Serviceability vs. affordability – What’s the difference and how does it affect me?

ByAndrew Mirams
Serviceability vs. affordability

Many medium- to high-income earners believe that when they apply for a home loan there will be no trouble getting it approved. Often this is the case.

But sometimes this isn’t necessarily the case because lenders assess each applicant on a number of factors including their ability to service the loan.

Now, serviceability (how the banks and regulators want a lender to look at you and be sure you can meet your loan repayments with a buffer on top) is different to affordability (what you actually pay and can afford on a month to month basis), so this article will outline the key differences between the two as well as how you can improve your chances of a bank saying “yes” to your application instead of “no”.

Affordability vs. serviceability

When applying for a home loan, a lender will assess whether each applicant has the necessary cash flow to pay, or service, the mortgage.

And just because someone has a reasonable income, it doesn’t mean that they will automatically be given the green light. 

Therefore the term serviceability means the ability of a borrower to meet loan repayments.

This will be assessed on a number of contributing factors including:

  • Income, which can include your salary, rental income and investments.
  • Living expenses, which can be more for high income earners who tend to live more lavish lifestyles. That is, their expenses rise up to meet their income! 
  • Debt expenses and other commitments such as credit card limits or personal loans.

As a general rule of thumb, your borrowing capacity, which is another way of saying serviceability, is between 5 & 6 times your total gross annual income. This income is inclusive of your wages or income(s), rents and other earnings like overtime, commissions or bonuses. All can be used towards the assessment of your borrowing capacity. And for the self-employed, this includes your profit, wages paid to yourself and then adding back of expenses such as deprecation and other items.

In the best part, it’s a quite complex method to working out someone’s serviceability which is why working with a mortgage broker who can do this for you is often going to lead to you achieving a different or better result.

This figure is known as the “debt service ratio” and is a borrower’s monthly debt expenses as a proportion of monthly income. This helps lenders evaluate whether they can afford the loan. But this isn’t the only method. Some use an income figure that is uncommitted after allowing for all living and loan servicing costs and other a Net Servicing ratio.

Confused yet?

Each lender has its own assessment method, that’s why it pays to engage with a professional mortgage broker who can cut through all this for you!

In assessing your application, banks will also apply certain calculations to your existing mortgage loans, rental income and any credit card debt. For example, your rental income may be reduced by 20 to 25 per cent to allow for vacancies and your credit card debt will be assessed as though your cards are all up to their limits (not balances), etc. 

And then there’s the way banks look at our self-employed clients. Are they using the average of the past 2 years profits, are they using 1 year profit, will they use the directors wages being paid or a combination of all of the above?

See what I mean?

Conversely, the term affordability refers to a borrowers’ capability to pay off the home loan.

Lenders will consider whether an applicant can continue to live the lifestyle they do now while making mortgage repayments. If not, then the loan application may not be approved.  

Why is affordability so much harder now?

Over recent times, lenders have changed their calculations of living expenses, which is having an impact on affordability and loan serviceability criteria.

I think we can all agree that the cost of living, in recent years, has risen quite dramatically.

Lenders need to be able to assess someone’s living expenses firstly, before they will even commit to a loan for them. Ultimately, your live before you buy or invest and if you can’t afford to live, then you definitely can’t afford to borrow.

In the past, a fairly generic calculation was used to assess a borrower’s living expenses, but given the hot property market in some cities this criteria is now assessed at a more individualised level.  

You will be asked more information about your living expenses now, and also asked to break down these expenses on a monthly basis. Everyone now has to do this, and whilst frustrating, it’s not your broker or even bank mandating this, but the Australian financial regulators like APRA (Australian Prudential Regulation Authority) or ASIC (Australian Securities and Investment Commission).

Interest rates remain your single biggest mortgage cost and your affordability is simply the minimum monthly repayment you are required to pay. Whereas, when a serviceability calculation is done, there is a mandated buffer of 3% added to the borrowing capacity equation i.e. current day home loan interest rate is 5.34%, however banks assess your serviceability with a 3% buffer added on being 8.34%.

