While the process will vary between institutions, there are some key criteria most lenders use to assess potential borrowers. We’ve broken down what a lender will ask for from you, why it needs it and what will inform its decision to ultimately approve or reject you.
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| Lender | Home Loan | Interest Rate | Comparison Rate* | Monthly Repayment | Repayment type | Rate Type | Offset | Redraw | Ongoing Fees | Upfront Fees | Max LVR | Lump Sum Repayment | Additional Repayments | Split Loan Option | Tags | Features | Link | Compare | Promoted Product | Disclosure |
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
6.04% p.a. | 6.08% p.a. | $3,011 | Principal & Interest | Variable | $0 | $530 | 90% | 4.6 Star Customer Ratings |
| Promoted | Disclosure | |||||||||
5.99% p.a. | 5.90% p.a. | $2,995 | Principal & Interest | Variable | $0 | $0 | 80% | Apply in minutes |
| Promoted | Disclosure | |||||||||
6.09% p.a. | 6.11% p.a. | $3,027 | Principal & Interest | Variable | $0 | $250 | 60% |
| Promoted | Disclosure |
Identity documents
The first thing your lender will want to ensure is that it has your details on record so you can’t disappear into the sunset without repaying a cent. It will request basic identity documents that prove your identity and residency. These might include:
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Driver's licence
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Passport
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Medicare card
Prove you can pay - HEM and serviceability explained
Once your lender is satisfied you are who you say you are, it will verify that you will be able to repay the loan. While home loans are secured against the property, repossession is still a time consuming and expensive process lenders want to avoid, so there are several criteria applicants need to satisfy. While the basic calculation is subtracting your expenses from your income to see if you will have enough each month to make payments, it’s a little bit more complicated than just that.
Income
If you are an employee, demonstrating your income is as simple as a few payslips. The self-employed may need to provide more evidence of their income, like tax returns or financial statements for their business. Since self employed people tend to have a slightly higher default rate, lenders will adjust their standards accordingly, so it’s a bit harder to be accepted for a loan.
Expenses (HEM)
When assessing expenses, lenders are required to use the Household Expenditure Measure (HEM) alongside your expense history. This is a formula that estimates a minimum monthly expenditure for a given household, taking into account age, location, number of dependants and standard of living, among several other things.
When you apply for a home loan, you will need to submit your income and expenses over a given period, say six months. Your lender will come up with an average monthly expenditure based on this. When it assesses your application, it will typically use the higher out of this figure or the number generated by the HEM.
Serviceability buffers (and floor rate)
After taking into account your income and expenses, your lender will have a good idea of how much you can currently afford in repayments. Over the course of a home loan though, the interest rate you are paying is likely to change many times. There’s also the chance your financial circumstances change (illness, loss of job etc.) that could affect your ability to repay the loan.
This means that lenders will want to stress test your mortgage, to make sure you’d be able to continue paying at a higher rate (or your repayments become higher relative to your income). APRA currently enforce a 3% serviceability buffer that lenders need to use to do this. This means if you are applying for a loan at 5% p.a., your lender will generally be testing whether you could repay the loan at 8% p.a.
Some banks have relaxed serviceability tests for certain refinancing applicants in light of high rates. For example, CommBank have introduced a new ‘Refinance Alternate Assessment’, where borrowers with strong credit and a low enough LVR can instead be tested against a 1% buffer, allowing them to refinance. Other major banks have brought in similar exceptions to avoid situations where borrowers are ‘trapped’ with a higher rate, unable to refinance to a lower one because of the 3% buffer - known as the mortgage prisoner effect. APRA responded by imploring banks to only apply these exemptions in ‘exceptional and limited’ circumstances.
Prior to 2021, APRA also enforced a floor rate of 7%. Applications were judged against the higher of this floor rate or the agreed rate plus the serviceability buffer. This is not currently enforced, but most banks will have their own floor rate. CommBank have a floor rate of 5.40% p.a, as of September 4th 2023. This means if an applicant who qualified for a refinance alternate assessment was trying to get a 4.20% p.a rate, CommBank would see if they would be able to repay the loan at 5.40% p.a, since this is higher than the 5.20% p.a you get when you apply the buffer.
