What is serviceability?
Serviceability, an essential part of the home loan approval process, is a lender-specific calculation of borrower capacity to repay a proposed home loan.
Lenders apply their own policy standards against your income, expenses, and debt obligations to calculate how much cash is available for the new home loan repayments.
Importantly, just because a loan may seem affordable to you, a lender may not calculate your serviceability the same way.
As a mortgage broker since 2008, I know that serviceability results can vary widely among lenders which makes it confusing for borrowers.
The main reason for lenders to differ in serviceability results is they apply their own policies and standards to their own serviceability calculators.
In many cases, you can pass a serviceability test at one lender and fail at another.
The question of serviceability is not around whether you can afford the loan, but:
Can you prove affordability on the lender’s terms?
In this article I get into the weeds on serviceability and take you through 17 different ways a borrower’s serviceability can be impacted. Some you can control and some you cannot.
What I cannot do is provide a generic serviceability calculator when each borrower scenario differs—as does the lender perspective. Lenders design their own serviceability calculators for their own assessment needs. Mortgage brokers know that. This is why mortgage brokers are well placed to assist both existing and new borrowers.
Why does serviceability exist?
Banks perform a serviceability test for two main reasons:
- Ensure they lend in a responsible manner as required by law.
- Ensure any home loan approvals fit within their own risk appetite.
How does serviceability work?
I have conducted thousands of serviceability assessments for lenders over my mortgage broking career.
I have two main points for readers:
First – Understand that is an essential test in the home loan approval process.
I do not remember a loan being approved that did not pass the lender serviceability test – consider it non-negotiable.
Final – While it is helpful to know what can move the needle for serviceability, going too deep too early can get you side-tracked.
I recommend using a mortgage broker. They establish your needs and objectives as the priority. The good ones conduct serviceability assessments PRIOR to submitting your home loan application.
Calculating serviceability
To calculate serviceability, a lender performs the following calculation to work out the surplus income available for a proposed home loan.
Serviceability calculation
Incomes – from employment, business, investments
less
Living expenses
less
Ongoing commitments including any existing loan repayments
equals
Surplus for new loan repayments
Lenders might change the numbers for each category of income and expense to align with their own policy, which means some figures used in the calculation will not be the same as actual.
For example, commission income may be an accepted, but only 80% used in a serviceability calculation as it is less certain than a base wage.
This is where differences in lender serviceability calculations can be stark – and confusing for borrowers.
Once the lender figures out the surplus amount remaining for the proposed home loan repayments, they can finalise their serviceability assessment.
Serviceability results
Numbers are numbers and they do not always tell the full story. So, calculating serviceability can yield different types of answers, depending on the lender.
Even if a borrower shows a capacity to repay the proposed loan repayments, they could still fall short in other areas of serviceability.
My recommendation is to know serviceability is a thing. You do not need to understand it. That is what brokers are for. I introduce borrowers to brokers.
Below are three measures I commonly see in lender serviceability results.
Surplus
A ‘pass’ result needs to show the borrower has leftover funds each month after allowing for the proposed loan repayments. Some lenders want to see a surplus that is greater than “just affording the loan”. Instead of eeking out a $1 per month surplus, some lenders need a defined surplus amount, say $300 per month. This provides an extra buffer for scenarios they consider higher risk.
Debt servicing ratio (DSR)
Debt servicing ratio (DRS) gives lenders a feel for the proportion of income, after living expenses, required for debt commitments.
Instead of defining a surplus dollar amount required, lenders can use a ratio. Technically, a ratio over 1.00 means a borrower demonstrates a surplus. However, sometimes a lender can require a higher DSR, say 1.15, if they consider the application higher risk. I have seen higher DSR’s used in applications involving foreign income currency.
Debt to income (DTI) ratio
The debt to income ratio (DTI) provides an indication of overall lending exposure for the borrower. The “debt” usually includes all debt: credit cards, existing and new home loan to name a few.
If a borrower demonstrates a surplus on a serviceability test, a lender can still decide they are carrying too much debt as a proportion of their income—although borrowers may sometimes disagree!
There is only so much debt a lender is willing to be party to.
A high DTI may not necessarily lead to a declined loan application, but it often prompts a closer look at the proposal. A DTI of 6 is considered high.
Serviceability vs Borrowing capacity
While serviceability deals with the calculation of lending capacity for a specific scenario, borrowing capacity is a more generic indication of an amount you could borrow, based on some estimates.
All things being equal, you should pass a serviceability test provided it falls within your borrowing capacity.
The lender-specific nature of serviceability calculators usually means results differ across lenders for the same borrowing scenario.
Below is a real servicing capacity extract showing how lenders differ in the amount they could lend for the same scenario. Lenders can be close—but rarely the same.
Results can vary
Serviceability results reflect lender policy. So, unless lenders share the same policies, serviceability calculations will likely differ.
These figures show some variance, but I would not consider it overly significant. This application was fairly standard, if there is such a thing. It had a reliable base income, a credit card, and not much else.
We see more variance between lenders when borrowers present with uncertain income sources like bonuses, foreign income, or are self-employed. Different approaches to serviceability can mean serviceability passes (approval) fails (decline), depending on the lender.
What impacts serviceability?
