Home loan serviceability: What is it and how can you increase yours?

Calculating your home loan serviceability.

When taking out a home loan, the amount a bank or lender will grant you will depend on a few things. Along with your loan to value ratio (LVR) and credit score, you’ll also likely hear the term “serviceability” pop up. But what does serviceability mean, and why is it so important?

Home loan serviceability meaning

When a bank calculates your home loan serviceability, they are essentially stress-testing your ability to pay off a mortgage. They do this by looking at your income and expenses (among other factors) to determine how much you could comfortably afford to pay. 

Based on this information, banks will generate your debt service ratio (DSR). This is how much of your monthly income you can expect to go towards "servicing" or paying off your debt, expressed as a percentage.

While there’s some flexibility when setting serviceability floors, banks will generally err on the side of caution. That’s because the Australian Prudential Regulation Authority (APRA) holds banks to strict standards to ensure they’re not issuing loans to borrowers who can’t afford them.

How is home loan serviceability calculated?

When determining your ability to service a home loan, banks will take your after-tax income and subtract expenses and any other liabilities, such as credit card debt or money owed on another loan.

Banks will also add a 3% buffer to your home loan interest rate to accommodate any future rate hikes. That means if you sign up for a $500,000 loan with an interest rate of 5% p.a., you’ll be assessed on your ability to pay off that same loan at 8%. 

Before July 2019, lenders would use a minimum interest rate of at least 7%, but this was deemed needlessly high and amended to better reflect the current interest rate environment. Nowadays, lenders are advised to add a margin of at least 3% to a loan’s rate.

How is income assessed for your home loan?

The amount of income you earn in a year is pretty high on the list of things lenders look at. Essentially, all they are looking for is a consistent salary over a stretch of time. But how your income is assessed isn't always clear cut, especially if you work overtime or freelance. 

Those who work in emergency services can generally expect to have overtime payments included in their serviceability assessments. But for professions where overtime payments aren’t so frequent, or aren’t as integral a part of the job, lenders might consider them at a reduced rate.

Restrictions will also apply to any income you receive from second jobs. For example, if you freelance or work in the gig economy to supplement income from your main job, any money you earn may only be considered if you have held the job continuously and for a certain period of time.

As for income from rental properties and investments, lenders will apply a buffer to account for any vacancy periods or fluctuations in the market, meaning that any money you receive from your portfolio will only be partially assessed.

RELATED: CommBank, Westpac, and NAB just lowered their serviceability tests for refinancers

How can you increase your home loan serviceability?

How much you can borrow for a mortgage will ultimately depend on your lender and the criteria they use to test your serviceability. However, there are still strategies you can take to put your best foot forward.

Here are the main ways you can increase your home loan serviceability:

  • Increase your income
  • Reduce debt
  • Reduce your expenses
  • Lower your credit limits

Lenders don't want their loan competing with other claims on your hard-earned income, so the more financial wiggle room you can demonstrate, the better. Otherwise, you might unintentionally look like a home loan red flag

Let's explore why each of this tactics could work.

Increase your income

The most obvious way to increase your home loan serviceability (though by no means the easiest) is to increase the amount of money you earn. You could do this by asking your employer for a pay raise, applying for a higher paying job, or even taking on a second job.

Reduce your expenses

Lenders will scrutinise your spending habits over the three months prior to applying for a home loan, so if you want to boost your borrowing power, you’ll have to rein in any unnecessary purchases and show you can be responsible with your money.

Reduce debt

If you have any existing debt, try to pay it off as soon as possible. If you’re not sure where to start, identify which debt is accruing the most interest and tackle that one first.

Lower your credit limits

When determining your serviceability, lenders will usually calculate your minimum monthly repayment at 3% of your approved credit card limit. High credit limits don’t go over well, so try to reduce them where you can. And if you have any unused cards it’s a good idea to cancel them too.

Borrow with another person

Whether it’s with a partner, a parent or a friend, you’ll have an easier time applying for a home loan with another person than if you’re borrowing solo.

If you’re thinking of taking out a loan, use our home loan borrowing calculator to get a rough estimate of your borrowing power based on your current income and living expenses. And if you’re wondering where rates currently sit, browse our home loan comparison page for an idea.

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