These are some examples of the current floor rates at some of Australia’s largest banks.
|
Floor rate |
|
|---|---|
|
CommBank |
5.40% p.a |
|
Westpac |
5.05% p.a |
|
NAB |
4.95% p.a |
|
ANZ |
5.10% p.a |
|
ING |
5.50% p.a |
|
Macquarie |
5.30% p.a |
Floor rates correct as of 04/09/2023
Creditworthiness
Your lender will also do its due diligence on your credit history to see how you’ve gone with previous bills and debts. Even if you can demonstrate a strong income, a chequered history of unpaid bills or debts you’ve defaulted on is likely to raise red flags, and your application could be referred to the lender's credit department for a more in-depth assessment.
What enhances risk for a lender
Deposit size and LVR
Loan to value ratio (LVR) is one of the main metrics lenders use to assess how risky a loan is. LVR refers to how big the loan is relative to the size of the asset used as collateral. It is a means to assess the risk of negative equity (where the loan balance exceeds the value of the asset), which could result in the lender making a loss in the event of a default.
Imagine you take out a loan of $900,000 to buy a property for $1,000,000. This would make your LVR 90% (900,000/1,000,000 x 100). Now imagine after one year, you have paid off $40,000, so you have an outstanding loan amount of $860,000. At the same time, the property market has dropped and the property is now only worth $800,000. Should you now default on your repayments, and the bank repossesses the property, it will make a loss, since it is owed $860,000 and will not be able to recoup this full amount by selling the property.
Lenders will take the LVR into consideration when assessing a loan application. Higher LVR loans present a greater risk, so lenders are often more apprehensive before issuing them. A high LVR (80% or above is usually a good benchmark) means there is less chance the application will be accepted, and also usually means you will be charged for Lenders Mortgage Insurance (LMI). This is a policy designed to protect the lender from the risks of negative equity.
LMI can sometimes be tens of thousands of dollars. It’s one of the big reasons why putting together a sizeable deposit is useful, and it’s definitely something to check before you pursue a home loan. You can use our LMI calculator to estimate how much you could be charged.
Riskier suburbs
Although loans with an LVR above 80% being charged LMI is a general rule of thumb, it is by no means a uniform policy. In many cases, lenders will alter this threshold in certain areas they deem riskier. Property in mining towns, for example, where demand can fluctuate wildly, might be deemed more likely to run into negative equity positions, and thus lower LVR thresholds might be imposed. Areas particularly susceptible to natural disasters like flooding (like Lismore in NSW) could also have similar restrictions.
Debt to income ratio
Another factor lenders consider is an applicant’s debt to income ratio (DTI). This measures how big your total debts are relative to your annual income. For example, let's say you have $400,000 outstanding on a home loan, and $50,000 on your car, and your annual salary is $100,000. Your debt to income ratio would be 4.5, since your total debts are 4.5x bigger than what you earn in a year.
The higher your debt to income ratio, the bigger a risk you are in the eyes of lenders. Often, there will be a threshold lenders will not allow borrowers to exceed. These are the upper limits at some of Australia’s largest lending institutions.
|
Maximum debt to income ratio |
|
|---|---|
|
CommBank |
If DTI > 4.5, the application is monitored. When it exceeds 7, it needs to be manually approved by credit |
|
Westpac |
Applications where DTI is > 7 are automatically referred to credit analysis |
|
NAB |
8 |
|
ANZ |
7.5 |
|
ING |
8 for owner occupied loans, 6 for interest only, 6 for investment loans |
Correct as of 04/09/2023
Savings.com.au’s two cents
As a borrower, it can be easy to get frustrated by the hoops your lender is making you jump through before you can get the funds you’re after. A rejected application might seem absurd; you are a customer after all, and you wouldn’t catch many other industries refusing somebody's business.
Responsible lending though is crucial to the stability of our economy. Loans are usually a bank's largest asset, so if it is forced to write off too many because customers can’t repay them, it might run into problems meeting liabilities.
A bank collapsing can have huge ramifications for the whole financial system, and could result in a government bailout or lead to a recession. High default rates can also lead to an oversupply in the property market, which often means prices slump.
You should generally accept that any reputable lender will have fairly stringent mortgage lending criteria. It’s a good idea to familiarise yourself with them all, including all the ways you can minimise the cost (reducing LMI, getting a better rate etc.). Once you begin your application, being as transparent and personable as possible could go a long way to streamlining the process.
First published on June 2023
Picture by R Architecture on Unsplash
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