There really is a lot for you to learn
If you are an experienced borrower and are looking for current lender requirements click here. Otherwise for new borrowers who are determined to get a thorough understanding please read on – however don’t forget when we feel sick we all google the symptoms and figure out we must be dying… thankfully most doctors know better, after all that is what they are trained and paid for. Well when it comes to home loans that is all that we do – we aren’t real estate agents or accountants or financial planners – we do nothing but home loans. Best of all the lenders pay us but that doesn’t mean we are tied to any one lender, we have no ties and plenty to choose from so why not save yourself a lot of frustration and let us do what we do best….just give us a call absolutely no obligation.
The Paper Wars
Often first home-buyers (even some second home-buyers!) are overwhelmed and daunted at the complexities of applying for a home loan and it is not just the lenders. Unfortunately much of this is caused by the regulations, laws and procedures that exist to protect you. So we have the banks, mortgage insurers, ASIC, lawyers, various state land titles office, various office of state revenue. This can become frustrating but if you keep in mind that we are not trying to create more work for you or ourselves, we are all simply trying to comply with our license conditions while trying to keep your discomfort to a minimum.
So if you’ve never had much experience in applying for a home loan, this could be a good place to start. In this overview, I provide borrowers with an outline of the lending process pretty much from the ground up – the way it works and why. Hopefully if you understand how the process works, you will be less intimidated and hopefully less frustrated with the outcome.
Having said that, if I need my car repaired I don’t read a workshop manual, I look for a mechanic who I can trust, someone with experience, ability and a who offers a fair deal. If you are looking for home loan then find a mortgage broker who can provide you with good honest advice, based on experience and product knowledge – someone who will offer you a fair deal… someone like us
SATISFYING LENDERS’ CRITERIA
There are several criteria that lenders require applicants with no existing property to meet. These are effectively “hurdles” all of which must be jumped before a loan application can proceed.
1. Serviceability – Lenders have a legal requirement to be satisfied that you can meet your mortgage repayments every time on time – this called ‘loan serviceability’ . There is no single calculation for this as different lenders vary in the range of things they focus on. But in all cases they will base their response on your current and historical pattern of your income/employment. Also keep in mind that lenders cannot use the current interest rate when calculating your borrowing capacity – they must allow for increases and so the rate used will normally be around 1.50 to 2.00 percent above the current average.
If your lender is satisfied that you can afford to repay the loan, then you’ve crossed the first “hurdle” towards a successful loan application.
2. Stable Employment – The second hurdle is to prove that your income level is secure. This can be demonstrated showing continuity of employment history. If you’ve recently changed to a similar job after a long stint in a previous position, that’s fine. But if you’re on probation or have undergone a major career change (from brain surgery to carpentry), lenders may want six or even 12 months of stability. If you’re self-employed or on a contract, lenders take confidence in your future by looking at your past. Most lenders apply the rule of thumb of averaging the income you declared to the tax office over the past two financial years. However if there is a large disparity from one year to the next they will usually take the lower and add 20%. So the ideal situation is 2 years in current job with no wide pay discrepancy from one year to the next. However if you can demonstrate a good stable career path with say no more than 3 employers over 2 years and no significant breaks ( eg 3 months in Europe ) then most lenders will accept 6 months in your current job and/or two years continuous in the same field. If you are on probation then it is less likely that lenders can obtain LMI lenders mortgage insurance and so 80% LVR will be maximum.
3. Security – If the bank is confident that you can service the ongoing loan, there’s still one more hurdle. The property that you purchase is used as the security for the mortgage. This means that the lender holds the title documents until you have repaid the loan. The quality of the security is very important to the lender and so they will pay close attention to the type of building ie: house, unit, studio, farm etc and the location.