A much shorter list would be if we asked what doesn’t impact serviceability….
I have put together a list of 17 ways serviceability can be impacted. Some you can control and others you cannot.
Note: As with all things banking, this is a general guide and not advice to be acted on. See a mortgage broker for advice specific to your situation.
BORROWER
- Credit score
A good credit score can improve servicing capacity as low credit scores can attract extra servicing buffers, like requiring larger surpluses.
INCOME
- Income – Base salary
Base salary for permanent employees is considered a very reliable income source, so packs more servicing punch than less certain incomes. The higher the based salary income, the better from a servicing point of view. - Income – Variable
Think variable incomes – commission, bonus, overtime, etc.
Not all lenders accept 100% this income, some may not accept it at all, which can reduce your servicing capacity. If you intend relying on this income for loan repayments, you may need to find a lender with a policy to match. - Income – Self employed
I often hear people say self employed income makes home loan approvals difficult. Yes, self employed incomes can be negatively impacted on serviceability calculations – but not at all lenders. Mortgage brokers can offer great value in this space because the serviceability treatment of self employed borrowers is so varied. - Income – Foreign
Of the lenders that accept foreign currency income, there can be differing views on the strength of each currency. Serviceability calculations will have various built-in buffers to accommodate the currency risk for foreign income.
EXPENSES and COMMITMENTS
- Existing property loans
Provided these home loans still serve a purpose and is part of your overall plan, it might be worth re-looking at the loan structure to ensure it does not impact your servicing. Sometimes a refinance home loan can improve your serviceability for any new lending. - Living expenses
Some living expenses are non-negotiable, like groceries. You cannot pretend they are not there. Others living expenses are very discretionary. The higher your living expenses, the more it will negatively impact your servicing capacity. Consider what you really need to afford a reasonable lifestyle when working out living expenses. - Other commitments
If you have ongoing expenses already committed to, these can detract from your surplus income and reduce servicing capacity. Some commitments like child maintenance payments can be unavoidable. Others, like car leases, could be an optional expense that will impact servicing negatively. - Personal debt
Think credit cards, store cards, personal loans and even HELP/HECS debt. Each of these can eat into any surplus you might need for your new home loan repayments. The lower your personal debt repayments the more debt you should be able to service.
A quick tip on credit cards, the higher the credit limit, the less you can usually service, even if you pay it off every month.
HOME LOAN
- Home loan purpose
Rates for investment are often higher than owner-occupied but when you add rental income and, in some cases negative gearing benefits, servicing capacity can outweigh that of an owner-occupied home loan. - Interest rate
Interest rates can increase or decrease over time, so when searching for a home be mindful that serviceability can change with rate movements. - Lenders mortgage insurance (LMI)
Loans that require LMI are considered higher risk, so often have more buffers built into servicing calculations than non-LMI loans. - Loan terms
A longer loan term of say 30yrs, can show a higher servicing capacity than a 20yr loan term. - Loan to value ratio (LVR)
The lower LVR the better. Higher LVR’s are considered a higher risk loan so serviceability can be reduced due to:
– Higher interest rates
– Extra surplus required
– Higher debt servicing ratios (DSR)
– Strict debt to income (DTI) measures - Ongoing fees
Ongoing home loan fees are not repayments, so reduce servicing capacity. - Property type
There is standard property that lenders like—so put less obstacles in the way of approval. There are non-standard properties too, like student accommodation. These can attract higher serviceability hurdles. These hurdles are in place so lenders approve only the strong borrowers. - Repayment type
A P&I repayment feature should produce a higher servicing capacity than interest only loans. - Standard home loan vs Line of credit
Home loans will generally service better than a line of credit. A home loan is usually a lower rate with repayments calculated over a longer term, giving greater servicing capacity.
FAQs
What are interest buffers?
Australian banks get risk-guidance from their regulator, the Australian Prudential Regulation Authority (APRA), which recommends adding about 3.00% on top of the interest rate when performing serviceability calculations. I say ‘about’ because the buffer amount can change.
The interest rate buffer is designed to test if a borrower can withstand significant interest rate increases.
Even if you have a fixed rate home loan to help with certainty of repayments, Australian lenders do not offer fixed rates for the entire loan term. Borrowers commonly fix loans for up to five years and should be prepared for a new rate when the fixed rate ends.
Does serviceability change over time?
Part of understanding your servicing capacity, is that it can change—sometimes dramatically.
Here are some borrower-specific changes that can impact servicing:
- Job changes
- School fees
- Taking our personal loans
There are also changes outside borrower control like:
- Interest rate movement
- Bank policy changes
- Regulation changes
Final word
A successful home loan approval process relies on a positive serviceability result. Lenders use serviceability calculations to help them get a full picture of a home loan application.
This article has explained the principles of how lenders calculate serviceability. I covered the main impacts on servicing I have seen in my mortgage broking experience, including some borrowers can control.
Borrowers should work with their mortgage broker to understand the impact any financial changes have on serviceability capacity (positive or negative). This is particularly important in the lead up to a home loan application as some financial choices are difficult to undo.
Mortgage brokers keep the goals and objectives of the borrower central to the process, rather than get distracted by serviceability.
Remember, you do not need to understand all the ins and outs of serviceability calculators. A mortgage broker can do this for you.
