Lots of home buyers think that the most important thing you need to do before purchasing property is to save up a substantial deposit.
Many people ignore other financial aspects of buying a home that can be seen as just as important, if not more important, by the lenders who’ll actually looking at your home loan application.
The more boring you are, the more chance you have of getting a loan. It’s as simple as that.
Spending habits
One of the most important things that banks look at is your spending habits. Most lenders use what’s called a household expenditure measure or a HEM.
Basically, what that is is an average spending for a couple or for a single person.
So they might say a single person that’s earning $120,000 a year who lives in a certain postcode will spend on average $1,700 a month. Other key factors the lenders look into are relationship status and the number of kids you have.
Now, that person could then put an application through us and put down that they spend $500 a month on groceries and everything else. The lender is still going to use that $1,700 figure.
And that’s the thing, it is based on those postcodes and people will probably be surprised how much data the banks have on this too – and how accurate it is.
The latest data that we received was that 85% of people are actually above that HEM amount, yet nearly every person we speak to declares to us that they’re below that amount.
Which is why banks rely on their own research and not what they’re provided with. They know that people don’t properly account for everything when they apply for a loan because the natural thing to do is say I spend nothing, you know, I don’t do anything, because you’re trying to incentivise the banks to approve the loan.
Each lender has their own formula to work out your HEM and there’s no reliable way to find out what yours is, no decent online calculators, so until you apply you won’t know what it’s meant to be.
Bank statements and discretionary spending
When you apply for a mortgage, lenders typically want to see three months worth of bank statements.
Now they’re not going to go line by line and add it up – actually some lenders do, and we try to avoid those ones for obvious reasons – but they’re looking at different things like spending habits.
You’ve got your fixed expenses. So you’ve got your rent, you’ve got your things that you need to live.
But then you’ve got discretionary spending. So gambling, lots of eating out, lots of holidays – they all add up.
In some cases, they can go above that HEM amount. So let’s say you’re spending more than the $1,700 they’ve estimated. As soon as you get above that $1,700 for spending, it’s going to affect your borrowing capacity.
So they’re looking at general living expenses and then anything that they would consider to be on top. Sometimes they might make their own assumptions. If you’ve been buying baby shower gifts, they might assume that you’re pregnant and buying for yourself.
Some lenders are very, very thorough. Others get everything. Others, if you’re declaring that you do a bit of gambling and you do a bit of this, it’s quite normal and that’s all factored into that $1,700.
You’d be very surprised at how much people actually get to spend without it affecting their HEM.
Liabilities and how they affect borrowing capacity
So in terms of discretionary spending and how it affects borrowing capacity, can we put it into specific terms?
Well, it depends if you’re going above that HEM amount, but there are certain things that will definitely affect it.
So liabilities are then expensed again on top of your living expenses. So if you’ve got credit cards, car loans or any personal loans or debt, that will increase your HEM as well. Even if your credit card balance is at $0, the mere fact that you could easily put money on the card will severely cut your borrowing capacity.
There’s a household expenditure measure for a single person, for a couple, a couple with one or more children. And then it also breaks down to how much income you earn and where you live.
We looked at this a couple of months ago and a $50,000 car loan actually had a bigger effect on borrowing capacity than having a child did.
What lenders don’t like to see
As well as what we’ve mentioned above, here are some of the things banks don’t like to see in your financial statements:
- High discretionary spending: If you’re a regular at the shops or online stores, it may be a red flag.
- Buy Now Pay Later: Any sort of indication that you might be a bit tight on money can cause you issues. Payday loans have a huge impact on your application.
- Gambling apps: Banks generally aren’t big fans of people who gamble. Obviously the more you gamble the worse it is as this is just seen as an expense. And, no, your winnings or your guaranteed strategy don’t help your case.
- Large cash withdrawals: Lenders don’t like it if you’re regularly taking out big sums of money because they don’t know where that money’s going.
- Lots of subscriptions: Having a subscription to a gym, Stan and Tidal is fine, but if you’ve signed up for every service out there that could be a problem as it shows regular, ongoing payments.
But again, if all of this fits underneath that HEM amount, then it should be fine. If it’s above, it can really affect your borrowing capacity.
What I’ve found in experience is lenders will actually look closer at your application if you’ve declared living expenses less than the HEM amount. Because they know that 85% of people are above that.
So they’ll ask for three months of bank statements and try to figure out whether you’re full of it or trying to manipulate your borrowing capacity.
Credit behaviour matters more than people think
The next big thing is credit behaviour. This is probably the number one thing we see a lot of the time.
People go into Harvey Norman, get the Latitude cards, months interest free, and they don’t realise that if you miss one payment, it gets reported back to your credit reporting company – usually Equifax or Illion.
If you miss a payment by more than a week, it can be listed on your credit file and that takes a huge hit to your credit score.
Most lenders need a credit score above 600 to even consider your application.
Lots of inquiries is another big issue. People think applying at 20 different places is the best way to compare rates, but every application shows up as negative credit behaviour. It’s the same as if you’re actually taking out 20 cards at once.
If you get flagged in this way, you end up getting bundled in with the desperados applying at 50 places in a day.
Lenders then look at that and go, I don’t want to give them money because they look desperate.
Credit behaviour is probably more important than your household expenditure measure.
Credit scores can recover
Your credit score is linked to the probability of you defaulting on a loan. It’s very accurate.
If your score is around 200, it might say you have an 85% chance of defaulting.
Credit scores do repair. If you behave yourself it will slowly go up. The quickest way to do this is to stop making inquiries and paying on time.
A mortgage broker can guide you on how to improve your credit score and can run a soft touch credit report that doesn’t affect your score.
Credit cards and buy now pay later
Other borrowing capacity issues are credit card limit, even if they’re unused.
A $10,000 credit card limit is assessed at about 3.8% per month, so $380 is used in your serviceability.
That can make a big difference.
So get rid of your credit cards if you can, or at least reduce the limits. Once you’ve been approved, there’s nothing stopping you applying for a new one.
Buy Now Pay Later is also now being reported on credit files. Every application is an inquiry. They’re often looked at more negatively than credit cards.
Having one isn’t necessarily bad, but having multiple can hurt you.
Stability matters
Stability is another big factor. They want to see that you can save a deposit over time. They want to see that you can hold a job for more than a couple of months.
People with stability are usually better at paying loans back.
The more boring you are, the more chance you have of getting a loan. It’s as simple as that.
Most lenders only look at around three months of behaviour. It’s not that long to behave yourself.
Improving your chance of getting a home loan
To summarise, yes, a deposit is important but lenders are looking at much more than that.
They look at spending habits, existing liabilities, credit behaviour and stability.
If you’re planning to purchase, start planning early. Speak to a mortgage broker. Work on your borrowing capacity before you fall in love with a house. Because the worst time to find out you have bad credit or late payments is after you’ve already picked a property.