How much can I borrow? How borrowing capacity can be impacted, massaged and manipulated (without breaking the rules of course!) (Ep.115)

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In this week’s episode, Dave, Cate and Pete take you through:

  1. The age-old question – how much can I borrow?Often the first question our strategic mortgage brokers get from eager clients is ‘how much can I borrow?”. Rarely straight forward, it’s a vexed question with various nuances to be worked through. Each lender has their own set of rates and policies, and mind you, there are about 60 lenders out there, all with varying products on offer! Which lender will treat your scenario the most favourably can be broken down into four key factors:
    1. assessment rates.
    2. variable incomes.
    3. interest only vs principal and interest
    4. how lenders mortgage insurance impacts purchase

In this episode, the trio tackle the ins and outs of assessment rates.

  1. What are assessment rates?The assessment rate is the rate that lenders use to assess your borrowing capacity and this rate is always higher than the rate you are actually going to pay on your mortgage. The purpose of the assessment rate is to stress test your ability to make repayments to account for future uncertainties such as: future rate rises, reductions in income, unemployment, change of employment, illness, divorce, expected events (having children) or other unexpected events that may happen during the loan term (which is often 30 years).
  2. The floor assessment rate. Floor assessment rates are mandated by APRA for the banks and also one of the tools that APRA used when trying to slow down interest only and investment loans. The floor assessment rate is the lowest rate that a bank will use to assess borrowing power. As an example, Westpac’s floor assessment rate is 5.05%. When assessing borrowing power, most lenders will use the higher of your actual rate + 2.5% OR the floor assessment rate.
  3. Why using online calculators is fraught with danger. There are many different considerations which go into answering the question ‘How much can I borrow?’ Loan to value ratios, lenders mortgage insurance, investment vs owner occupied purpose, fixed vs variable, principleand interest vs interest only are just a few of the considerations which can impact the answer. And that’s just scratching the surface!
  4. Loan to value ratios. Often referred to as LVR, the loan to value ratio is the proportion of the loan against the value of your property. For example, if your property value is $1,000,000 and the loan value is $800,000 – the LVR is 80%. The LVR is a fundamental component of borrowing to purchase property and lenders use this as a key measure to assess risk, when deciding whether to or not to approve a home loan. The general principal is that the higher the LVR the more risk there is to the lender in the event of market fluctuations and in particular, market declines. Each lender is different in their treatment of LVR and the correlation between LVR and assessment rates is an important one to understand.
  5. How will risk be factored in the future? Banks have started to price loans based on risk: the riskier the loan, the higher the rate. With open banking and credit scoring, moving to a system where the products and pricing available are based on your loan to value ratio and credit score will only become more prevalent in the coming years.
  6. The interaction of variable and fixed rates. Lenders often base their assessment rate on the rate that you’re actually going to be paying on the loan. But what happens if a portion of your loan is fixed? Will they take the lower or the higher rate? Will each loan have a different assessment rate? Or the rate that you will pay at the end of the fixed rate period?
  7. How times have changed. Take a stroll with the Property Planner and Professor down the memory lane of how mortgages were approved in the 80’s and 90’s. Much has happened since then,the advent of digitisation and growth of lenders has turned getting a mortgage into a far more complex exercise. Luckily, thanks to Aussie John, you have mortgage brokers that do all the hard work for you!
  8. Stay tuned for part 2 next week! In next week’s episode, the trio will cover variable incomes (which impacts 8 out of 10 people), interest only vs principal and interest and lenders mortgage insurance!


