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Serviceability describes the ability of an individual to repay a loan. Factors used to determine serviceability include the loan amount and the person’s income and expenses.
Known as the debt service ratio, this figure represents a calculation of the percentage of your monthly income that is apportioned to debt expenses. The maximum acceptable debt service ratio for most lenders is between 30 and 35 per cent.
Understanding what serviceability is and, more importantly, how you can have a positive influence on your own serviceability is vital to your success as a property investor. You’ll understand what impact each financial move you make will have on your ability to borrow so you can make smarter spending decisions.
How it is calculated
Each bank sets its own rules on how it calculates income; however, the following types of income are pretty standard across the industry:
- Regular salary (are you a full-time employee, contractor or business owner?)
- Company car (fully maintained)
- Shift allowance
- Income from second jobs (if held continuously for a year)
- Centrelink benefits (esp. Family Tax Benefits Parts A&B)
- Rental income (typically 75% as they allow for management costs; some lenders will allow as much as 100% of this income source)
Lenders won’t always count overtime (or will only count part of it) when they calculate your serviceability. The exceptions would be individuals employed in industries such as fire service, police and nursing – all professions known for routinely paying overtime.
The other part of the calculation involves liabilities. Debt (or potential debt as suggested by a line of credit or credit cards) reduces the amount you may borrow.
Credit cards are typically assessed with a minimum repayment of 2.5% to 3% of the credit limit.
What this means is that even if you owe nothing on your credit card, your lender will include a calculation, which assumes that you owe the entire approved limit.
This is because you have the ability to max out your credit cards, which would reduce your serviceability and create a risk for the lender.
Credit card limit = $15,000 x 3% = $450 (monthly payment)
Borrowing capacity reduced by approximately $60,000
As you can see it’s important to manage your credit card limits. Cancel any cards you don’t use or use very infrequently, and lower your available credit limit to the bare minimum needed.
The same strategy applies to a line of credit. The lender will typically count the full value of the loan when calculating serviceability so reduce or close your credit lines if you need to improve your serviceability.
Have kids? They don’t raise themselves! Lenders will typically reduce your serviceability, calculating anywhere from $40,000 to $60,000 per dependant.
Low doc loans won’t typically include the tax benefits for your negatively geared properties but full doc loans will usually include these figures.
The assessment rate is a figure lenders will use when calculating your serviceability. In order to ensure that you’ll be able to repay the loan should rates rise, the lender will add a percentage (up to 2%) on top of the variable interest rate when underwriting your loan.
Sometimes, lenders will also do this with fixed rate loans, but it depends on the length of the fixed term.
Tips to improve your serviceability
- Consolidate your unsecured debts by wrapping them up into your mortgage. Unfortunately, doing so increases the amount of interest you’ll pay because it pushes your repayments into the future.
- Pay off (or pay down) all of your existing debt and cancel unused credit cards. Reduce the available balance on those you choose to keep.
- If you have a P&I mortgage on your investments, switch to interest only loans instead.
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