This article was contributed by David Windler of Mortgage Supply.
It’s a constant frustration that by any measure of common sense, a client can afford what they are wanting to borrow but the myriad of maths that banks apply to their situation, means approval at a lesser amount or even worse a decline. It so often just doesn’t make sense.
It takes a bit to explain that back to the client, especially an investor client who is more impacted by current bank servicing requirements than any other type of client. Basically, the more debt you carry the more impact that the banks’ conservative maths has on your ability to invest further.
Let’s take a look at some of the ways that banks calculate your serviceability. It might not change the outcome for you but at least an understanding might remove some frustration and more importantly give you some idea of what you can do in order to buy again.
Lenders are looking to work out what surplus a borrower has left after all of their current obligations are taken care of by their incomes. Most lenders use what we call a UMI (Uncommitted Monthly Income) to measure this. It’s the dollar figure left over from income that could go towards servicing a new mortgage. Have enough of a surplus and you can borrow.
Let’s look at income first. When working out the UMI, banks will work off your net income. Basically, it’s that income that hits your bank account after tax and any other deductions (typically Kiwisaver). We’ll stick to PAYE earners for the purpose of this exercise as self-employed borrowers almost needs another article. Any rental income also goes into the mix but only at 80% of its value. The 20% that banks take off the top is to cater for your cost of ownership (vacancy, repairs, rates and insurance etc.)
On the other side of the ledger sit your expenses and these soon start eating into your net income. Banks have different prescribed deductions for couples, adults, dependants that take care of those baseline costs to live but they measure over the top of that, the applicants additional living expenses, rates, insurances, anything really that regularly comes out of the account. Life and health insurance deductions can’t be ignored and often impact older borrowers as premiums increase.
If spending habits are clearly over the bank minimums, then more scrutiny of the bank statements take place. And if accounts are overdrawn it becomes incredibly hard to gain approval. How can a bank approve a further expenditure (a new mortgage payment) if the applicants seem not to afford their current obligations?
Existing debt commitments are put into the mix, so that’s any car loan/personal loan payments etc and credit card limits are accounted for with 3% of the limit put in as a monthly expense. As an example, a $10,000 credit card limit attracts a $300 per month expense, whether the card is even used. The banks work on the basis that you could use it and that’s enough to see it hit the expenses column and reduce your borrowing power.
The big expense if of course the loan you are applying for and the mortgage lending you might already have. Lets look at how the banks treat these.
The loan applied for is always calculated as a principal and interest repayment typically over 30 years, but not at market rates. Banks use what we call a servicing rate to calculate the proposed repayment. This rate varies considerably from bank to bank. Some use the floating rate, say 5.7%, and others can use a rate much close to 8%. Straight away you can start to consider that banks maths can be different from bank to bank and the more you wish to borrow the great that gap could be.
The gap widens further when calculating the repayments on other mortgages you have. All banks will apply the same servicing rate to those repayments as well. It absolutely doesn’t matter that you have some debt on an interest only term at 3.89%, the banks will use their servicing rate and moreover apply it on a principal and interest basis. Again, the more debt you have, the greater the applied repayment figure and the more likely that servicing will fail.
For some this gap widens dramatically when a bank (and I can think of four) insists on understanding how long is left in the term of the mortgages you have and applies their servicing rate over the term remaining. Here’s an example.
An investor wishes to borrow to purchase another property, has plenty of equity in a portfolio and the portfolio has existing lending of $1,000,000 all interest only at 3.89%. That’s a repayment figure of $748 per week. The lending was taken out 10 years ago and originally was a 30-year mortgage. It means that these existing loans have 20 years to go. A number of banks will calculate this in the servicing calculator as a 20 year repayment, using their servicing rate! It takes what is in reality a $748 pw outgoing to one of $1900 per week…..a massive $1,152 per week difference a near $60,000 per annum difference in affordability that would require a gross taxable income of around $85,000 to fill the gap.
No wonder many investors feel stuck and frustrated, sitting on equity with positive cashflow in a flattish market. Many would believe it’s a good time to buy but just can’t get the funding to support their plans.
The solutions are always going to be many and varied and are absolutely particular to a borrowers very individual situation. But there are some common themes to explore.