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Going through the loan application process can be an exciting and challenging time in your life. Whether it’s for a personal loan, car loan or mortgage, there are many things a lender must consider when it comes to assessing your application and whether they are happy to approve your loan.
Lenders consider much more than your income and deposit when it comes to deciding if they’ll lend to you. Here are some of the things you can expect a lender to look at when assessing your loan application.
Your ability to service the loan
First things first, lenders are going to look at your ability to repay or 'service' the loan you’ve applied for. Lenders look at your employment history and salary as the main pillars when assessing whether you’re in a position to be able to comfortably service a loan. This includes looking at all aspects of your employment, such as whether you’re in a full time or casual position, how much steady income you bring home, whether you receive other variable income such as overtime, allowances, bonuses and commissions and how long you’ve been in your current role.
The other part of your serviceability is considering any other current commitments you may have. These could include car loans, credit cards, personal loans, other home or investment loans, etc.
With this in mind, consider what your other monthly repayments are. Do you have any dependents? Do you have any outstanding debt? These are all questions lenders will take into consideration.
It may surprise you, but lenders do not use the actual repayments or interest rate when working out whether you can afford a loan.“Typically, lenders add on a buffer to your interest rate when assessing your application which is referred to as an assessment rate,” says Inovayt Mortgage Broker Melbourne, Justin Coughlin.
“Lenders factor in a buffer of at least 2.5 per cent above the actual interest rate to ensure you can still afford the loan repayments if interest rates were to increase in the future. For example, if you’re applying for a home loan with an interest rate of 2.5 per cent, the lender will assess your ability to service the loan at a rate of at least 5 per cent.
Justin describes this process as, “the bank taking a holistic view of your household income and expenses and assessing your ability to make the proposed loan repayments.”
“If you can’t show that you can make these repayments, you can't qualify for a loan. Alternatively, if you have a good income and minimal other debts you're on the right track.”
Deposit amount
The next thing that will be scrutinised on your loan application is your deposit amount – that is, what savings you have to contribute. “The deposit amount and how that influences the loan-to-value ratio (LVR) is an important part of your application. If the LVR is over 80 per cent, you will potentially incur an extra cost called Lender’s Mortgage Insurance (LMI) as you don’t meet the 20 per cent deposit threshold required to avoid it,” says Justin. When it comes to home loans, a bigger deposit may show lenders that you have the financial discipline required for a mortgage. It is possible for lenders to approve you for a loan with as little as a 5 per cent deposit, however the closer your deposit is to 20 per cent, the less you will need to pay in LMI.
Check out our blog to find out How Much of a Deposit You Should be Aiming For.
Financial history and credit score
Your financial history and credit score will also play a part when it comes to your loan application approval. Any outstanding defaults, large debts and bankruptcies can cause potential red flags on your application process, as well as a low credit score. These will help the lender assess whether they are comfortable lending to you based on where you are in your financial journey.
On a positive note, if you have current loans and the lender can see that you have been making your repayments on time every month over the last few years, this will increase your credit score and demonstrate that you are good at managing your money.
Read our blog for advice on whether you can get a personal loan with poor credit.
How to prepare for your loan application
It can be intimidating when preparing to submit your home loan application. Here are some things you can do to put yourself in the best position to obtain approval on your loan.
1. Check your credit score – Your credit score is going to give you the best indication as to where you sit financially. You can check your credit scores on sites such as Equifax and ClearScore. Equifax defines an average credit score as 622-725 and a very good score as 726-832. Check what your score is, and you’ll get an understanding as to whether you’re on the right track to be approved for a loan.
2. Assess your financial situation and any outstanding debts – Be realistic when looking at your financial situation. Look at any outstanding debts you have and see whether you can pay these off or consolidate them into one. Consider culling any subscriptions you don’t use such as streaming services, gym memberships and buy now pay later programs, too.
3. Prepare your paperwork – All lenders are going to request paperwork, so it doesn’t hurt to get yours in order. Have on hand acceptable forms of ID, payslips from the past three months, evidence of savings in your account, and all statements of current debts you have such as car loans and HECS/HELP debts.
4. Consider other costs involved – Applying for a home loan is a huge process, and there’s so much more when it comes to up-front costs than just the deposit. You will also need to consider lenders mortgage insurance (LMI) if your deposit is less than 20 per cent along with stamp duty, legal and conveyancing fees and other costs associated with moving.
5. Obtain pre-approval – If you are on the hunt for a property, obtaining a pre-approval is something real estate agents will look at favourably when submitting offers on properties. Being pre-approved for an amount means you have gone through the initial home loan application process, and the lenders can give you an idea of the maximum amount you can borrow. This is not formal approval which you will need to obtain after finding a property.
As we've covered, there are many things a lender takes into consideration when it comes to assessing your loan application which is why it's important to be working a professional mortgage broker that understands how each lender will assess your specific situation. Each person's financial circumstances are unique and therefore it’s important to consider your own position when deciding what is right for you.