Many borrowers are wondering how they can improve their borrowing capacity in light of this tighter lending environment especially as property prices, across the country, continue to increase.

Some time ago, New Australian Prudential Regulation Authority (APRA) rules have also limited the flow of interest-only loans to 30 per cent of total new residential mortgages.

How much can I borrow?

Just as lenders have differing serviceability criteria, they also can have different calculations when it comes to how much they will lend you. 

This was highlighted by a “secret shopper” experiment by APRA in 2016 where it presented “applicants” to different banks to assess how much they were willing to lend to each of them.

The insightful results showed that the most generous lenders were prepared to lend 50 per cent more than the most conservative. 

With lending to investors being more closely watched and regulated, it’s no surprise that the disparity between owner-occupiers and investor borrowers was the greatest.

The outcome of the survey showed that banks were willing to lend at levels ranging from five to 6.5 times a borrowers gross income. 

However, a caveat to that is that the borrower would need to also produce a 20 per cent deposit to keep their loan to value ratio (LVR) within the banks preferable or sweet spot range of 80/20 or below.

If your LVR is above this amount, you would also be liable for Lenders Mortgage Insurance, which can impact your borrowing capacity as well as the servicing tests at these higher levels get even stricter for a borrower, given the risk profile. 

How can I improve my borrowing capacity?

With home loan serviceability on the radar of lenders, borrowers should do everything they can to improve their borrowing capacity as well as their chances of being approved for their chosen loan product.

There are a number of ways that you can improve your attractiveness to banks which can include:

  • Understand your living expenses or even have a budget that you work towards before even making any loan applications. All too often we see people guessing these expenses and potentially costing them selves opportunities to get into the market.
  • Compare home loans – one of the easiest ways to improve your borrowing capacity is to shop around for the best deal for you. Consider a number of different options and perhaps look for a mortgage broker that specialises in your situation e.g. Self-employed home loans. 
  • Many borrowers don’t understand that it’s the total limits of their credit cards that are counted in serviceability calculations, so consider cancelling some of them or lowering the limits. Reducing the limits on your credit cards can have a drastically positive impact on your borrowing power. This also relates to BNPL (buy Now Pay Later) facilities that issue you with a limit for your purchasing power.
  • People also don’t understand that personal loans or car loans – no matter the interest rate or potential tax benefit gained – have a massive negative impact on your borrowing capacity.
  • Another option is to consolidate your debt so that you only have one payment per month and also only one portion of debt that is accruing interest. Ideally, you should try to pay down any of this type of “bad debt” – such as a car loan – before applying for a home loan.  
  • With loan serviceability criteria tightening up, it’s also wise to document your finances – including all incomings and outgoings – so you can provide a thorough assessment of your regular living expenses. This is of particular importance for self-employed borrowers who can be faced with a more arduous loan serviceability assessment. One of the best tools we have seen for this is the Moneysmart budget planner https://moneysmart.gov.au/budgeting/budget-planner that we recommend people try if they have no other means to work out this. It has an online and excel version.
  • Saving a larger deposit, or using other investments to finance a deposit via equity, can increase the amount that you can borrow as well as showing the lender that you have good money and investment habits. 
  • As saving for a deposit has gotten substantially more difficult, look at options to use a government grant or incentive, or otherwise seek help from the “Bank of Mum & Dad” to assist with that deposit. There are numerous ways this can be taken i.e. cash gift or linking a family property as support under a guarantee – if you want to know more details on this, feel free to reach out to discuss

For any information on this or other matters, don’t hesitate to reach out to any 1 of our experts, all of whom can assist you.

Conclusion

Banks are still open for business and are willing to lend to borrowers with sound financial foundations. It doesn’t mean that solid borrowers with good credit histories and robust income levels can’t qualify for home loans, it’s more just a matter of the “hoops” you have to jump through to achieve your desired outcome.


As long as we continue have regulation in the markets – which is a good thing and keeps both our lending environment and housing markets “in check”, it is still important to do your proper research when considering your borrowing capacity versus your affordability.

Andrew Mirams
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