Many clients are surprised by how thorough the loan approval process has become. The government has put pressure on the banks over the past 18 months to tighten up their credit assessment processes. The purpose of this blog is to give you an overview of what the banks look at, what questions they ask and what you can expect from the process. If you haven’t applied for a loan for a few years, then it would be worth taking two minutes to read this short blog.
Statistical risk assessment = your willingness to repay
All banks use a statistical risk assessment (credit scoring) model. That is, they review the massive amount of data they have to try and identify statistical characteristics of good and not so good borrowers. What they are trying to assess is what they call your “willingness to repay”. Willingness to repay refers to your attitude towards how important it is for you to maintain an impeccable credit history. Rather than looking back (and reviewing how you have conducted past loans), the banks try and predict your future behaviour. Therefore, it’s important to identify if your loan application will reflect any of the characteristics because if it does, it will result in a low credit score and possibly a decline. I discuss below some of these characteristics.
Employment and income stability
Employment stability has a significant impact on your credit score. For example, if you’ve had three different employers in the last two years, the banks’ credit assessment model will flag you as a potential risk. The bank’s concern with respect to employment stability is that statistically people that change jobs regularly are also more likely to default on a loan. Of course, this is a statistic, and doesn’t apply equally to everyone.
Therefore, if you have changed jobs more often than usual recently then it is important that we address this directly with a lender. For example, we can explain that whilst you’ve changed employers, you haven’t changed roles/industries. Also, perhaps you’ve moved employers to advance your career. We can build a story around your employment history to demonstrate to the bank that you’re actually a lower not higher risk.
If you have just started a new job and you have a probationary period, it is possible a lender will want you to successfully complete that probationary period before unconditionally approving a new loan.
The bank will review the last few months of transactional bank statements to give them a picture of what your financial position and spending habits look like. In particular, they will look for the following:
If there are repayments going out to other institutions
They will look for monies being transferred to any other undisclosed accounts and/or loan repayments being direct debited from this account. What they are looking for is if you have any other liabilities that you haven’t disclosed in your application. Some people might have credit cards that they don’t use, so they forget to disclose them on the application. Nondisclosure rings alarm bells at the bank. Therefore, it is very important to ensure you have disclosed your financial position completely and accurately.
Living expenses and evidence of surplus cash flow
The government’s primary focus in recent times has been to ensure that the banks have a conservative approach to assessing your ability to meet the repayments of your new loan. A large part of this is making sure that they understand how much you spend on living expenses. Up until a few years ago the banks would use ridiculously conservative living expense assumptions i.e. I believe they were underestimating living expenses by 50% or more. Today, the bank will ask you to estimate your living expenses in the application form and verify this by reviewing your bank and credit card statements. If they believe you have underestimated your living expenses, they will make adjustments. Obviously, the higher your living expenses, the lower your borrowing capacity.
We have always worked closely with clients to determine how much they should borrow prior to lodging a loan application. If this assessment is conducted thoroughly, then it’s very unlikely we will run into problems at the application stage. When it comes to borrowing capacity, there are two questions to consider. Firstly, how much can you borrow? Secondly, how much should you borrow? The answer to the latter question is typically less than the answer to the first question. That is, banks will typically lend people more money than they should borrow – although the gap between these two amounts is a lot smaller these days.
The bank will review bank, credit card and loan statements to identify if you have made repayments on a timely basis. If you have made late repayments on any accounts recently (in the last six months) then it is important that you be upfront about this. Depending on the situation, we might decide that the best approach is that we address this upfront when lodging the application.
Credit card statements
The banks will review your credit card statements and they will be looking for two things. Firstly, their looking your spending habits as discussed above. Secondly, they will want to ensure that you have made repayments on a timely basis. When assessing your borrowing capacity, the bank will assume your credit cards are fully utilised i.e. they are maxed out. This means they include 3% of your total credit card limits as a monthly expense (if you have $50k of credit card limits, that’s a monthly expense of $1,500). Cancelling credit cards that you no longer use therefore increases your borrowing capacity.
In your 60’s and beyond
Some lenders will have concerns with approving a 30 year loan for someone in their 60’s. Firstly, not all lenders take this view – so lender selection becomes important. Secondly, we need to be able to articulate a loan exit strategy i.e. how will the borrower be able to repay the loan.
Too much rental reliance
If rental income constitutes more than 50% of your total income, the bank might have some concerns with this. This is called ‘rent reliance’. In this situation we need to address this concern in our credit submission. Again, using the right lender is also important.
A lender has a legal responsibility to ensure you can afford a loan. In this regard they will review your cash flow to ensure you have sufficient income to meet the repayments. They will typically calculate loan repayments on a principal and interest basis at a benchmark interest rate – being around 7.5% p.a. at the moment. They will only include 70% of gross rental income and will typically exclude overtime and bonuses. Some lenders using debt-service ratios (a loan to income ratio) as rules-of-thumb. Borrowing capacity between lenders can vary dramatically.
A lot of credit checks
The bank will review your credit record. Your credit record lists all the loans that you have previously applied for. If you have applied for a lot of loans recently (say in the last 12 to 24 months), it will reduce your credit score. Again, if you have made a higher than normal amount of applications recently then it’s probably better for you to address this upfront. You can explain to lender the circumstances around these applications to allay their fears that you’ve been shopping your credit around. You can request a copy of your home credit record from here at no cost.
One shot with each lender
We have had situations in the past where a prospective client has already approached a lender directly and have come to us once they have experienced problems/issues/delays. A common cause for these problems is an inexperienced banker i.e. the banker they dealt with did not have the requisite experience to know how to present the application to credit to maximise its approval. In this situation, it can be hard for us to resolve these issues with the current lender. Therefore, if you are going to deal directly with a lender, make sure you have an experienced banker. Alternatively, deal with an experienced broker like us.
More than just filling out an application form
Navigating this tight credit environment requires a high level of knowledge and experience. Not only do you need to select the right lender and have the right contacts within that lender, but you also need to present an application in the right format to demonstrate to the lender that the borrower is a low credit risk.
Whilst you might think you’re a very low credit risk, because of the way banks now assess applications, you might not be seen that way by the banks. After 15 years of experience, we have seen it all. We have helped thousands of borrowers in various circumstances, different histories, complex structures and so on. When applying for a loan, professional credit advice is often invaluable – even if you think your application is a “no-brainer”. If you would like to discuss your existing or prospective mortgages, click here for a confidential and obligation free discussion.