How do lenders determine affordability to repay a loan?

A lot of people have their own personal budget in mind and believe that they would have no issues in a certain payment that would fit within their budget. The problem is that lenders have their own calculations, which would sometimes be much different to your own budgeting.

What is not usually taken into consideration is the lenders own serviceability calculations and their standard living expenses based off the Henderson Poverty Index (“HPI”). There is usually a set expense taken away from your after tax income and this would be based on your marital status and/or how many dependents you have.

Some lenders will allow you to mitigate living expenses if you have a working partner, where other lenders will request that the partner apply as a co-borrower if their income is required to show affordability. This can get a little bit confusing understanding exactly how each lender works with their living expense calculations.

What can be classed as income is another important point to make out. If you are a family, you may be earning family tax benefits and each and every lender will determine differently how much of this they would allow as useable income for affordability purposes. This may be the same for other forms of income such as government pensions, superannuation drawdowns, and rental income from investment properties or regular dividends from shares. Incomes such as Newstart Allowance or Youth Allowance are in most cases not acceptable forms of income by most lenders.

The lender will use the total of all your incomes after tax and then subtract all your expenses, including their standard living expense based of HPI. Your expenses would include mortgage/s or rent, other loans, other regular ongoing expenses and your credit card/s.

What a lot of people don’t understand is when your credit card is considered as an expense, the lenders will calculate the expense amount as a percentage of your total credit card limits, even if your credit cards are fully paid. Their reasons for this are that it is still accessible funds to borrow. For example, there is nothing stopping you from fully drawing down your credit cards a day after you take out your car loan, so this is considered in regards to calculating your credit card as an expense.

Once all your expenses including the standard living expenses are subtracted from all of your total income, this will leave you with a surplus. This surplus must be larger than the monthly payment amount in your car loan proposal; otherwise you will not fit the lender’s servicing guidelines.

Some lenders may expect a minimum surplus buffer of $1 and other lenders may require a larger surplus than that. This is where it also gets really confusing unless you understand each and every lender’s criteria. Not only does each lender have a slightly different calculation for living expenses, they may require a larger surplus after car repayment also, so this is when a good qualified professional finance broker can be very useful.

This is why it is very important for brokers to understand your full financial position prior to recommending any lender, as they want to make sure you fit the right lender based off your circumstances, whilst also making sure that they can get you the best deal  from their panel of lenders. There is no use quoting a loan product that you wouldn’t qualify for and capacity to repay is one of the biggest factors taken into consideration.

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