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Understanding Lender Considerations: Calculating Your Servicing Capacity for a Residential Home Loan

Writer's picture: Doug StevensonDoug Stevenson


When you're in the market to secure a residential home loan in Australia, lenders take various factors into consideration to assess your servicing capacity. Your ability to repay the loan is a primary concern for lenders, as it helps them determine your eligibility and the terms they can offer. In this comprehensive guide, we'll explore the key components of servicing capacity, explain crucial terms such as Max Capacity, Monthly Surplus, DTI (Debt-to-Income Ratio), Product Rate vs Assessment Rate, HEM (Household Expenditure Measure), LMI (Lenders Mortgage Insurance), and the First Home Guarantee.


Servicing Capacity: The Basics

Servicing capacity is a crucial element in a lender's assessment of your suitability for a home loan. It refers to your ability to meet your monthly mortgage repayments while also covering your existing debts and living expenses. Lenders employ a range of factors and calculations to evaluate your capacity, ensuring that lending is responsible and sustainable for both you and the lender.


Max Capacity

Max Capacity, also known as borrowing capacity or serviceability, is the maximum amount a lender is willing to offer you based on your financial circumstances. It takes into account your income, expenses, and other financial obligations. While it provides an estimate of what you can afford, it's essential to consider your personal budget and long-term financial goals when determining how much you should borrow.


Monthly Surplus

Your Monthly Surplus, often referred to as disposable income, is what remains after deducting all your monthly expenses, including your mortgage repayment. Lenders typically require a certain level of monthly surplus to ensure you can comfortably manage your loan. A healthy monthly surplus reflects your ability to handle financial emergencies and unforeseen expenses.


Debt-to-Income Ratio (DTI)

The Debt-to-Income Ratio (DTI) is a vital metric that lenders consider. It measures the proportion of your monthly income dedicated to debt repayments, including your potential mortgage. In Australia, lenders typically aim for a DTI of 30-35%, which means that your total monthly debt repayments should not exceed 30-35% of your monthly income.


Interest Rate Considerations

Your ability to service a home loan can also depend on the interest rate you're offered. Here's where Product Rate vs Assessment Rate comes into play.


Product Rate vs Assessment Rate

Product Rate is the interest rate you'll pay on your home loan. It's the rate that the lender advertises and is usually the lower of the two rates. However, lenders use a more conservative rate, known as the Assessment Rate, when evaluating your servicing capacity. This rate is typically higher and is used to ensure that you can still afford your loan even if interest rates rise.


Living Expenses and the HEM

Living expenses are an essential part of assessing your servicing capacity. Lenders use a benchmark known as the Household Expenditure Measure (HEM) to estimate your basic living costs. The HEM is a predetermined standard, and it varies depending on your location, family size, and lifestyle. Lenders will compare your declared living expenses to the HEM to ensure that you can meet your loan obligations while maintaining a reasonable standard of living.


Risk Mitigation: Lenders Mortgage Insurance (LMI)

When you're borrowing a substantial portion of your property's value, lenders may require you to pay Lenders Mortgage Insurance (LMI). This insurance protects the lender in case you default on your loan. LMI doesn't directly affect your servicing capacity, but it's an additional cost that may be factored into your financial calculations when determining the affordability of the loan.


Government Initiatives: The First Home Guarantee

For first-time homebuyers, the government offers incentives and programs to assist in entering the property market. The First Home Guarantee is one such initiative. It comprises two key elements:


1. First Home Loan - This is designed to help first-time buyers enter the market with a smaller deposit by allowing them to borrow with as little as 5% of the property's value. It's important to note that while a smaller deposit might make the purchase more accessible, it can also affect your servicing capacity. A smaller deposit often means a larger loan, and lenders will assess your ability to manage the associated repayments.

2. First Home Super Saver Scheme (FHSSS) - This allows first-time buyers to save for a deposit within their superannuation fund, benefiting from potential tax advantages. While this scheme can be advantageous for saving, it's not directly related to servicing capacity.


