding up all their income, then deducting any outstanding debt they may have, as well as other expenses AND their monthly loan repayment with the buffer built into their calculations.

What counts as income?

When calculating your serviceability, many lenders will consider the income you have from your regular salary and wages, as well as alternative sources including rental income, investments and benefits.

But not all income is treated equally. Because rental and investment income can fluctuate, many lenders will only take into account about 80% of this income or less.

Methods of calculating serviceability

There tend to be three different methods banks use when calculating your serviceability which includes:

Debt Servicing Ratio (DSR): This method calculates the borrower’s monthly expenses as a percentage of monthly income. Most lenders use a maximum DSR of between 30-35%.

Net Surplus Ratio (NSR): This method is the opposite of the DSR method and calculates the amount of money that’s left after all expenses have been paid.

Uncommitted monthly income (UMI): This method calculates the amount you will have left each month after all expenses (including mortgage repayments) have been taken away from your before-tax (gross) income.

Generally, most banks won’t make which method they use publicly available knowledge, which means you may get different serviceability calculations depending on which lender you go with.


Why is having a good home loan serviceability important?

Uno Home Loans Chief Executive Anthony Justice told Savings.com.au lenders wouldn’t feel comfortable letting people borrow money with poor serviceability.

“When you're trying to get a home loan, lenders want to know that you can comfortably pay off the payments every month and therefore when they're assessing whether or not they're going approve you for a loan, they have a look at that, and that's called serviceability,” Mr Justice said.

“They want to understand the amount of money you've got coming in and the amount of financial commitments that you've already got.

“And then when they add the financial commitment of your home loan, they want to make sure you still have enough money to cover all of that.”

Lendi Chief Executive David Hyman told Savings.com.au having good home loan serviceability was vitally important in the borrowing process.

“The way banks think about that is they look at income and they look at all of your debt and commitment, and they apply various benchmarks to those to factor in good times and bad and ultimately work out how much you can borrow,” Mr Hyman said.

“What that really means for individual borrowers is really a range, because it's different bank to bank, but really a range of the banks that will let you borrow from them and how much they'd be willing to lend.

“Ultimately, when you're going through either the refinance process or purchase process it's a key part of the process in terms of where you focus your efforts and what you're eligible for.”


How can you improve your home loan serviceability?

No matter your level of home loan serviceability, there are a number of ways you can improve it:

Cut back on spending

Mortgage Choice CEO Susan Mitchell said that although challenging, cutting back on discretionary spending and saving more was one of the most obvious ways to improve serviceability.

“It’s no secret that the more money you save to contribute to a deposit, the less you will need to borrow,” Ms Mitchell told Savings.com.au.

“This can also have an added benefit of either significantly reducing or eliminating the need to pay LMI [lenders mortgage insurance], which can cost thousands of dollars depending on the loan you choose.

“It’s also a great time to look at any expenses that you took on during the lockdown period and you may no longer need - think about all your tv subscriptions - do you really need them all? Cutting back on discretionary spending will also look good in the eyes of lenders.”

Mr Justice said lenders look at what you’re spending money on over time and want to know you’re not overstretching yourself.

“Certainly individuals can look at some of the discretionary things that they spend money on and if you can reduce those and take away some of those luxury or discretionary items from your day to day savings, then obviously you're going to cut your overall level of spending down,” he said.

Have a budget

Mr Hyman said effective budgeting was a great starting point for good financial practices and improving serviceability.

“It's really about saying if you're about to go and take on this huge commitment of a mortgage, in the six to 12 months leading up to that you should really plan your expenses as if you've got that mortgage and start saving that extra cash, but more importantly, start reducing your expenses along the way,” he said.

“What that will ultimately do is do two things. One it'll get you into really good financial habits that you know are sustainable because you've actually done them in practice, not just looked at them on paper.

“Two, in that sort of month or two before you ultimately are ready to buy the house and the bank's looking at how much you can borrow, your expense base will be lower than the previous serviceability and obviously the assumption would be that you'd continue that expense base, post getting the mortgage.”

