Serviceability, an essential part of the home loan approval process, is a lender-specific calculation of borrower capacity to repay a proposed home loan.
Lenders apply their own policy standards against your income, expenses, and debt obligations to calculate how much cash is available for the new home loan repayments.
Importantly, just because a loan may seem affordable to you, a lender may not calculate your serviceability the same way.
As a mortgage broker since 2008, I know that serviceability results can vary widely among lenders which makes it confusing for borrowers.
The main reason for lenders to differ in serviceability results is they apply their own policies and standards to their own serviceability calculators.
In many cases, you can pass a serviceability test at one lender and fail at another.
The question of serviceability is not around whether you can afford the loan, but:
Can you prove affordability on the lender’s terms?
In this article I get into the weeds on serviceability and take you through 17 different ways a borrower’s serviceability can be impacted. Some you can control and some you cannot.
What I cannot do is provide a generic serviceability calculator when each borrower scenario differs—as does the lender perspective. Lenders design their own serviceability calculators for their own assessment needs. Mortgage brokers know that. This is why mortgage brokers are well placed to assist both existing and new borrowers.
Banks perform a serviceability test for two main reasons:
I have conducted thousands of serviceability assessments for lenders over my mortgage broking career.
I have two main points for readers:
First – Understand that is an essential test in the home loan approval process.
I do not remember a loan being approved that did not pass the lender serviceability test – consider it non-negotiable.
Final – While it is helpful to know what can move the needle for serviceability, going too deep too early can get you side-tracked.
I recommend using a mortgage broker. They establish your needs and objectives as the priority. The good ones conduct serviceability assessments PRIOR to submitting your home loan application.
To calculate serviceability, a lender performs the following calculation to work out the surplus income available for a proposed home loan.
Incomes – from employment, business, investments
less
Living expenses
less
Ongoing commitments including any existing loan repayments
equals
Surplus for new loan repayments
Lenders might change the numbers for each category of income and expense to align with their own policy, which means some figures used in the calculation will not be the same as actual.
For example, commission income may be an accepted, but only 80% used in a serviceability calculation as it is less certain than a base wage.
This is where differences in lender serviceability calculations can be stark – and confusing for borrowers.
Once the lender figures out the surplus amount remaining for the proposed home loan repayments, they can finalise their serviceability assessment.
Numbers are numbers and they do not always tell the full story. So, calculating serviceability can yield different types of answers, depending on the lender.
Even if a borrower shows a capacity to repay the proposed loan repayments, they could still fall short in other areas of serviceability.
Below are three measures I commonly see in lender serviceability results.
Surplus
A ‘pass’ result needs to show the borrower has leftover funds each month after allowing for the proposed loan repayments. Some lenders want to see a surplus that is greater than “just affording the loan”. Instead of eeking out a $1 per month surplus, some lenders need a defined surplus amount, say $300 per month. This provides an extra buffer for scenarios they consider higher risk.
Debt servicing ratio (DSR)
Debt servicing ratio (DRS) gives lenders a feel for the proportion of income, after living expenses, required for debt commitments.
Instead of defining a surplus dollar amount required, lenders can use a ratio. Technically, a ratio over 1.00 means a borrower demonstrates a surplus. However, sometimes a lender can require a higher DSR, say 1.15, if they consider the application higher risk. I have seen higher DSR’s used in applications involving foreign income currency.
Debt to income (DTI) ratio
The debt to income ratio (DTI) provides an indication of overall lending exposure for the borrower. The “debt” usually includes all debt: credit cards, existing and new home loan to name a few.
If a borrower demonstrates a surplus on a serviceability test, a lender can still decide they are carrying too much debt as a proportion of their income—although borrowers may sometimes disagree!
There is only so much debt a lender is willing to be party to.
A high DTI may not necessarily lead to a declined loan application, but it often prompts a closer look at the proposal. A DTI of 6 is considered high.
While serviceability deals with the calculation of lending capacity for a specific scenario, borrowing capacity is a more generic indication of an amount you could borrow, based on some estimates.
All things being equal, you should pass a serviceability test provided it falls within your borrowing capacity.
The lender-specific nature of serviceability calculators usually means results differ across lenders for the same borrowing scenario.
Below is a real servicing capacity extract showing how lenders differ in the amount they could lend for the same scenario. Lenders can be close—but rarely the same.
Results can vary
Serviceability results reflect lender policy. So, unless lenders share the same policies, serviceability calculations will likely differ.
These figures show some variance, but I would not consider it overly significant. This application was fairly standard, if there is such a thing. It had a reliable base income, a credit card, and not much else.
We see more variance between lenders when borrowers present with uncertain income sources like bonuses, foreign income, or are self-employed. Different approaches to serviceability can mean serviceability passes (approval) fails (decline), depending on the lender.
A much shorter list would be if we asked what doesn’t impact serviceability….
I have put together a list of 17 ways serviceability can be impacted. Some you can control and others you cannot.
Note: As with all things banking, this is a general guide and not advice to be acted on. See a mortgage broker for advice specific to your situation.
BORROWER
INCOME
EXPENSES and COMMITMENTS
HOME LOAN
Australian banks get risk-guidance from their regulator, the Australian Prudential Regulation Authority (APRA), which recommends adding about 3.00% on top of the interest rate when performing serviceability calculations. I say ‘about’ because the buffer amount can change.
The interest rate buffer is designed to test if a borrower can withstand significant interest rate increases.
Even if you have a fixed rate home loan to help with certainty of repayments, Australian lenders do not offer fixed rates for the entire loan term. Borrowers commonly fix loans for up to five years and should be prepared for a new rate when the fixed rate ends.
Part of understanding your servicing capacity, is that it can change—sometimes dramatically.
Here are some borrower-specific changes that can impact servicing:
There are also changes outside borrower control like:
A successful home loan approval process relies on a positive serviceability result. Lenders use serviceability calculations to help them get a full picture of a home loan application.
This article has explained the principles of how lenders calculate serviceability. I covered the main impacts on servicing I have seen in my mortgage broking experience, including some borrowers can control.
Borrowers should work with their mortgage broker to understand the impact any financial changes have on serviceability capacity (positive or negative). This is particularly important in the lead up to a home loan application as some financial choices are difficult to undo.
Mortgage brokers keep the goals and objectives of the borrower central to the process, rather than get distracted by serviceability.
Remember, you do not need to understand all the ins and outs of serviceability calculators. A mortgage broker can do this for you.
Mark Nolan (aka Nols) writes about loans, homes and everything in between. Since realising he does not need to work so much, Mark started writing to educate anyone ready to learn from his personal, investing and business experience.
Empowering his readers drives his content.