## Education Debt: HECS (Higher Education Contribution Scheme)

For many Australians, higher education opens the doors to better career opportunities and increased earning potential. However, the debt incurred through the Higher Education Contribution Scheme (HECS) can impact your servicing capacity when applying for a residential home loan.


How HECS Impacts Servicing Capacity

HECS is considered a form of unsecured debt, and lenders typically include it in their assessment of your financial obligations. When you have a HECS debt, it affects your monthly expenses, and the amount you owe depends on the type of courses you've undertaken and your income level.

The impact of HECS on your servicing capacity varies depending on the size of your HECS debt and your income. It's essential to keep in mind that while HECS repayments are based on your income, they are another financial commitment that may reduce your monthly surplus.


When applying for a home loan, lenders may consider your HECS debt in combination with other factors like living expenses, credit card debt, and the HEM benchmark. This comprehensive assessment helps lenders determine whether you can comfortably meet your mortgage repayments while managing your other financial obligations.

To improve your servicing capacity when you have a HECS debt, you may want to consider strategies such as increasing your income or reducing other debts. Additionally, seeking professional financial advice can help you understand how to balance your HECS repayments with your homeownership goals.


Credit Cards and Their Impact on Servicing Capacity

Credit cards have become a common financial tool, offering convenience and flexibility for everyday expenses and larger purchases. However, credit card debt can significantly affect your servicing capacity when applying for a residential home loan.


How Credit Cards Impact Servicing Capacity

Credit card debt is a form of unsecured debt that lenders consider when evaluating your ability to service a home loan. The amount of credit card debt you carry, the minimum monthly payments, and the credit limit all influence your financial obligations and, consequently, your servicing capacity.


Lenders assess your credit card debt by considering:

1. Credit Card Balances: The outstanding balance on your credit cards is included in your monthly expenses. Lenders typically use the minimum monthly payments when calculating your financial commitments.

2. Credit Limits: The total credit limit available across all your credit cards is a part of the assessment. Lenders are concerned not only with the existing debt but also with the potential for accumulating more debt in the future.

3. Repayment History: Lenders may also review your credit card repayment history to assess your financial responsibility.

Credit card debt can reduce your Monthly Surplus, increasing the likelihood of being declined for a home loan or receiving a lower loan amount than expected. It can also influence your credit score, which is another crucial factor lenders consider during the application process.

To minimise the impact of credit card debt on your servicing capacity, consider these strategies:


  • Pay down your credit card balances to reduce your monthly financial obligations.

  • Avoid accumulating additional credit card debt, especially when you're preparing to apply for a home loan.

  • Make payments on time to maintain a positive credit history.


Understanding how HECS and credit card debt impact your servicing capacity is crucial when seeking a residential home loan. Managing these financial obligations effectively, reducing other debts, and maintaining a healthy credit score can improve your chances of securing the loan amount you need for your dream home. Additionally, working with a financial advisor can provide tailored guidance to help you achieve your homeownership goals while maintaining financial stability.

In conclusion, your servicing capacity is a multifaceted evaluation that considers your financial health, living expenses, interest rates, and government initiatives like the First Home Guarantee. To maximise your chances of securing a residential home loan, maintain a healthy monthly surplus, manage your DTI, and be mindful of the assessment rate and the HEM. By understanding these components and seeking expert financial advice, you can navigate the complexities of the lending process and achieve your homeownership goals while ensuring financial stability and sustainability.



*The information provided on this website is for general education purposes only and is not intended to constitute specialist or personal advice. This article has been prepared without taking into account your objectives, financial situation or needs. Because of this, you should consider the appropriateness of the advice to your own situation and needs before taking any action. It should not be relied upon for the purposes of entering into any legal or financial commitments. Specific investment advice should be obtained from a suitably qualified professional before adopting any investment strategy.

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