There was a time not so long ago when it was easy to persuade a bank to give you a loan. In fact, it seemed like they were giving money away. Things have tightened up, however, and some people have been surprised to find themselves being turned down for a home loan.
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So, what are the criteria a bank uses to determine if you qualify for a home loan?
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There are three key criteria the bank will measure a potential borrower against;
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Serviceability
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Equity
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Character
Serviceability (sometimes called capacity).
This measures your ability to repay a loan. It is, in effect a measure of your income minus your expenses. This is why banks get you to fill out an application form with records of your monthly earnings and monthly spending.
Banks use varying formula to calculate serviceablity and will have different requirements regarding the surplus funds you should have at the end of each month. However, in general terms, banks will expect you to have a monthly surplus of around $300 after all your expenses have been paid.
What this means is that existing debt and overspending will greatly affect your serviceability and, therefore, your ability to get a bank loan.
Equity (sometimes called Collateral).
This measures your net worth. That is, the value of what you own minus the value of what you owe.
Banks are interested in this because, should anything goes wrong and the bank has to move in and reclaim their money by selling your home, they want to make sure they will recoup the money you owe them. This is why part of the application form will include a measure of assets versus liabilities.
The security, for a mortgage, is usually your home and so banks are interested in your LVR; that is, your loan to value ratio. LVR is the amount you will owe on your house divided by the amount it is worth. And banks will usually only loan up to 80% LVR. That means, if you want to buy a new home you will usually need at least 20% of the purchase price as a deposit. It also makes it quite easy to work out how much you can afford to spend on a house – just multiply your deposit by five.
Character.
This is, believe it or not, the most important criteria and measures your perceived intention to repay the money you have borrowed. Banks assess this by looking at your financial track record.
Taken into account will be things like; previous defaults on any type of loan repayments, fines owing, constantly going into unarranged overdraft, poor credit rating, a poor job history.
This is one reason banks ask for three months bank transactions before giving out a loan – it’s to check how you manage your finances. Many people underestimate the need to have a good credit and banking record.
We need to remember;
We need to remember, banks take a risk when they lend money to a customer and so want to minimise that risk by ensuring;
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we are able to pay the money back,
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have something they can sell if we can’t,
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and have a character that indicates we are willing to make the necessary sacrifice to repay it.
The challenge is simple; we need to be proactive in ensuring we are attractive clients to the bank in these areas;
• Serviceability
• Equity
• And character.
If your path to financial freedom is being held back because of one of these criteria, the challenge is to formulate a plan to get on track.
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