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Will a lower buffer boost your borrowing power?

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Now that Australia’s banking regulator has lowered the lenders’ borrowing buffer, more people should be able to borrow more funds to buy their new home.

For the last few years Australia’s banking regulator, APRA, has required lenders to use a minimum 7 per cent interest rate when assessing a new customer’s ability to service the loan, even though the rates lenders were offering were lower.

It made sense. With interest rates at historic lows, this buffer protected borrowers from repayment pain if rates ever went up. This hasn’t happened. In fact, after remaining unchanged for a long time, the Reserve Bank’s official rates have dropped twice in the last two months – going from 1.5 per cent to 1 per cent. So the gap between the rates lenders are offering and the 7 per cent minimum has got wider, and no longer reflects the conditions of the mortgage market.

All lenders have had to apply the 7 per cent rate to all new home loan assessments to ensure people can afford their repayments, and to make sure banks stick to a common lending standard. Now APRA has lowered this buffer.

That doesn’t mean good lending practices have been thrown out the window. Instead, lenders can now review and set their own minimum interest rate floor, as long as it’s a buffer of at least 2.5 per cent more than the loan’s interest rate. With many home loans offering interest rates well below 4 per cent, this means the rate that lenders can now assess your loan is somewhere in the mid to high fives.

For APRA, it’s all about flexibility. Lenders can set their own serviceability standards for their borrowers, which can improve access to loans and provide more competitive products, while still maintaining a good level of responsible lending practices.

For borrowers like you, it’s all about affordability and borrowing power when buying a new home.

A lower buffer is better for borrowers.

In simple terms, this change could mean that more people can now get a home loan. People’s borrowing capacity will increase as the amount of interest they need to cover each month decreases. For many people looking to get a new mortgage, this could mean the difference between getting approved or not.

If you’re already a homeowner, more people looking to buy could improve the current flat housing market, which will help protect the value of your home.

So how much can you borrow?

The APRA change is essentially about improving serviceability – your ability to make the repayments on a regular basis.

On top of the deposit you have, a lender will look at your income, living expenses and existing debt to calculate whether you’ll have enough money left over to afford the repayments. To work this out they come up with a score called the net income surplus (NIS). Obviously, this needs to be positive, i.e. the money you have left over to pay the loan is more than the repayments.

And that’s why APRA still need lenders to include a buffer, because if rates go up, your repayments go up and you may no longer have enough money left over to service the loan. The new 2.5 per cent buffer still protects you from this.

As well as serviceability, there are other factors lenders take into consideration you’ll probably hear about when applying for a loan. Things like:

Loan to Value Ratio (LVR). This is basically how much deposit you have compared to what you need to buy the home. If you have a $60,000 deposit and the home is valued at $300,000, you’ll have a $240,000 mortgage and your LVR is 80 per cent. Banks generally like an LVR of 80 per cent or lower, but it can be as high as 95 per cent.

Debt to Income Ratio (DTI). Lenders look at how much you earn to help work out how much you can borrow. Your DTI ratio is your total debts divided by your combined income (before tax). A loan of four or five times your income is a good ball park figure.

As you can see, the way a bank assesses your serviceability to approve you for a loan is a lot more complex than simply plugging in your income and applying their interest rate. And working out factors like your NIS, LVR and DTI can be tricky and time consuming. You don’t want to apply for a loan only to be declined because you got your personal financial details wrong. Simply being declined for a loan can affect your ability to get approved next time you apply.

It’s so important you know exactly where you stand in the eyes of a lender before you apply by getting an accurate financial snapshot of your current situation. You don’t want to make the mistake of using an official application process to establish your borrowing power.

That’s why we’re here to help. We’ll sit down with you and go through all the details a lender requires, to not only help you navigate the process and make sure you look good to the lenders, but also to ensure you find a loan that’s right for you.

Please get in touch to organise a chat. We’re more than happy to do it at a time and place that suits you.

Any advice contained in this article is of a general nature only and does not take into account the objectives, financial situation or needs of any particular person. Therefore, before making any decision, you should consider the appropriateness of the advice with regard to those matters. Information in this article is correct as of the date of publication and is subject to change.