02 Aug 2017
First posted on Australian Property Investor Magazine
The purpose of this post is to outline how different banks determine your borrowing capacity in 2017.
How do lenders calculate your serviceability?
Lenders calculate your borrowing power by calculating your income and subtracting your assessed expenses. The left over monthly/yearly surplus is then used to extrapolate your borrowing power. This hasn’t changed.
Every lender calculator can also be broken down into individual parts. Lenders have changed how they calculate individual parts of their calculations, leading to big drops in borrowing capacity. For example, minimum living expenses are higher, assessment rates are higher, other income treatment is lower, etc.
Property investors seeking to understand borrowing capacities can ‘generalize’ lender calculators into three distinct categories:
Today, most banks have a lender calculator that mirrors the 2017 version of the APRA prudential practice guideline. This guideline is very prescriptive as it sets the rules for each component of the serviceability calculator. The individual parts of these calculators work like:
There are quite a few lenders out there that deviate slightly from the APRA prudential guideline. They usually diverge in one or two individual components of the APRA calculator and produce a better borrowing capacity result. For example, some of these calculators have one or more of the below characteristics:
These calculators are still very much in the 2014 era. Typically, they aren’t deposit taking institutions and therefore currently fall outside APRA’s prudential practice guideline (although APRA want to change this). These lenders usually charge a premium for lending and usually involve greater finance risk, as your options to move elsewhere are very limited. They usually also have less flexible policies and products, and often have ‘price for risk’ models – for example, they usually don’t do construction loans, have stricter employment policies for their cheaper rates, drop rates by LVR bands, etc.
Observations about borrowing capacities today:
What are the results of these calculators?
To depict how these lender calculator works, we have run three basic scenarios to test how much someone can borrow for an owner occupier loan, on a principle and interest repayment over 30 years.
Expenses are the same across each scenario: minimal living expenses, 6k credit card, no other debts. The intention of each scenario is to show how lender calculators change for property investors specifically, and to demonstrate the differences between the three calculator segments we’ve raised above.
Borrowing capacities fall dramatically for APRA lenders as debt rises. For aggressive lenders, additional debt does not hurt borrowing capacity as much. It is these aggressive lenders that property investors can use to grow larger sized portfolios. Beware, there are risks of doing so and these need to be managed.
Borrowing capacities are also dramatically different between different major lenders. Some target property investors better than others. In this example, we show the ~$500,000 borrowing capacity difference for an investor with $2million in existing properties between major banks. While this gap has closed dramatically in recent years, there are still divergences between lender calculators. This offers scope for strategic and structured finance planning.