Lenders need to consider the unlikely situation of you becoming unemployed, injured or on long-term benefits. The lender needs to be satisfied in this worst-case scenario that they can sell your property quickly for a sufficient amount to recover their loan. So a 3 bedroom house fifteen minutes from Melbourne might sell in 3 weeks where as a 3 bedroom house in Bourke might take 3 years. For this reason on normal residential the base limit is 80% of the property value (known as a loan-to-value ratio or LVR). Where as in other locations where property might not be so easily sold the base LVR may drop to 60% or lower. It is only possible to go beyond the base LVR when lender can obtain lenders mortgage insurance or LMI, – see below for more information.
4. Equity / Savings – This is closely related to security as equity is the difference between how much the property is worth and how much you are borrowing. So for borrowers with no existing property your equity is – your total deposit less costs. Since the mortgage insurers are involved in most loans over 80% ( there are only two insurers at this time in Australia) they want to know if you’re prudent with money or whether you tend to spend everything you get. For that reason, they prefer all borrowers who wish to borrow more than 90% of the value of their property to have shown discipline and saved at least 5% of the value of their property purchase price. Don’t confuse savings with deposit as your deposit may come from various sources such as selling a car, or gift from Mum – while these can be used as deposit they DO NO QUALIFY as genuine savings. Before the GFC home loans were available to first home buyers with no savings at all – the only way that can be done today is with a parent who offers their property as security guarantors.
WHY PEOPLE ARE DISQUALIFIED FROM LOANS
Apart from failing to meet the lender’s criteria as outlined above there are a number of common reasons why lenders decline loan applications from potential borrowers. Being aware of these ’causes of disqualification’ is a critical part of our function as a mortgage broker. However we can only perform that if you are full and upfront with all the information before the application process begins – remember every loan application appears on your CRA (credit report). The main reasons for rejection:
1. Lenders have learned that they must be guided by a borrower’s track record, not by promises of an employment promotion or better business earnings. Usually, this makes sense. However, it can also be unfair on applicants such as those who have been out of the workforce to raise children. Even when employers provide evidence that a job will be held open for the borrower, lenders will often turn them down. Lenders will also often decline those on probation in a job or people who have had several positions over the past 2 or 3 years. In each of these above cases, some lenders are more lenient than others, so it is important to consult with with us before proceeding.
2. Lenders must be satisfied with the property being offered as security – for lenders the ideal property is a middle price range 3 bedroom house in the suburbs – the further you move from that model the less likely you will find a loan. Remember that lenders don’t share in the capital gains of your property – they are only mildly interested in it’s potential and much more interested in its limitations. If a lender is forced to foreclose and sell your property they want to be able to do this quickly and that means they prefer a property that attracts the interest of a wide market. The more restricted the potential pool of buyers becomes the less attractive the property is to lenders. First and foremost it must be ‘residential’ property ie: a place where people will live and by definition this excludes holiday rentals, boarding houses, many serviced apartments, student accommodation etc. Lender’s are also often hesitant to extend finance on an apartment development where they already carry a high exposure. Likewise inner city locations, rural and remote locations will all very probably have restrictions on LVR.
3. A main reason for a loan application being declined is due to a borrower’s credit record. This is not just defaults as every application you for credit shows on your CRA and too many applications for credit/loans over recent years can mean automatic rejection. If you have had credit problems in the past then from the lender’s perspective it’s understandable that they will be hesitant – if you’ve defaulted on a past loan, what’s to say you won’t default on a new one? However, there are traps for everyone here for example we’ve had a loan held up for a client who had been a public servant for 25 years and was only seeking to borrow 56% of the property value because of a disputed bill with a telephone company. He ended up paying the bill just to get his credit record clean so that the loan could proceed. Another borrower was defaulted because he’d lived in a shared house and had gone overseas thinking a bill was being looked after. So be careful. Small blemishes even if they’re not your fault can make lenders shy away – and they stay on your credit record for 5 years.
4. Finally another reason for rejection is ‘failure to disclose’. Lenders take a very dim view of applicants who forget to mention a credit card or who claim their job is full time when it is casual etc. Once a lender finds an omission deliberate or accidental they will then review the application very closely and probably conduct additional checks. Keep in mind that obtaining a loan by deception is not clever, it is very probably illegal.
