Time to read : 6 Minutes
A long time ago, in a lending landscape far away, I worked as a mortgage broker. Every now and again, I’m reminded that most home loan applicants don’t know what a lender looks for when they assess your home loan application. So, I’ve broken it down here.
When you apply for a home loan, you’re basically asking a lender to front you the money to buy a house or apartment – and you’re asking them to commit to this for 25-30 years.
Most home loans aren’t held for that long, but your lender has to assume you will hold it, and they may need to prove this to regulatory authorities, like the Australian Prudential and Regulatory Authority (APRA).
Under Australia’s responsible lending obligations, they consider every application carefully. The Australian Securities and Investment Commission (ASIC) also has rules around responsible lending.
Before your lender agrees to risk their money on you, they look at the 4 Cs.
The Four Cs of Credit
Capacity: can you repay your home loan? Do you have a stable job and steady income? Do you have other debts?
Character: have you had loans before and paid bills on time?
Collateral: do you have assets the bank can sell if you don’t repay the loan?
Capital: do you have savings, a car, or other assets that can cover the debt?
Lenders typically look at:
your income and how you earn it
the value of the property you're buying
your savings and spending habits (ie household budget)
your credit history (this is where they look at late bill payments, credit card interest charges, etc.)
your assets and debts.
This last part takes into account the value of everything you own, and the value of everything you owe. The difference between these two numbers is your net worth.
Here's a simple example of your net worth calculation:
Assets | Liabilities |
|---|---|
Car: $15,000 | HECS-HELP Debt: $35,000 |
Savings: $10,000 | Car Loan: $15,000 |
Furniture, belongings, jewellery etc. $10,000 | Credit Card Debt: $1,500 (calculated as 30% of $5K limit) |
Superannuation: $35,000 | |
Total Assets: $70,000 | Total Liabilities: $51,500 |
Total net worth = $18,500 ($70,000 - $51,500) – great news! You’re in the black.
If you're interested in knowing your net worth, you can calculate your own net worth.
What do lenders consider when assessing home loan applications?
Income
Your income affects how much you can borrow, and this varies by lender.
Regular salary is the best type of income, and you’ll be asked to prove this with recent payslips.
Bonuses, overtime, and other extra pay do count – but they’re assessed differently by each bank. Often, your loan assessment will base these amounts on the average of this income over 2 years.
If commissions form a major part of your income, make sure you work with a broker who understands this. Some lenders don’t allow commissions to count as income, some only count up to 80% of your total commissions, and others will take it all. A good broker will know where to take your loan for the best chance of success.
Side-hustles are not often treated as regular income, unless you can prove consistent earnings over a set period – and even then, only some lenders will accept this as income that counts towards your borrowing capacity.
Rental income is usually taken at 80% of the actual income – but it depends on your lender. Short-term rentals like AirBnB might only be calculated at 50%, and some lenders won’t accept this income at all.
Income from shares is usually shaved to just 10% of actual earnings.
Although some countries are treated differently from others, overseas income is often discounted or ignored. Speak to your broker to find out more.
Be aware: Self-employed people face more scrutiny from lenders and may need to show they have a stable income shown by two consecutive years of business tax returns. It may be easier to showcase your income if your business pays you a set, stable wage.
There are also lenders that are more accepting of self-employed income calculations, and a good broker will know this.
Employment History
Consistent employment history is important – especially if you’ve been in the same, or similar, roles for a long period.
Avoid changing jobs 3-6 months before applying for your home loan.
Probationary periods and casual jobs are often a problem for lenders.
Side hustles (as mentioned above) aren't typically considered stable income and many lenders have strict rules when it comes to second jobs. That said, it's not impossible to have this income included. Speak to an experienced broker who'll know the ins and outs.
Savings
A history of saving your income shows you can manage money; ie you have more money coming in than going out.
Be aware: When your lender looks at your savings, they look at the regular deposits going into your account to build up your balance. A sudden lump sum deposit (eg from your tax refund, inheritance, or a monetary gift), is not usually considered as ‘savings,’ because there’s no proof you’ve built this up yourself.
