Lenders like people to think that the only way that they can increase their borrowing capacity is to either increase their income or provide higher security. I have provided proven techniques that will increase your borrowing potential by worker smarter and not harder.
To devise strategies to achieve this we must firstly get a better understanding of how the Lenders assess your application.
Almost every institution uses a to determine how much you can afford to borrow. Each bank has their own system but they are all fundamentally the same. The serviceability test is a mathematical formula designed to determine the portion of total income that is represented by total debt.
The two indicis are:
i). Debt Service Ratio – (‘DSR’)
This is the ratio of your loan repayments to your gross income
For most lenders this figure should not exceed 30% for singles and 40% for couples, and
ii). Net Debt to Income Ratio – (‘NDI’)
This is the ratio of your net disposable income to total debt commitments
Total Debt Commitment
For most lenders this ratio must be greater then 1.25:1
Another thing that lenders often do is to adjust the income items down and expense items up. Examples of these include:
bonuses and commissions - average out over 2 years
contractor – average out the income earned
discount rent from an investment property - usually reduced by 20%
credit card repayments – apply 20% of the total limit as debt repayment amount
living expenses per adult and child – debt amount is increased with every child
when determining the DSR and NDI ratio, the lender will apply an inflated interest rate to the proposed loan and for any existing loans with that lender.(eg. Actual rate is 7% but use 10% when calculating all loan repayment debt).
Now that we have a better understanding of the fundamental basics of how lenders determine borrowing capacity, we can now apply strategies to improve the amount you are able to borrow. I will show you ways to significantly increase your borrowing capacity by working smarter and not harder.
Loyalty and convenience is the main reason people continue to use the same lender to borrow money. Unfortunately this is reducing the amount that you are able to borrow.
It also usually costs you more to do business with the same lender than to use a competitor. It is very common to find a lender offering a better deal when you threaten to take your business elsewhere.
By obtaining loans from different lenders your level of borrowing we be greatly improved. It is a simple case of all lenders using a serviceability test to determine your level of borrowing so by using different lenders the effective interest rate applied to loans with other lenders is the actual rate and not a higher assessment interest rate used to calculate your monthly commitment.
Loans with other banks - $500,000
Actual interest rate – 7%
New Loan application - $300,000
Actual interest rate 7%
Assessment Interest Rate applied to serviceability test – 10%
All loans are with the same bank
Loan Repayments = Total loans x Higher interest rate
($750,000 +$300,000) x 10%
Loans are with different Banks
Loan Repayment = (Loans with other banks x actual repayments)
+ (New Loan amount x Higher interest rate)
= ($750,000 x 7%) + ($300,000 x 10%)
= $52,500 + $30,000
The difference between scenario A and B is $22,500pa or $1,875 lower monthly commitment amount. So as far as the lender is concerned you have effectively add an extra $1,875 per month tax free to your net income. This means that you will be able to borrow more money. Now that’s working smarter and not harder.
It is important to note that even though all lenders apply the serviceability test, each lender has their own assessment criteria. That is why it is important to research the lenders or use an experienced professional mortgage broker to do this for you.
2. Consolidate Short Term Debt into Long Term Debt
The aim is to reduce the monthly outgoings which inturn will improve the DSR and NDI. This can be easily done by taking one or more of the following actions
Transfer all loans from Principal and Interest into an Interest Only loan. This includes your home loan. It is prudent to ensure that the loan facility allows you to make extra payments against your home loan without penalties or fees.
Reduce your Credit Card Limit or cancel some or all of them. Then reapply for new credit cards once the loan is approved. Lenders normally assume that you have utilised your credit card capacity because you have full access to debt. There are a hand full of Lenders who may ignore the credit card limit if you can prove that the balance is repaid in full every month. That is why cards like American Express are not included.
Move any short term debt into the home loan or use your line of credit to pay them off. Such as car lease, credit card balance, personal loan. Not only will this reduce the monthly repayment amount but it is usually at a much lower interest rate.