OPTIONS IF YOUR LOAN APPLICATION IS DECLINED
If a lender declines your application for a home loan, it is worth seeing a broker about your prospects of success with other lenders, or to explore other means of proceeding towards obtaining a home loan. It is important to note that if your loan is declined by the mortgage insurer that decline applies to all lenders using that insurer (there are only two).
Also, see if you can find out why the lender has declined your application. You can try to meet their concerns?
Consider if any parents or family can help with assistance with the loan. But only ask if you’re comfortable in doing so and are confident that you’re not exposing them to any risk.
If your loan application is rejected, it may be best just to wait for a few months until you can better satisfy lenders’ criteria. Having a little longer to build up savings and employment stability may lead to success in the loan application with your preferred lender the next time around.
WHAT LENDERS SEE AS A GOOD BORROWER
Lenders see you as a perfect borrower if the following criteria are met:
- You can show a record of steady employment;
- If self-employed, you can show a tax returns with sound stable income over the past two financial years;
- You are a permanent resident or citizen of Australia
- You have no blemishes on your credit record
- If this is your first home loan, you can show a good track record of saving – at least 5% of the property’s value.
- Existing loans all current with no late payments
LENDER’S MORTGAGE INSURANCE (LMI)
There are two big traps in lender’s mortgage insurance or LMI as it’s known in the industry.
The first is to think that it gives you protection against defaulting on your loan – for instance as a result of redundancy. It doesn’t!
It is, as it calls itself, lender’s mortgage insurance and exists to protect the lender against your default. If you do default and your mortgage has lenders mortgage insurance, then not only will the bank chase you for repayments, but the insurer may do so as well. The choice of insurer for LMI is not yours but the lender’s.
(Mortgage Protection Insurance is a policy that covers you for your mortgage repayments if you are sick, disabled or unemployed.)
The second trap is that, where lenders require mortgage insurance – generally if your loan to valuation ratio exceeds 80% – it is common practice for the lender to issue an ‘approval in principle’ before LMI has been obtained. Accordingly where approval in principle has been given but LMI is subsequently declined, the approval in principle cannot proceed to unconditional approval and the approval is then revoked. So if you require LMI don’t take the lender’s ‘approval in principle’ as anything more than one hurdle on your way to unconditional approval. Even if your valuation comes in OK, you can still be declined if LMI is declined. So be aware of this trap.
Note: There are only two major LMI providers in Australia. LMI agreements with each of them vary only very slightly from one lender to another but the conditions each provider requires do vary somewhat. So if you are knocked back by the LMI with one lender you may have a chance with another lender that uses the other provider. As brokers, we are aware of which insurers each lender on our panel uses and so may be able to assist you decide which LMI provider, and so which lenders would consider your application most favourably.
The fee for Lenders’ Mortgage Insurance is paid by the borrower as a once only fee at loan settlement and varies depending on the value of the property being purchased and the size of the borrower’s deposit. This is a graduated scale increasing on both property value and percentage borrowed so on a $500,000 loan at 85% the premium may be $5,500 whereas on a 95% LVR at $500,000 a premium of $13,400. LMI is more difficult to obtain and more expensive for loans of $1 million.
