Article by Patrick Lynch, Head of Operations at Long Property
You may have heard how much tougher it is to obtain an approval nowadays, but you may not know how a Lender actually assesses an application. In this article, I provide an overview so you can better understand the amount of work involved in the lengthy loan assessment process.
The primary reason why the assessment process is taking longer (compared with 2 or more years ago) is that Banks are being very thorough, following the additional intense scrutiny of the Royal Commission, regulators, media and the public. There is a fear-driven incentive to get things right, which has slowed down the availability of credit. Even if you thought you had provided everything, it’s not uncommon to be asked for additional documents and/ or clarifying information. Good Brokers work with Lenders to get loans approved, it just takes more time and effort to ensure approval and deliver a positive client experience.
To give you a better sense, assessment can be categorised via the following four categories:
- Character
- Capacity
- Collateral
- Conditions
I’ll go through each of these now in further detail.
-
Character
Would you lend to someone who you are unsure will repay you? Lenders have multiple ways to determine whether an applicant is of good character and creditworthiness.
The lending equivalent to a résumé and references is repayment history. Lenders often check bank, loan and credit card statements for missed payments or non-disclosure. They will request a credit report, which contains personal information and credit history (e.g. types of credit held or applied for, repayment record, etc.). Some Lenders will auto-decline applications if there are any issues above.
A Lender will also consider living arrangements (renter or home owner, length of time at each address), employment background (part/ full-time, casual/ permanent, length of service, local/ overseas – including, with consent, contacting employers) and residency status (temporary/ permanent resident, citizen).
-
Capacity
Why give money to someone who can’t repay it? Capacity is the ability to service debt. Lenders are required to lend responsibly and assess servicing by considering income and expenses (living and other commitments), using a calculator to work-out whether a Borrower can meet their obligations as they fall due.
Lender policy will differently assess definite/ confirmed (base salary or self-employment) versus less certain income (e.g. bonus/ commission and rental income), shading the second to 80% or less. Living expenses depend on lifestyle, dependents, etc. (see more here). Finally, the Lender will look at existing and proposed debt, applying a higher assessment rate to current loans, and review other ongoing liabilities such as personal/ car loans, credit card limits (not balances), HECS/ HELP, rent, etc.
The servicing calculator will need to show a surplus of income over assessed expenses, or a ratio above 1.00 times. Even then, Lenders can make judgement calls and decline applications when concerned with non-quantitative factors (e.g. savings history or age).
-
Collateral
What is the Borrower’s contribution, i.e. ‘skin-in-the-game’? In a purchase, this is often cash – the Lender will provide a percentage of the purchase price, but the Borrower will need to contribute the balance plus pay any government or other charges. For example, you are buying a $1million home, and the Lender will provide $800,000. Potentially, you need to contribute $200,000 plus costs.
In this scenario, the LVR (Loan-to-Value Ratio) is 80%; this tends to be the maximum, as above this increases the Lender’s risk should the property need to be sold. LVR will be determined by a valuation carried out at the Lender’s instruction (and sometimes the Borrower’s cost). The valuation can be a physical inspection of the property or computer generated with reference to market information.
Alternatively, the contribution can be equity in a property, a parent’s gift or willingness to go guarantor for a loan, or using surplus cash as additional or alternative security. A larger Borrower contribution can lead to a better interest rate as the potential risk for the Lender is reduced. Some Lenders will permit more than an 80% lend. This may attract Lender’s Mortgage Insurance (LMI), which is insurance paid by the Borrower that protects the Lender. A Borrower benefits by requiring a smaller contribution, with LMI reducing the Lender’s risk in case of loan default.
-
Conditions
So you’re of good character, can demonstrate an ability to pay, and are providing the Lender with security in case of repayment issues. Great! What are the loan terms?
Your Lender will issue Loan Documentation confirming the terms (e.g. interest rate/ type, repayment type, etc.) and conditions. Your approval may be subject to more information or documentation like the reduction of credit card limits or clearance of other debts, receipt of an Insurance Certificate of Currency, or the provision of a progress schedule for construction loans.
Conclusion
The Lender finalises assessment by checking the file and Loan Documentation, then contacts your conveyancer/ solicitor (purchase) or existing Lender (refinance) to arrange booking, before settling the loan. Congrats!
It isn’t a difficult process but does involve a lot of work by the credit assessors. Because of the impact of factors such as the Royal Commission, Lenders have become very thorough and even standard applications often require additional effort. Patience, experience and expertise is needed to navigate this lending environment.