Use individual Names to acquire the loans rather than joint names where possible. It is common practice for couples and partners to apply for a loan in joint names. This makes each borrower liable for the full debt of the loan. As a result when the Bank assesses the loan application it applies the full value of the loan commitment to each party individually which can dramatically increase the monthly commitment amount and reduce your borrowing capacity.
3. Reduce Your Liabilities Using Other Legal Entities
Entities such as Trusts or companies that have sufficient income and are structured correctly can be used to obtain loans in their own right without you having to be a borrower or guarantor to the loan. This can be for new loans or to transfer existing loans from your name into the name of the entity. Remember, if set up correctly you can still be in control of the property without being personally liable for the debt.
It is very important to get the right legal structure and receive the right mortgage advice to ensure that this is achieved as all too often inexperienced lenders say that it can’t be done only because they do not know how to do it or their lender doesn’t provide for it.
4. Use Other Peoples Equity
Often people may have the income but not the deposit required to buy a property and visa versa. A simple way to overcome this is to obtain the deposit from one person and the loan from the other person. The other person could be a family member or a friend. They can use savings or a Line Of Credit and you both enter into a legal agreement regarding the repayment and liabilities of both parties.
This is great for parents helping their children get started as it is far less risky than having them Guarantee the loan or be a joint borrower. Their only risk is the money that they have lent for the deposit.
5. Use Other Peoples Income
For a lender to allow another entity to be a co-borrower they require the co-borrower to receive a direct benefit from so doing.
Through setting up the right structure such as a Trust, a third person can be a co borrower to enable you to borrow more money without them having to be on the title to the property. They receive a direct benefit as the beneficiary of the trust.
6. For Self Employed
As a self employed person there are opportunities available to you that may not be available to an employee. In the past it was very difficult for the self employed to obtain a loan because they paid themselves minimal income or their business showed minimal profits in order to minimise their tax. Often there were no tax returns by which the lender could use to substantiate their income. But these days it is easier to obtain a loan as a self employed person than a traditional borrower.
Lo Doc Loans for Self Employed. In fact a self employed person is not required to provide tax statements or other evidence of income to validate their application. They need only to show that they have at least 20% deposit and a perfect credit rating. (Some lenders even accept as little as 10% deposit but usually charge higher interest). This is called a Lo-Doc loan and the interest rates these days are comparable to the standard loan interest rates.
The tax departments raised concern about this loan product as borrowers on their loan applications were stating higher incomes than what they declared in their tax returns. So the tax department took it upon themselves to threaten to audit these borrowers. If caught the borrower could potentially face a dilemma of either tax evasion or financial fraud.
To overcome this, lenders now offer a new product known as a No-Doc loan. As the name suggest the borrower is not required to make any representation as to their income. The main requirement is that the borrower has been self employed or has an ABN for a minimum of 2 years (some lenders don’t require the 2 year period).
A strategy to reduce paying 20% deposit. If you purchase a property that is below market value by say 10% then you may be able to negotiate with the lender to accept the valuation price as the security value which means that you only need to contribute a 10% deposit.
Increase borrowing capacity by increasing your wage. If you want to use a normal full doc loan then you will need 2 years of tax returns to substantiate your income. In some cases it may be worth while to increase your wages to enable you to borrow more. The increase will generally result in a higher tax bill but the negative gearing benefits from property may help to reduce the tax burden.
Use a Self Managed Superfund to provide the deposit. A self employed person may use the funds held in their self managed superfund to contribute to the purchase of a property. There are very strict guidelines and regulations governing this but an experienced professional advisor will be able to structure this for you.
7. Increase Rental Income
If you own investment properties a good way to increase your income is to raise the rent on your investment properties. You could do this in a number of cost effective ways which we won’t go into here.
A well presented proposal can often persuade lenders to assess an application based on what you intend to do.
For example. If you are living in your own home and you intend to rent out both the new investment property and your home and move into a rental property or with relatives for low or no rent. So long as the rent received from your own home will be greater then the expected rent that you will be paying then your serviceability will be improved and so to your borrowing capacity. After you have obtained the loan then you may be able to move back into your home when you can financially afford to do so.