What is home loan serviceability?

If you’re in the market for a home loan, you’ve probably come across the term ‘serviceability’. This refers to your ability to meet your mortgage repayments. Lenders use this figure to calculate whether you can afford to repay your loan under the responsible lending rules.

According to the Australian Securities & Investments Commission’s (ASIC’s) guidelines, financial institutions must have reasonable checks in place to ensure people don’t take on massive debts they cannot afford to repay. To meet this requirement, lenders calculate your serviceability at a higher interest rate, so you won’t reel under mortgage stress if interest rates rise in the future. How different lenders calculate serviceability differs, but it’s commonly based on your income and expenses.

Before 2019, when someone applied for a home loan, lenders were required to check if they could repay their loan at a minimum rate of seven per cent. However, lenders are now allowed to set their own ‘floor’ rates for stress rating, provided they add a three per cent buffer on their current interest rates (previously this was 2.5 per cent). This is needed to ensure that borrowers will still be able to meet their repayments if interest rates rise. 

A reasonably high annual income should therefore increase your chances of home loan approval in many cases. However, your income isn’t the only factor that affects your serviceability. For example, if you’re a high-income earner, but your expenses are also high, you may find it challenging to qualify for a home loan owing to poor serviceability. 

Some of the contributing factors used to assess your home loan application include:

• Your income, which includes your salary and any secondary income, such as rental income and money earned from investments.
• Your actual living expenses, including what you spend on your clothing, personal well-being and even your pets. 
• Ongoing debt expenses and other commitments, such as your credit card limits, and any personal, education or car loans.

All these factors help lenders evaluate whether or not you can afford the loan. As each lender has a different assessment method, your serviceability may differ from lender to lender. For instance, some lenders may approve you for a higher amount than others. You can get a general idea of how much you may be allowed to borrow using RateCity's Borrowing Power Calculator. 

However, home loan serviceability is different from affordability. A lender’s estimate of your serviceability is based on the information provided by you. You may be the best judge of how much you can really afford to spare each month to pay towards your home loan. It may be helpful to calculate your monthly repayments for different sized home loans to figure out how much you can comfortably afford to repay.  

Tips to increase your home loan borrowing capacity

Your borrowing capacity, which refers to the maximum amount of money you can borrow to purchase a home, has dropped. As per new APRA rules, from November, 2021, banks are required to check if people can repay their mortgage at three per cent more than their current interest rate, or the ‘floor’ rate set by them – whichever is higher. This three per cent buffer doesn’t apply to non-bank lenders. 

The aim of the move is to prevent people from taking on risky levels of debt but it also reduces the borrowing capacity of the average homebuyer. However, there are a few things you could do to help improve your borrowing capacity despite the hike in the serviceability buffer.

The most straightforward way to potentially increase your serviceability is by increasing your income. You may take up a second job (if your schedule allows for it) or apply for a higher paying job to increase the amount of money you earn. Of course, this is easier said than done. Not everybody can find the time or motivation to work two jobs or multiple shifts to boost their income. 

A simpler alternative could be to reduce your expenses by curbing unnecessary costs and spending your money in a more responsible manner. You may also work on reducing your debts to increase your home loan serviceability. 

You could also consider lowering your credit card limits. Higher credit card limits contribute to more debt on your credit file, irrespective of whether there’s a balance available on your card. 

It’s also often helpful to check your credit score before applying for a home loan. If you find your score is low, consider ordering a copy of your credit report and checking for any incorrectly listed information. While this isn’t very common, sometimes errors do creep into credit reports, and you can have them removed by flagging the issue to the credit rating agency concerned. You may also like to read these practical tips for boosting your credit score.

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