Home ownership is a significant financial milestone, and for many people, securing a home loan is the way to achieve this goal – unless you’re a lottery winner, of course! A crucial part of the home loan process is assessing ‘serviceability’. In this blog, we'll delve into what home loan serviceability is and why it matters for potential homebuyers.
What is home loan serviceability?
Home loan serviceability refers to a borrower's ability to meet their mortgage repayments comfortably and consistently over the life of the loan. So, the lender doesn’t just consider what you can afford at the time of application, but also into the future if interest rates were to change or your income was altered.
Banks and lenders assess your serviceability by examining various financial factors to ensure loan obligations can be managed without encountering financial hardship.
The key factors that influence home loan serviceability
Let’s take a look at what lenders and banks pay close attention to when it comes to home loans and serviceability.
Income
When you apply for a home loan, lenders typically consider your income as the primary factor in determining serviceability. A stable and sufficient income helps ensure that you’ll be able to meet the regular repayments that are required.
Regular income streams, such as employment or business earnings, are thoroughly scrutinized during the loan approval process. That’s why we ask to see your pay slips or end of year statements (or similar) as part of your application.
Personal income that will be considered includes:
- Employment income including overtime and/or commission
- Sole trader business profits
- Government payments or benefits from Centrelink
- Any investments such as rental income or dividends.
Expenses
To gauge serviceability, lenders review the existing financial commitments and living expenses that a borrower has. This includes costs such as utility bills, groceries, insurances, and other ongoing expenses. A clear understanding of these outgoings helps lenders assess how much of the borrower's income is available for loan repayments.
When applying for a home loan, you’ll be asked to provide bank statements and information on what you spend, where and how often. This means that you may be asked to explain certain spending and to review whether it is ‘essential’ spending or not.
Debt-to-income ratio
The debt-to-income ratio is a crucial metric used by lenders to evaluate home loan serviceability. It compares a borrower's total debt to their gross income. A lower debt-to-income ratio is generally good because it’s an indication of a healthier financial position and an increased likelihood that the loan repayments will be met.
If you have a credit card that you’re not using, you may want to consider closing the account before applying for a home loan. This is because even if you don’t owe money on it, your available limit will be included in the calculations, and it could reduce your overall borrowing capacity.
Interest rates and loan terms
Lenders will always consider the impact potential interest rate fluctuations could have on a borrower's ability to repay their loan. That means they will generally calculate whether you could still be able to repay the loan if the interest rate increased by a minimum of three percentage points (this may vary depending on the lender). Remember, your current and estimated future earnings will be taken into consideration.
The loan term, or the length of the loan, also plays a role here. Longer terms – 30 years instead of 25 years, for example – may result in lower monthly repayments but could increase the total interest to be paid over the lifetime of the loan.
Why does home loan serviceability matter?
Knowing about home loan serviceability is important for anyone considering a home purchase. By understanding the factors that influence it and how lenders assess it potential homebuyers can better prepare for the loan application process. To increase your serviceability, look at increasing your income, reducing your debt, reducing expenses or unnecessary spending, and lowering your credit limits.
Banks and lenders assess serviceability to reduce the risk of loan default. By ensuring a borrower can comfortably manage repayments, lenders reduce the likelihood of financial distress and improve the overall stability of loan portfolios. As a responsible lender, P&N Bank always works to protect our borrowers from potential financial strain and by doing so, we meet our responsible lending obligations too.
When it comes to getting a home loan, no question is a silly one and our team is available to help. Make an appointment to speak with one of our Home Loan Specialists today. They can meet you in-branch, at home or work or via video call and can answer any questions you may have about the home buying journey. If you have a broker, they'll also be able to assist.
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