Home Loans: Here’s How to Make Sure You Don’t Borrow More Than You Should
When it comes to securing a home loan, a lender looks at facts to determine what you can afford. But, you are the only person who truly knows what you can manage financially. Therefore, it is vital you crunch the numbers yourself, before applying for a home loan. This way you’ll avoid getting yourself into a sticky financial situation.
How Lenders Assess Loan Eligibility
Most lenders want to see records of income, assets, and debts. Thus, they’ll require proof of income and want to know what property – dwellings, land, vehicles, and household goods – you own. Also, they’ll want to see what you owe on personal loans and credit cards. Why? Well, these factors enable them to determine your borrowing power. Plus, they can also decide if you are a high or low-level risk.
The central questions a lender needs answered include:
- Loan serviceability – can you afford to repay the loan without any financial hardship?
- Financial information verification – is all information you’ve submitted true and accurate?
- Credit history – are you able to manage your finances well over time?
- Loan to value ratio (LVR) – is the property you want to buy worth more than the amount you’re borrowing?
When accessing your ability to repay a mortgage, a lender typically applies a higher interest rate to your loan repayments. This process ensures if rates rise you’ll be able to manage home loan repayments without financial hardship. For instance, let’s say you apply for a 4.4% loan, then a lender will apply a rate of 6.4% to make sure you can afford the loan repayments.
Do All Lenders Assess Loans the Same?
The Consumer Credit Code governs all lenders, which the Australian Securities and Investments Commission (ASIC) regulates. Under this code, lenders must ensure that you or any other borrower can repay their loan. This code also ensures lenders disclose your rights and responsibilities under their credit arrangement. Also, they must truthfully reveal all contract information – interest rates, fees, and commissions.
However, the Australian Prudential Regulation Authority (APRA) also govern banks. Therefore, they are subject to another set of lending risk criteria that needs meeting to gain loan approval.
Can You Borrow More Than You Can Afford?
In a lending review, ASIC found mortgage broker home loans had bigger LVRs than lender direct loans. The ASIC review also found a high number of loans were equal to the Household Expenditure Measure (HEM) benchmark. As a result, some borrowers were just within their financial means. So, they had little residual income should anything unexpected occur financially.
A recent home loan survey also found a quarter of respondents presented ‘mostly factual and accurate’ applications. The most common underestimation given in a loan application was living costs. Other understated expenses included debts. Some loan applicants also admitted to overstating income or assets, which accounted for 15% of misrepresentations.
Based on this information, then yes, it is possible to borrow more than you can afford. Thus, it’s vital that you give accurate information when applying for a loan, and that you consider your financial circumstances.
How Can You Safeguard Against Borrowing Too Much?
There are a number of ways you can ensure you don’t borrow more than you can afford. These are as follows:
- Write down your income and expenditure – be realistic and write down exactly what you spend weekly. Include eating out, buying coffee and lunch, groceries, car costs, school fees and insurances, as well as entertainment costs. Then deduct these expenses from what you earn to calculate your residual income. Can you afford to service your mortgage?
- Estimate home loan repayments – calculate what your actual home loan repayments will be per month. Next, add an extra 2 to 3% to the repayments. This increase allows you to see if you can still afford the mortgage if rates rise.
- Factor in home buying costs – when buying a home many of us just think about the purchasing cost, and home loan repayments. But, there are more costs than this when it comes to home ownership. Added costs include council rates, water use, emergency services, stamp duty and conveyancing fees. Collectively these can add thousands per year to the cost of home ownership making it harder to manage mortgage repayments.
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