Home loan serviceability: What is it and how can you increase yours?
Lenders look at all sorts of criteria when you apply for a home loan so that they can assess whether you’re a good fit for their product. This can include your loan-to-value ratio (LVR), credit score, borrowing power, as well as something called home loan serviceability.
But what does serviceability mean, and why is it so important?
What is home loan serviceability?
Serviceability in home loans refers to your ability to afford a mortgage. When a bank calculates your home loan serviceability, they look at your income and expenses (among other factors) to determine how much you can 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.
Why is serviceability important?
Banks do this so that they can limit their risk exposure.
For example, if you borrow money from a lender to buy a home, but you aren’t able to repay it, resulting in default, your lender will be forced to sell your home to recover their costs. In this respect, they will have missed out on the profits that they receive from lending you money, in the form of interest repayments.
In short, banks work out your home loan serviceability to see if you’re a safe bet.
Lenders generally err on the side of caution when setting their serviceability tiers. This is due to the Australian Securities and Investments Commission (ASIC) holding lenders to strict, responsible lending standards , to help ensure they’re not issuing loans to borrowers who can’t afford them, or engaging in predatory lending.
How to calculate home loan serviceability
To calculate serviceability, lenders may subtract your monthly living expenses from your monthly, after-tax income to find your net income surplus.
They then take your net income surplus and divide it by the monthly cost of your debt commitments (e.g. credit card debt or personal loans) and your projected monthly repayment amount to find your net serviceability ratio.
However, it’s important to remember that each bank or lender can calculate mortgage serviceability differently, depending on their lending criteria. This means one bank might judge that you can afford to service a $500,000 home loan, while another would only lend you a maximum of $475,000.
Banks will also add a 2.5 to 3% buffer to your home loan rate, in case of future interest rate rises. 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%. Again, this comes back to lenders limiting their exposure to risky investments.
As mentioned earlier, lenders use different criteria to calculate mortgage serviceability. So, it’s hard to know precisely what the bank will lend you. However, you can estimate your borrowing power (i.e. how much a bank may agree to lend you) using a borrowing power calculator.
How can you increase your home loan serviceability?
Despite lenders having different serviceability criteria, there are a few steps you can take to improve your serviceability ratio in general, which includes:
- Increasing your income
- Reducing your debt
- Reducing your expenses
- Lowering your credit limits.
This is because lenders want to see as much financial wriggle room as possible, to help put their minds at ease about your ability to pay off your loan.
Let’s go into more detail about the steps you can take to improve your serviceability.
1. 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.
2. 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.
3. 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.
4. 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.
5. 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. Look into whether a home loan guarantor is the right move for you.
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.
What is the difference between serviceability and borrowing power?
In home loans, serviceability is determined by your income and expenses. Mortgage serviceability mainly focuses on your ability to afford the monthly repayments on a certain sized loan. Borrowing power, on the other hand, is all about how much you can borrow at any given time. Borrowing power focuses on your available capital – in other words, your income, savings, and equity.
* WARNING: This comparison rate applies only to the example or examples given. Different amounts and terms will result in different comparison rates. Costs such as redraw fees or early repayment fees, and cost savings such as fee waivers, are not included in the comparison rate but may influence the cost of the loan. The comparison rate displayed is for a secured loan with monthly principal and interest repayments for $150,000 over 25 years.
** Initial monthly repayment figures are estimates only, based on the advertised rate. You can change the loan amount and term in the input boxes at the top of this table. Rates, fees and charges and therefore the total cost of the loan may vary depending on your loan amount, loan term, and credit history. Actual repayments will depend on your individual circumstances and interest rate changes.
^See information about the Mozo Experts Choice Home Loan Awards
Mozo provides general product information. We don't consider your personal objectives, financial situation or needs and we aren't recommending any specific product to you. You should make your own decision after reading the PDS or offer documentation, or seeking independent advice.
While we pride ourselves on covering a wide range of products, we don't cover every product in the market. If you decide to apply for a product through our website, you will be dealing directly with the provider of that product and not with Mozo.