15 Startling Facts About Loans in Australia That You Never Knew
The four C’s of credit
- The capacity of your ability to repay the loan. Do you have a stable job and a steady income? How long have you been in your job? Do you have other debts or obligations?
- Character or your willingness to repay the loan? Have you had a loan before? Do you generally pay your bills on time?
- Collateral or do you have assets the bank can sell to get their money back if you don’t pay?
- Capital or assets. Do you have other assets, such as a savings account, car, or shares that you could use to repay the debt?
So what does this mean in practice for home loan borrowers?
- Income
Your income and how you earn it will affect how much money you’ll be able to borrow. And this will vary greatly between lenders. Often this will determine which lender is appropriate more than the rate will.
Not all income is created equal. The best is a regular ordinary-time salary as evidenced by several consecutive payslips. Each bank has its approach to assessing additional pay such as commissions, bonuses, overtime, shift allowance, and other loadings.
The best source of income is a regular ordinary-time salary as evidenced by several consecutive payslips.
Overseas salary will often be severely discounted or ignored depending on the currency in which it is earned.
If you get a portion of your pay in shares, these will likely be heavily discounted.
Many Government benefits may not be counted as relevant income.
Self-employed and business owners will generally face greater scrutiny, to ensure their income is sustainable. The best result will be achieved with two consecutive tax returns with steady to slightly increasing income.
Be aware that your creative accountant usually seeks to reduce taxable income to minimize your tax bill – it’s just in the DNA. This may backfire when it comes to demonstrating to a lender that you’re good for a loan.
Rental income and related expenses will also be treated differently and can have a huge impact on which lender is appropriate for you.
Income from share investments will usually be ignored unless received over many years.
- Employment history
A consistent employment record is important.
Don’t change jobs just before you want to get a home loan.
Probation is a no-no for many lenders.
Casual positions and second jobs often are disregarded or significantly discounted by lenders. And don’t expect your side hustle to get treated like a steady wage.
- Savings.
A demonstrated history of saving from your income is an important element in demonstrating that you’re good for a loan.
Firstly, because it shows that you can manage your money, and secondly, because the more savings you have, the lower proportion of the purchase price you will need to borrow.
- Deposit
Regardless of how much income you have, each lender will have an upper limit as to how much of the value of the property they will lend. This ratio is called the Loan Value ratio (LVR or LTV).
The lower rates are often only available to those borrowing less than 80% of the value of the property, but it can be possible to go as high as 95%. And with a parental guarantee of 100% or even more.
- Spending habits
Lenders will usually closely examine your bank and credit statements for a period of up to six months to get an insight into your spending habits and to ensure you aren’t exceeding your limits or making late payments.
They will look for regular transfers or payments which might indicate a debt or other fixed commitment. And they will look to see if you are regularly spending less than you earn consistently with the savings you are claiming.
No matter how frugal you might be most lenders have adopted a floor on the living expenses they will accept.
- Credit score
All lenders will review your credit file to look at your history of credit usage and repayment behavior.
The are some red flags that will limit your options and potentially lead to a decline. Court judgments, bankruptcies, and defaults are obvious. Innocent ones such as multiple inquiries (often just shopping around or chasing sign-on bonuses for credit cards) or credit with some types of lenders, can lead to questions or even a decline.
Some lenders use a computer algorithm to filter applications, so your application might be auto-declined and not even get looked at by a human if too many of these red flags are present.
Unlike the USA, your credit score (as shown on many websites) is not used as a hard and fast indicator. Many lenders use their algorithms.
But your credit score is a useful indicator to self-assess. Your credit score is a number derived from your credit file, that attempts to identify how likely you are to default and is typically measured on a scale of 0 to 1,200 or 0 to 1,000. Each of the three main bureaus has its scale and methodology.
Generally speaking, the higher your score, the more desirable a customer you are. Paying your bills on time and making regular progress in paying down debts result in a higher credit score, while bankruptcies, defaults, unpaid debts, and multiple unsuccessful loan applications will result in a lower one.
- Assets and liabilities
What you own and what you owe is another key determinant in whether you will qualify for a loan and for how much.
Your assets can include cars, superannuation, and any properties you may already own.
Liabilities, on the other hand, can include credit card debts, personal loans, car loans, or other home loans.
When it comes to credit cards, it’s the limit that matters not how much you owe. So consider getting rid of the ones you don’t need.
- HECS/HELP
Although HECS/HELP is a liability, it is treated differently than other debts – mostly because it is.
Read more on why HECS is not like a real debt.
What matters here is not the balance on your account, but the impact it has on your take-home pay.
So making additional payments won’t make any difference unless it results in the total balance being cleared. This cash flow will usually be better directed to increasing your deposit.
- Debt to Income Ratio
The total amount of debt (other than HECS/HELP) that you have relative to your income is becoming increasingly important when it to comes to how much you can borrow.
This will have a big impact on people with investment properties which generate rent to service the loan but still add to the total debt burden.
Debt multiples of up to six will get little scrutiny even if they may not be prudent as a borrower. Nine times is likely to be an upper limit for most.
- In some cases, student loans will not affect your debt-to-income ratio.
If your student loans are in deferment, underwriters can exclude them from the calculations made to figure out your debt-to-income ratio. It is assumed that if your student loans are still in deferment, you have just recently graduated from college and you will soon get a great job that will have a higher income.
- Having assets does not mean what it used to.
Despite having large sums of money in the bank or in assets that could be liquidated, if you don’t have adequate income, lenders may not allow you to borrow from them. They want you to show that you will be continuing to gain money and assets to pay your current financial obligations as well as any others you may accrue while you are paying them.
- Being self-employed can make it hard to qualify for a home loan.
Sometimes, self-employed borrowers find it difficult to get a mortgage because they write off so much of their income making it appear that they have very little spending money. If you are a business owner, keep in mind that the amount you are showing the IRS as income may help you pay smaller amounts in taxes; however, it also looks like you are making less money to lenders as well.
- Some home loan options require little or no down payment.
If you research what types of loans you qualify for, you may find that you can get a home loan with as little as a 3% down payment through HUD or even sometimes $0 down through a VA program.
- You can have your home loan payments automated.
Most lenders offer a way to have money automatically transferred from your bank account directly to your lender. This technology makes it easier to ensure payments are made on time and that a late or missed payment never damages your credit score.