When you apply for a home loan, lenders will look at both your income and your expenses when determining how much they are prepared to lend you.

Your ability to pay off a loan is known as your serviceability – your ability to service (pay off) the debt to the bank.

When you apply to a lender for a home loan, they will not use the actual interest rate on the home loan to do their serviceability calculations. They use what is called an assessment rate.

An assessment rate is generally 2.5% higher than what the standard variable rate might be, and it is a safety buffer of sorts for the lender.

This assessment rate is also used as a tool by regulators (such as APRA), to limit borrowing when they feel house prices are rising too quickly.

Example:

A borrower who is seeking to take out a $500,000 home loan, at an interest rate of 3%, will be required to make repayments of $487 per week on a 30-year P&I loan.

However, the lender will assess their application at a higher rate, say 5%, meaning they would actually need to be able to afford $620 per week, based on their income and expenses.

On top of this, lenders will also take a borrower’s debt-to-income ratio (DTI) into account. Your debt-to-income ratio measures your total debt, including all credit card limits, compared to your before-tax income.

For a couple, this would be a combination of both of your gross incomes and debts. Generally, a DTI of 6 is acceptable, but above 7, it becomes increasingly difficult to obtain a loan, and lenders will scrutinise the application closely.

Example:

If you earn $100,000 per year in income before tax, lenders will want to see that you are holding less than $600,000 in total debt and credit card limits combined.

Income includes your salary or income from your business, current rental income, and any future rental income from an investment property.

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