Your serviceability is vital when it comes to getting a home loan, so how can you improve it?
Securing a home loan can be hard enough, but not understanding home loan serviceability could make the process a whole lot more difficult.
We asked the experts about how to improve your serviceability, as well as exploring why it’s so important.
Buying a home or looking to refinance? The table below features home loans with some of the lowest variable interest rates on the market for owner occupiers.
Base criteria of: a $400,000 loan amount, variable, principal and interest (P&I) home loans with an LVR (loan-to-value) ratio of at least 80%. If products listed have an LVR <80%, they will be clearly identified in the product name along with the specific LVR. The product and rate must be clearly published on the Product Provider’s web site. Introductory rate products were not considered for selection. Monthly repayments were calculated based on the selected products’ advertised rates, applied to a $400,000 loan with a 30-year loan term. Rates correct as at 03 August 2020. View disclaimer.
What is home loan serviceability?
Home loan serviceability refers to a potential borrower's ability to service a loan. Essentially it gives a lender an idea of how easy or hard it will be for you to make your loan repayments.
It’s also referred to as your borrowing power, as lenders use it to decide how much money you’re eligible to borrow.
Serviceability is calculated by using a formula that takes into account things like your income, expenses, and various other financial commitments, which will then generate a figure, known as the debt service ratio.
Different lenders have different ways of calculating serviceability, as well as having different maximum debt service ratios.
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
Proving your ability to service a home loan is vital to being approved and being able to borrow the amount you want.
But much of improving your loan serviceability comes down to common sense and good financial practices.
Improving your serviceability can improve the whole state of your finances and ensure you learn effective budgeting techniques you can carry with you for life.
The entire market was not considered in selecting the above products. Rather, a cut-down portion of the market has been considered which includes retail products from at least the big four banks, the top 10 customer-owned institutions and Australia’s larger non-banks:
- The big four banks are: ANZ, CBA, NAB and Westpac
- The top 10 customer-owned Institutions are the ten largest mutual banks, credit unions and building societies in Australia, ranked by assets under management in November 2019. They are (in descending order): Credit Union Australia, Newcastle Permanent, Heritage Bank, Peoples’ Choice Credit Union, Teachers Mutual Bank, Greater Bank, IMB Bank, Beyond Bank, Bank Australia and P&N Bank.
- The larger non-bank lenders are those who (in 2019) has more than $9 billion in Australian funded loans and advances. These groups are: Resimac, Pepper, Liberty and Firstmac.
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.
In the interests of full disclosure, Savings.com.au and loans.com.au are part of the Firstmac Group. To read about how Savings.com.au manages potential conflicts of interest, along with how we get paid, please click through onto the web site links.
*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.
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