The insurers place various conditions on applications and among these are length of employment, income tests and deposit conditions. For example if your deposit is from the sale of a house, you will be expected to show evidence of this. If it is from savings, you will again be expected to establish that you have saved that amount over a minimum three months. They also restrict maximum lending (LVR) into various locations. For example, regional centres are typically 90 to 95%, while smaller centres may be 85%, and inner city may be 65%. It is important to keep the LMI policy in mind, as this almost always over-rides the individual lender’s policy. –
TYPES OF INTEREST RATES
Loans come in a variety of guises. However the loan types shouldn’t be confused with the Interest type. Interest types are;
- principal and interest (P&I) – here your loan payment covers the interest charge plus some of the original loan amount. Thus reducing the loan balance over the life of the loan;
- interest only (IO) – whereby you agree to pay only the interest charge for a specified period, typically 5 years. Most loans (except most lines of credit) revert to P&I after some period. Note some lenders use ‘interest based’ which unlike interest only means you continue to pay the same monthly payments even if you have reduced the balance of the loan. In this case the loan is effectively P&I
- variable home loans – whereby the interest rate charged moves up and down in line with certain indicators, typically the Reserve Bank Cash Rate. So if the Cash Rate increases .25% then you can expect your home loan rate to increase by approximately the same amount .25% (though from time to time lenders do take changes in rates to disguise their own increase in margins – or highlight their reduction in margins.). Some rates are based on other indicators and you should understand the implications of this;
- fixed interest rate loans – which lock you into a given rate for a specified period, typically between 1 & 5 years – though if you want longer periods (up to fifteen years) we can arrange them for you. So even if the variable rate increases by 5% you are protected and pay the rate you agreed at the outset until the end of the fixed rate period. However you are locked in, if the variable rate decreases by 2% and in these situations it can be very expensive to ‘break’ your fixed loan.
So it is possible to have a mixture of the above eg: Fixed for 3 years with Interest Only or 25 years variable with Principal & Interest and almost any combination even part fixed and part variable (sometime referred to as a split).
TYPES OF LOANS
Competition in the market place has not only seen lower margins for lenders, but a greater diversity of features and additional benefits being offered to attract your business. Superficially this would appear to be beneficial for you the borrower. However the features, discounted rates and variations in fee structures often simply make it much more difficult to do direct comparisons between products.
Offset accounts coming with claims such “pay your loan off quicker” are common place and often they are quite incorrect, especially if you are paying higher interest rates or ongoing fees to obtain the so-called benefit. For example, on a $100,000 home loan a $300 annual fee (typical to most professional packages) is the equivalent of .30% in additional interest rate. So a 6.70% rate with a $300 annual fee is actually 7.0% on a $100,000 loan.
A line of credit (LOC) is essentially a perpetual interest only loan – although by its very nature there is nothing to restrict you reducing the principal at any time either by lump sum or just monthly salary deposits. Thus if you have a line of credit for $300,000 on which you owe $250,000, you only pay interest on the $250,000 you have drawn.
All-in-one accounts are usually a single home loan account that allows direct salary deposits and some withdrawal functions – these are often limited to a few ATM or transfers per month and a linked credit card account. The potential savings are similar to the above however be aware that some accounts are so limited you may need a standard transaction account – and fees if applicable must be taken into account when comparing products.
There are some basic loans being offered that provide free unlimited redraw and unlimited principal reductions. So theoretically you could pay your salary into the loan account and withdraw as you require the funds or by using your credit card for monthly expenses then make an end of month payment into your credit card. So a loan like this can act very much like an all-in-one account, although you have to consider possible credit card and transaction account costs.
Finally, remember that many of these accounts require you to exercise discipline in their use, if your long term ambition is to repay your loan principal.
Now that you understand more about home loans click here to continue to learn about the actual application procedure
The Perfect Borrower
It’s not that you have to be perfect but understand that the further you move away from the following model the less appealing you gradually become to lenders. So Mr or Mrs Perfect are:
- between 30 and 45 years old
- stable residential history
- buying a 3 br house 8 to 20 kms from the CBD
- working for known employer with good future prospects
- at least 2 years in current job
- stable, reliable base income that does not rely on bonuses or overtime
- good savings or past loan history
If you are under 25 or over 65 then of course you can still get a home loan however your chances of ticking all of the boxes reduce slightly. Likewise a 2 br unit is fine where a 1 br CBD unit can be a big problem or on the other hand a 50 hectare block with a shed just won’t cut it. There is no single cut off point it is the overall picture that matters. Some lenders are better than others when it comes to exceptions or unusual circumstances and it is our job to know that. Why not give us a call to discuss your situation.