Reduce your debt

Ms Mitchell said reducing your debt as well as closing unused lines of finance was extremely important when applying for a home loan.

“Pay down your credit cards and any personal loans you may have before applying for a home loan,” she said.

“You may also want to reduce the limit on your credit cards and close any card accounts you no longer use. You may not know this but lenders consider unused cards as potential debt even if you aren’t using the card, which can impact your serviceability.”

Mr Hyman said sometimes people had credit card limits as high as $40,000 which would be looked at unfavourably by lenders.

“Just reducing your overall credit card limit by $10,000 or $20,000, can have a massive impact on your borrowing power.”

Check your credit history

Ms Mitchell said it was important your credit report was an accurate representation of your credit history.

“By checking your credit report with an online provider, you will be able to identify any discrepancies and have them investigated before you apply for your home loan,” she said.

“You can request these reports free and online from a number of providers. This will also allow you to change any credit behaviour that might adversely affect your ability to secure a home loan such as not paying your bills on time.”

Avoid payday loans

Mr Hyman said lenders viewed payday loans as massive red flags and potential borrowers should steer well clear of them.

“If you've gone to a Nimble or one of the other payday lenders and taken a loan, out, ultimately the banks will view that as a negative because they're quite expensive,” he said.

“And typically people only take them out if they're in a situation where they can't make it from paycheck to paycheck to paycheck. So I'd really avoid taking on services like that.”

Increase your income

Both Mr Justice and Mr Hyman said increasing your income was a viable way of improving your serviceability, but for obvious reasons was one of the less viable ways.

“There's a couple of obvious ways to improve your serviceability, increasing your income is one way but of course that’s not always easy to achieve,” Mr Justice said.


How long does it take to improve your home loan serviceability?

Mr Hyman said in the context of looking to buy a house or refinancing, improving your serviceability could happen fairly quickly.

“If you're wanting to reduce your expenses and use that as a way to drive your serviceability up, that can be done and demonstrated in a six month period while you're still either saving for that deposit for the first time, or if you're building up extra equity,” he said.

“Reducing things like credit card limits, those things can happen relatively immediately. So if you're sitting there with a $35,000 credit limit, and you only ever use five or ten grand at a time, calling the bank and cutting that down from $35,000 to $10,000, that can happen on the same day.”

Mr Justice said how long it took to improve your home loan serviceability depended on the individual.

“A lot of this is about helping individuals change their behaviours, some people are good at changing their behaviours quickly and other people find it harder to change their behaviours,” he said.

“So I think obviously it's not an overnight thing. You've got to create a bit of a track record for a lender to see a pattern of behaviour, but the sooner you as an individual can demonstrate that pattern consistently over a period of months, then you can change it relatively quickly.”


Savings.com.au’s two cents

If you want to stand the best possible chance of being approved for a home loan, it’s important to understand what loan serviceability is and ways you could improve your own serviceability.

In trying economic conditions, it can be even more important to prove your high serviceability capacity to lenders.


Photo by Kelly Sikkema on Unsplash. 



Disclaimers

The entire market was not considered in selecting the above products. Rather, a cut-down portion of the market has been considered. Some providers' products may not be available in all states. To be considered, the product and rate must be clearly published on the product provider's web site. Savings.com.au, yourmortgage.com.au, yourinvestmentpropertymag.com.au, and Performance Drive are part of the Savings Media group. In the interests of full disclosure, the Savings Media Group are associated with the Firstmac Group. To read about how Savings Media Group manages potential conflicts of interest, along with how we get paid, please visit the web site links at the bottom of this page.

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Emma Duffy is Assistant Editor at Your Mortgage and  Your Investment Property Mag, which are part of the Savings Media Group. In this role, she manages a team of journalists and expert contributors committed to keeping readers informed about the latest home loan and finance news and trends, as well as providing in-depth property guides. She is also a finance journalist at Savings.com.au which she joined shortly after its launch in early 2019. Emma has a Bachelor in Journalism and has been published in several other publications and been featured on radio.

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