A word about lenders

Just as you would be if you were lending your money to a total stranger, lenders are very cautious. Remember, even if your house soars in value, there's no big upside for your lender in backing you. They will only ever get their money back plus a competitive interest rate. Lenders never want to lose their money but in today's economic climate, they can ill-afford a bad loan and even less the bad publicity of a foreclosure. So that's why they err on the side of reducing their risk and so impose strict lending criteria.

SATISFYING LENDERS' CRITERIA

There are five main criteria that lenders require first-time loan applicants to meet. These "hurdles" all must be jumped before a loan application can proceed.

1. First and foremost you must be an Australian citizen or permanent resident living in Australia. Australian expats living and working overseas can usually (dependent on location) borrow 80% and in some cases up to 90%. If you are on a spousal/partner visa there are some options to borrow above 80%. Overseas borrowers and temporary visa holders with stable employment can borrow up to 80% from some lenders.

2. To be satisfied that you can meet regular mortgage repayments, lenders want to know that your income stream is adequate. (A very rough guideline is that your income is seen as adequate if your repayments can be met from 35% of your income, but lenders will look at things more closely than this). Pay no attention to online calculators even if they are on the lender's web site, they are more focused on generating an inquiry than giving you accurate information. If your lender is satisfied that you can afford the calculated repayment level, then you've crossed the first "hurdle" towards a successful loan application.

3. The second hurdle is to prove that your income level is secure. This can be demonstrated by a borrower's continuity of employment history. If you have recently changed to a similar job after a long stint in a similar position, that's fine. But if you're on probation or have undergone a major career change (from brain surgery to carpentry), lenders may want to wait 6 or even 12 months. If you're self-employed or on a contract, lenders take confidence in your future by looking at your past. Most lenders apply the rule of thumb of averaging the income you declared to the tax office over the past two financial years.

4. If the bank is confident that you can service the loan, there's still one more hurdle. They consider the unlikely situation of you becoming unemployed, injured or on long-term benefits. The lender needs to be satisfied in this worst-case scenario that they can sell your property for a sufficient amount to recover their loan. They obviously don't want to wait for 12 months for the market to improve and as such, they are usually comfortable with lending up to 80% of the value of a normal residential property. This is known as a loan-to-value ratio (LVR). It is possible to increase the borrowed proportion up to 95% LVR for an owner-occupier if the lender takes out lenders' mortgage insurance, at a cost of between 1% and 3% of the property value paid for by you - see below for more on LMI.

5. Finally the fifth criterion mainly applies for first home-buyers or borrowers who have no equity in existing property. Mortgage insurers want to know if you're prudent with money or whether you tend to spend everything you get. For that reason, they prefer all borrowers who wish to borrow more than 80% of the value of their property to have genuinely saved at least 3% (more commonly 5%) of the value of their property purchase. Genuine savings include money in savings accounts, share or investments (held for 6 months) - they do not include first home buyers grant, a gift from parents, the sale of a car or any borrowed funds. While these additional funds can be part of your deposit they are not 'genuine savings" - Return to top

WHY PEOPLE ARE DISQUALIFIED FROM LOANS

There are a number of common reasons why lenders decline loan applications from potential borrowers. Being aware of these 'causes of disqualification' before the application process can be valuable for applicants - remember every loan application appears on your credit report (CRA).

1. The Consumer Credit Code makes it clear that lenders cannot lend to a person who has no ability to repay ( NOTE: the present tense 'has') , therefore promises of a new job, an employment promotion or better business earnings cannot be accepted. A written binding contract may be acceptable. This can be unfair on applicants such as those who have been out of the workforce to raise children. Even when employers provide evidence that a job will be held open for the borrower such as maternity leave, lenders will often turn them down. Lenders will also often decline those on probation in a job. In each of these above cases, some lenders are more lenient than others, so it is important to consult with someone who knows the market well.

2. People are often disqualified from a loan even if they can afford it, as they cannot demonstrate a track record of saving. That is because the money they've been using for their home has been given or lent to them. Lenders and mortgage insurers want to see a proven record of thrift to demonstrate the ability for repayment.