Show notes

  • How much can I borrow? 
  • The first question we often get as strategic mortgage brokers 
  • It’s a vexed question, often nuanced and rarely straight forward 
  • Understanding your own personal circumstances and how it can impact your lender choice.  
  • Broken down into 4 key factors – assessment rates, variable incomes, io vs PI and How LMI impacts purchase price.  
  • Assessment rates 
  • The rate that lenders use to assess your borrowing capacity. This rate is often referred to as the buffer rate or assessment rate because it is higher than the rate you are actually going to pay. 
  • Stress test your ability to make repayments, to account for the following future uncertainties: 
    • Future rate rises 
    • Reduction in income 
    • Unemployment or changing jobs 
    • Illness 
    • Divorce 
    • Expected events like having children 
    • Unexpected events that may happen during the loan term – which can be up to 30 years 
  • Floor assessment rates are mandated by APRA for the banks – this is one of APRA tools that they used when trying to slow down interest only loans or investment loans.  
  • Most lenders will use the higher of: 
    • Your actual rate + 2.5%; OR 
    • Floor assessment rates 
  • Example – Westpac’s floor assessment rate is 5.05%. If we get a rate of 2.74% for owner occupied P&I loan then adding 2.5% will make the rate of 5.24% which is higher than 5.05%. Thus the final assessment rate will be 5.24%. 
  • There are so many different things which go into considering how much can I borrow, which is why keying some details into an online calculator is fraught with danger. 
  • Back in the day 
  • No internet – you’d have to do your calculations on the Casio calculator.  
  • You would have to get dressed up nicely to see your bank manager.  
  • Bank manager was a family friend – came to a birthday party, other functions. Because it was your bank manager who approved the application.  
  • Now it goes to someone faceless to determine if you can afford the loan. 
  • Now computers talk to each other, government departments talk to each other, banks talk to each other. Now we don’t even get the end of year payment summary, the ATO already knows what you earn. Things have changed a lot through digitisation and also deregulation of banking system in late 80’s and 90s.  
  • Back then it was the 4 major banks and now there are 60, we have 40 odd on our panel.  
  • 1999 – Number of lenders then was 15, had to call the banks to find out what their rates and products are, it wasn’t on their website. 
  • LVR – pricing on risk 
  • LVR is the proportion of the loan against the value of your property. Eg: if your property is $1,000,000 and the loan is $800,000 – the LVR is 80%. 
  • Banks have started to price loans based on risk – the riskier the loan, the higher the rate.  
  • Once you borrow more than 80%, you’re paying LMI.  
  • With open banking and credit scoring, your interest rates will more and more be priced on LVR and credit score, rather than being able to choose what loan and interest rate you’re after. This will become much more prevalent in the coming yours.  
  • Loan to Value Ratio (LVR) is a fundamental component of borrowing to purchase property. 
  • Lenders use LVR as a key measure to assess risk for prospective borrowers when deciding whether or not to approve a home loan 
  • The general principal being the higher the LVR the more risk there is to the lender 
  • LVR is defined as the amount you are borrowing expressed as a percentage of the value of the property you are purchasing/own. 
  • For example: Property value is $500,000 and you are borrowing $350,000 then LVR calculation is: $350,000 divided by $500,000 = 70% LVR 
  • The risk levels lenders are prepared to lend within broadly fall in to the following groups: 
    • Low Risk: loans that are <80% LVR 
    • Medium Risk: loans that are >80% LVR and below <90% LVR 
    • High Risk: loans that are >90% LVR and below <95% LVR 
    • Very High Risk: loans that are >95% LVR and below <98% LVR 

  • Assessment of variable vs fixed rates 
  • The lender will base the assessment rates of the rate you’re actually paying 
  • Some will take the higher of the fixed or the variable rate.  
  • Some lenders like ANZ take SVR rates even if the loan is fixed.  
  • And some add 2.5% on the rate.  

Gold Nuggets

David Johnston – The Property Planner’s Golden nugget: When you’re looking to borrow, take the time and listen to and understand the factors that go into your borrowing capacity. If you understand what’s causing the outcomes for you, it can educate and empower you to the lender you select, keeping your advisors more accountable. Ask them to send you a copy of the calculator they’ve completed, a good one will be completing a number of them.  

Peter Koulizos – The Property Professor’s Golden nugget: As you increase your LVR, your interest rate also increases. Don’t hope that you’re going to get a rock bottom interest rate, if you’re planning to borrow more. Go and see your strategic mortgage broker, as it varies from lender to lender.

Market update

  • Sales outweigh listings. Data from Domain shows that for every new listing, there are 1.4 sales. In simple terms, more properties are being sold than put on the market for sale. This spells a challenging buyer-seller imbalance and one that we can anticipate will be exacerbated by the impacts of lockdowns across our nation.
  • Correlating covid cases with housing sales. Interesting data tracking the number of daily covid cases and the number of housing sales in the Northern beaches of Sydney shows that the higher case numbers, the higher the sales volume. Ability to trade during the pandemic is one key factor, but what is causing this buyer demand? The trio question whether it is happening across broader Sydney and whether it is a correlation or merely a coincidence.
  • Sharp decline in ‘Time to buy a dwelling’ index. The Westpac-Melbourne Institute’s “Time to buy a dwelling index” has posted a sharp decline of 8 points from July, down to 88.9 in August. This is the second lowest reading in the last 10 years. The index is a good forward leading indicator of what is likely to happen in the market and suggests owner occupiers are feeling the heat and the market is getting too heady for first time buyers and upgraders. Remember! When the rest of the pack are fearful can be a very good time to buy.

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