Ryan Smuts: Understanding serviceability

I get asked about bank servicing criteria all the time. Comes with the territory I suppose.

The cautiousness I totally get. Imagine putting in all the hard work to get prepped up as the ‘ideal borrower’ only to find that the banks are looking
at something else entirely different!

Say you are after a home loan. You take your living expenses away from your net income to work out your monthly surplus (or deficit 😱). You put that number
into any one of those online mortgage calculators, tinker with the total loan amount, loan terms and interest rates before arriving at a rough idea
of how much you can afford to borrow. It makes total sense to assume that the bank would lend you what its calculator is telling you.

Only it won’t. Because banks look at servicing very differently. They start with your net income and minus either your actual living expense or their preset
bank minimum for a borrower if you situation whichever is the highest. In the current market, we are seeing banks increasing their
preset minimums dramatically while clients are spending more cautiously in preparation for the coming recession. So being fiscally prudent actually
doesn’t help you from a serviceability point of view.

But that’s not it. Any proposed new mortgage debt is stress-tested on banks’ qualifying rates, not market rates. Which means you could be on a
2.99% loan but tested at 6.50-7.30% on a P&I basis. See how this can slow down first-home buyers even after they’ve put a deposit together?

Not that it is any more smooth-sailing for investors. As you grow your portfolio, two things tend to happen:

You generate a rental income which would support further borrowing; and
Some of your debt get put on an interest-only basis to maximise tax efficiency.

Sounds great? Not really.

Banks usually account for 75%-80% of the gross rent only. The thinking is that the opex of owning rentals (think vacancy, rates, insurance, management,
maintenance etc) would chew up 20-25% of the rent irrespective of your business efficiency or acumen. Imagine having a quarter of your income taken
off the table just like that!

Also, you will never rid yourself the P&I stench even if you are on interest-only loans. Say you have a 30-year mortgage 5 of which are on interest-only
and you apply for a new loan. Your existing debts will be assessed at a 6.50-7.30% qualifying rate over 25-years. That could dramatically decrease
your serviceability.

Still not quite seeing it? Let’s use some hard numbers to illustrate the point. Say you have $500K of lending on a 30-year term at 4.25%. For the first
five years, you are on interest-only. The property is returning $600 gross per week ($31,200 p.a.) and costing you $5K p.a. of opex and $21,250 of
mortgage repayments per year.

By your count, the property would be cash positive at $4,950 p.a. or just over $95 per week.

‘No.’ says your bank. Firstly, opex would be $7,800 (being 25% of $31,200)and mortgage replaying would be $43,344 (assuming the higher 7.25% qualifying
rate). So from the bank’s point of view, your property is losing you $19,944 p.a. or $384 per week.

See how a dramatically different set of serviceability criteria changes your ability to get a deal across the line?

My advice? Get in touch with your broker early in the piece to work out your serviceability and borrowing capacity. When you know what you can afford,
you waste less time looking at pipe-dream deals. Working out your serviceability early also gives you more opportunity to improve your borrowing position.

My team and I are actively working with investors to get deals across the line even throughout COVID-19. Feel free to send me an email if you would like to have a chat about how we can help you meet your investment goals in 2020.