3. The other main reason for a loan application being declined is due to a borrower's credit record. From the lender's perspective that's understandable - if you've defaulted on a past loan, what's to say you won't default on a new one? However, there are traps for everyone here - we've had a loan held up for a client (who had been a public servant for 25 years and was only seeking to borrow 56% of the property value) because of a disputed bill with a telephone company. He ended up paying the bill just to get his credit record clean so that the loan could proceed. Another borrower was defaulted because he'd lived in a shared house and had gone overseas thinking a bill was being looked after. So be careful. Small blemishes even if they're not your fault can make lenders shy away - and they stay on your credit record for 5 years. - Return to top

OPTIONS IF YOUR LOAN APPLICATION IS DECLINED

If a lender declines your application for a home loan, it is worth seeing a broker about your prospects of success with other lenders, or to explore other means of proceeding towards obtaining a home loan. It is important to note that if your loan is declined by the mortgage insurer that decline applies to all lenders using that insurer (there are only two).

Also, see if you can find out why the lender has declined your application. You can try to meet their concerns?

Consider if any parents or family can help with assistance to service a loan. But only ask if you're comfortable in doing so and are confident that you're not exposing them to any risk.

If your loan application is rejected, it may be best just to wait for a few months until you can better satisfy lenders' criteria. Having a little longer to build up savings and employment stability may lead to success in the loan application with your preferred lender the next time around. - Return to top

WHAT LENDERS SEE AS A GOOD BORROWER

Lenders see you as a perfect borrower if the following criteria are met:

• You can show a record of steady employment;
• If self-employed, you can show a tax declaration of sound income over the past two financial years;
• You are a permanent resident or citizen of Australia
• You have no blemishes on your credit record
• If this is your first home loan, you can show a good track record of saving 5% of the property's value.
• Existing loans all current with no late payments - Return to top

TIPS ON IMPROVING YOUR CHANCES FOR LOAN APPROVAL

Your chances of obtaining a loan are maximised if you can meet the lenders' criteria as closely as possible. As each loan application you make is likely to be logged on your credit record, try to make your first application as strong as possible.

• If you think there's doubt about whether you can get a loan, see a broker before you apply for a loan to gauge your chance of success before any inquiry appears on your CRA;
• Wait a few months if necessary to improve your match with lenders' criteria;
• Be absolutely honest in your loan application - any discrepancies will soon show up, so be totally upfront with your broker or lender from the start;
• If you're a first time borrower and want to borrow more than 90% of the value of the property, you may have to demonstrate your savings record. Remember, it seems a bit silly, but lenders want to see a growing positive balance in your savings account. So, although it might be less efficient to do so, delay paying off debts that can wait in order to build up your positive savings record;
• Make sure your credit rating is good by ensuring all bills are paid on time. If in doubt, chase up the credit reporting agency Veda Advantage and get a copy of your credit record;
• If you are facing any credit problems, contact providers to try to come to an arrangement with them that keeps your credit record clean. Even a $260 telco dispute can be a major barrier if you have limited deposit. - Return to top

LENDERS MORTGAGE INSURANCE (LMI)

There are two big traps in lenders mortgage insurance or LMI as it's known in the industry.

The first is to think that it gives you protection against defaulting on your loan - for instance as a result of redundancy. It doesn't! It is, as it calls itself, lenders mortgage insurance and exists to protect the lender against your default. If you do default and your mortgage has lenders mortgage insurance, then not only will the bank chase you for repayments, but the insurer may do so as well on its own and the bank's behalf. The choice of insurer for LMI is not yours but the lender's. LMI is often confused with Mortgage Protection Insurance which is a policy that covers you for your mortgage repayments if you are sick, disabled or unemployed. Let us know if you are interested in getting this kind of insurance as we may be able to help.