This rule also protects the lender from applicants who have a relative ‘dump’ a lot of money into their account just to get their loan approved, and then move that money back out. Borrowers who might do this are not a good risk for the lender, which is why they look at several months of your savings accounts and not just the amount you hold in there.
Deposit
Each lender has a limit on how much of your property’s value they will lend, known as the Loan to Value Ratio (LVR).
Lower interest rates are often available if you’re borrowing less than 70% of your property’s value, which means you might need a deposit between 20-30% – or more, if you don’t want to borrow to cover your stamp duty up front either.
You may be required to demonstrate that you have your deposit, or that you will have it by the time your loan settles. Your lender may look at your savings history to see if you know how to put money away towards your home deposit.
Spending Habits
Lenders examine your bank and credit statements to understand your spending habits.
Regular transfers or payments indicating debts may not be in your favour.
Lenders also use a minimum living expense benchmark known as HEM (Household Expenditure Measure). HEM is a calculation the bank does taking into account:
your household (eg whether you’re single, or part of a couple, do you have kids, how many, etc)
your postcode (based on the average cost of living in certain areas)
income (there is an average cost for what most people or families in certain income brackets spend annually).
Note: HEM calculations are lender-specific, and you have no control over how a lender assesses your living costs. What you do have control over, is how well you manage your household budget.
If your broker challenges a lender’s assessment of what an average family spends in your postcode, they must have proof in your financial statements that your HEM is different to the average – and reasonable explanations as to why.
For example, if you don’t have a car, your living costs may be lower than HEM because you do not run and maintain a vehicle. Your broker can present this evidence on your behalf.
If your lender agrees, and lowers the HEM calculation for your application, then you’re more likely to be approved for a higher borrowing capacity.
Credit Score
Lenders review your credit history and score.
Red flags include court judgments, bankruptcies, and defaults.
Multiple credit inquiries can also be problematic.
Some lenders use algorithms to filter applications, so too many red flags can lead to an automatic rejection of your home loan application.
Assets and Liabilities
Your assets include any cars, your superannuation, cash accounts, belongings and other properties.
Your liabilities include credit card debts, loans, and any Buy-Now-Pay-Later arrangements (BNPL).
As of 2019, your HECS-HELP debt is included in your listed liabilities.
Be aware: your credit card limit matters, not just the balance. Even if you pay the balance to zero every month, most lenders’ calculations take 30% of your total credit card limit – for each credit card.
Your lender operates on the theory that, even if you’ve never used your card limit, you could at any time. Banks are not optimists.
Debt to Income Ratio
This is the final part of your home loan application calculation.
The income amount your lender uses is less than your ‘real’ income, because of the shaving for most forms of income.
The debt amount will, likewise, be rounded up for all forms of debt you hold.
Once your lender has worked out your net income, they’re allowed (by ASIC and APRA) to approve you for around six times your income. Again, this will vary by lender, and by applicant.
Sometimes it’s only five times, or three – and rarely, up to nine times. It’s case-specific and designed to protect you from falling into default, and your lender from incurring bad debts.
Bottom line
Navigating home loans can be complex. A good broker can help you understand what matters for your situation, save you time and hassle, and potentially save you money over the life of your loan.
Using a broker doesn’t cost more than going directly to a bank and can be much more convenient. They offer specialised knowledge that can help place your loan with lenders that are likely to favour your specific circumstances.
Lenders’ preferences change as often as their assessment algorithms. Getting some help to navigate your way through this will save you time, angst, and very likely quite a lot of money.
If you need help, Compare Club’s team of expert brokers would be happy to have a chat. To get started, fill out this home loan form.
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Financial disclaimer
The information contained on this web page is of general nature only and has been prepared without taking into consideration your objectives, needs and financial situation. You should check with a financial professional before making any decisions. Any opinions expressed within an article are those of the author and do not specifically reflect the views of Compare Club Australia Pty Ltd.