The second trap is that, where lenders require mortgage insurance (generally if your loan to valuation ratio exceeds 80%) it is common practice for the lender to issue an 'approval in principle' before LMI has been obtained. Accordingly where approval in principle has been given but LMI is subsequently declined, the approval in principle cannot proceed to unconditional approval and is then revoked. So if you require LMI don't take the lender's 'approval in principle' as anything more than one hurdle on your way to unconditional approval. Even if your valuation comes in OK, you can still be declined if LMI is declined. So be aware of this trap.

Note: There are only two major LMI providers in Australia. LMI agreements with each of them vary only very slightly from one lender to another but the conditions each provider requires do vary somewhat. So if you are knocked back by the LMI with one lender you may have a chance with another lender that uses the other provider. As brokers, we are aware of which insurers each lender on our panel uses and so may be able to assist you decide which LMI provider, and so which lenders would consider your application most favourably.

The fee for LMI is paid by the borrower as a once only fee at loan settlement and varies depending on the value of the property being purchased and the size of the borrower's deposit. This is a graduated scale increasing on both property value and percentage borrowed so you might pay 0.7% for an 83% LVR on a $300,000 value ie:$2100 whereas you could pay 2% or more on a 95% LVR at $500,000 ie:$10,000. LMI is more difficult to obtain and more expensive for loans of $1,000,000.

The insurers place various conditions on applications and among these are length of employment, income tests and deposit conditions. For example if your deposit is from the sale of a house, you will be expected to show evidence of this. If it is from savings, you will again be expected to establish that you have saved that amount (or at least 3% or 5% of loan amount depending on insurer) over a minimum three months. They also restrict maximum lending (LVR) into various locations. For example, regional centres are typically 90 to 95%, while smaller centres may be 85%, and inner city may be 65%. It is important to keep the LMI policy in mind, as this almost always over-rides the individual lender's policy. - Return to top

TYPES OF INTEREST RATES

Loans come in a variety of guises. However the loan types shouldn't be confused with the Interest type. Interest types are;

• principal and interest (P&I) - here your loan payment covers the interest charge plus some of the original loan amount. Thus reducing the loan balance over the life of the loan;
• interest only (IO) - whereby you agree to pay only the interest charge for a specified period, typically 5 years. Most loans (except most lines of credit) revert to P&I after some period,
• variable home loans - whereby the interest rate charged moves up and down in line with certain indicators, typically the Reserve Bank Cash Rate. So if the Cash Rate increases .25% then you can expect your home loan rate to increase by approximately the same amount .25% (though from time to time lenders do take changes in rates to disguise their own increase in margins - or highlight their reduction in margins.). Some rates are based on other indicators and you should understand the implications of this;
• fixed rate loans - which lock you into a given rate for a specified period, typically between 1 & 5 years - though if you want longer periods (up to ten years) we can arrange them for you. So even if the variable rate increases by 5% you are protected and pay the rate you agreed at the outset until the end of the fixed rate period. However you are locked in, even if the variable rate decreases by 5% and in these situations it can be very expensive to 'break' your fixed loan.

So it is possible to have a mixture of the above eg: Fixed for 3 years with Interest Only or 25 years variable with Principal & Interest and almost any combination even part fixed and part variable (sometime referred to as a split). - Return to top

TYPES OF LOANS

Competition in the market place has not only seen lower margins for lenders, but a greater diversity of features and additional benefits being offered to attract your business. Superficially this would appear to be beneficial for you the borrower. However the features, discounted rates and variations in fee structures often simply make it much more difficult to do direct comparisons between products.

Claims such "pay your loan off quicker" are common place and often they are quite incorrect, especially if you are paying higher interest rates or ongoing fees to obtain the so-called benefit. For example, on a $100,000 home loan a $300 annual fee (typical to most professional packages) is the equivalent of .30% in additional interest rate. So a 6.70% rate with a $300 annual fee is actually 7.0% on a $100,000 loan.

A line of credit (LOC) is essentially a perpetual interest only loan - although by its very nature there is nothing to restrict you reducing the principal at any time either by lump sum or just monthly salary deposits. Thus if you have a line of credit for $300,000 on which you owe $250,000, you only pay interest on the $250,000 you have drawn. When linked to a cheque and credit card facility and with salary crediting, your line of credit provides the same kind of flexibility as an offset account.

In fact it is generally more flexible although there are some specific tax implications with offset accounts that an LOC cannot provide. However unlike an offset provided that the line of credit allows you to capitalise interest, you don't even have to make repayments. Instead, when interest is charged to your account it is added to the balance of your loan. Thus for instance using the example above, if you need to pay $1,500 for interest on the $250,000, instead of being required to pay that amount into the loan, at the time that you would otherwise be required to pay interest, your balance simply becomes $251,500 for you to pay back when you like. But of course if your credit limit is $300,000 and you've already borrowed to that limit, the lender is going to want to see some payments into your account to service the interest.

As you can see, lines of credit are one of the most convenient forms of credit. They are also as effective and simpler than offset accounts. Often lenders will tell you that an offset account will save you thousands off your loan – because you're not charged interest on money you don’t need to borrow. But precisely the same thing is possible – usually more simply – using a line of credit.

Remember some people have trouble not spending money when its there. If that sounds like you, its best that you avoid a line of credit and submit yourself to the discipline of having to make regular payments of a size you have previously planned to make. Also keep in mind that if the borrowing on your line of credit is for investment purposes, interest on it will, in the normal course of events be tax deductible. In this case, you should be wary of attaching your credit card to the line of credit as some of the borrowing will then no longer be for investment purposes. This will complicate the calculation of your tax deductions for interest as some of the loan will remain investment related, but some will be related to personal expenditure. Where there's a mix of investment and non-investment borrowing it's usually preferable to have separate accounts for each kind of borrowing.

An 'offset' account is a sophisticated way of 'fine tuning' your lending requirements to your earnings and your daily spending. In addition to your home loan, you have a transaction account with the same financial institution. You deposit your income into the transaction account and use it for all your daily expenses, usually through a linked card or cheque account. Any money in this account is offset against the amount owing on your home loan and you only pay interest on the outstanding balance. So say, for example, that you have a home loan of $250,000 and you have a balance of $10,000 in your transaction account, you only pay interest on $240,000. Interest is calculated on a daily basis.

Offset accounts come in many guises and you should be wary of 'partial offsets' as opposed to 100% offsets. Partial as it's name implies, means that you don't get the full interest benefit and in some circumstances the benefit is less than what you would gain from a standard interest bearing transaction account. Even a 100% offset account can be a trap if it comes at a higher interest rate than what is otherwise available to you. See our first newsletter.

Particularly where the expenditure on your offset account is personal and it is offset against an investment loan, there are specific taxation implications upon which we recommend you seek professional advice.

All-in-one accounts are usually a single home loan account that allows direct salary deposits and some withdrawal functions - these are often limited to a few ATM or transfers per month and a linked credit card account. The potential savings are similar to the above however be aware that some accounts are so limited you may need a standard transaction account - and fees if applicable must be taken into account when comparing products.

There are some basic loans being offered that provide free unlimited redraw and unlimited principal reductions. So theoretically you could pay your salary into the loan account and withdraw as you require the funds or by using your credit card for monthly expenses then make an end of month payment into your credit card. So a loan like this can act very much like an all-in-one account, although you have to consider possible credit card and transaction account costs.

Finally, remember that many of these accounts require you to exercise discipline in their use, if your long term ambition is to repay your loan principal. - Return to top

Disclaimer: we are not investment advisers and the comments offered here represent opinion only and made without any indemnity whatsoever to anyone who is not a client. For our clients indemnity is offered subject to our normal limitation of liability available on our website and rebate agreement.

The comments are general in nature. Before making any investment decisions, clients are advised to seek independent advice relating to their individual circumstances from those professionally qualified to offer such advice. Unfortunately many people who are entitled by law to offer such advice are poorly qualified and/or have a conflict of interest in the provision of their advice as they receive commissions on the products they recommend. We recommend that clients find someone who has sound understanding of investment markets, a capacity to provide well explained advice relating to their individual situation and is not in receipt of any commission from those selling investment products.