When you’re applying for a loan, you’ll likely encounter a few stages along the way that you’re not familiar with. One important stage is the serviceability assessment, and this is used to determine whether you’re able to repay the loan on time and efficiently.
What exactly is “serviceability,” and how can you handle this portion of your loan application with confidence? In this guide, we’ll break down the serviceability assessment as well as the many factors that go into it. Applying for a loan might not be simple, but it doesn’t have to be intimidating.
What Is Serviceability?
When you complete a serviceability assessment for a loan, the bank is trying to determine your “serviceability.” This is defined as the ability of a borrower to meet loan repayments within the agreed time. In other words, they take into consideration your income, expenses, and so on to make sure you’re likely to repay the loan back.
Banks are in the business of making money. When they lend funds to borrowers, they want to know they’ll get payments on time. This is how they ensure they’re making strong investments.
The serviceability agreement results in a number known as the debt service ratio. This sounds complicated, but it’s a borrower’s monthly debt and expenses compared to their monthly income. This number helps lenders understand who is a safe vs. risky investment. For most lenders, this number rests between 30 and 35 percent at its maximum.
What Counts as Income?
The most important number in your serviceability assessment is your income. This is defined somewhat broadly according to most lenders, and it includes any of the following:
- Salary (from your primary employment and second jobs)
- Rental income
- Overtime income
- Commissions
- Centrelink benefits
Each industry is compared a bit differently when it comes to your income. For instance, if you work in an industry where overtime is not common, it’s unlikely that this will be taken into account to much extent. On the other hand, if you work in medicine or emergency response, overtime is a large part of the job so it will be considered more.
When it comes to Centrelink benefits, the ones that matter the most are the Family Tax Benefit Parts A and B. Similarly, if you have a second job, the income will only usually be taken into consideration if you’ve had this job for over a year. It’s about looking at the long-term big picture.
How Do Banks Determine Your Liabilities?
On the other hand of your income is your liabilities. These are expenses, debts, and other payments you owe regularly. The more you owe, the less you’ll be eligible for credit in the future.
What liabilities do they look at on the serviceability assessment?
- Credit cards
- Car loan
- Personal loan
- Existing rent or mortgage payments
- Student loans
When it comes to credit cards, the bank generally calculates a minimum repayment obligation between 2.5% and 3% of the overall limit. This means if you owe a balance on a card with a $10,000 limit, they’ll assume you’ll need a monthly repayment of around $300. Cancelling cards you don’t use is a great way to improve your serviceability.
Additionally, the number of dependents under your care also affect your liabilities. Banks recognise that raising children or caring for other dependents brings its own costs. Similarly, if you’re in a couple that shares finances, this will be taken into account as well.
How to Improve Your Serviceability
Luckily, it’s not too challenging to improve your serviceability when preparing for the assessment. The more time you have in advance, the better. This is why it’s essential to set clear, reasonable long-term financial goals.
You can improve your serviceability with these actions:
- Boost your income – Bringing in more income long-term will only help you. Whether you take on a second job or ask for a pay raise, these things can help your chances of securing a loan.
- Close unused accounts – Holding onto credit cards you aren’t using won’t do you any favors. This only appears more risky to lenders. If you’ve paid off a credit card account, make sure to close it.
- Reduce your expenses – Creating a budget to use to reduce your expenses is another important step. The less you spend, the more you’ll have to save.
- Compare rates – Last but not least, be sure to compare loan rates to find the best value and best interest rate to reduce the amount you’ll owe long-term.
Understanding the Serviceability Agreement
Whether you’re buying your dream home or just considering a home long in the future, you need to understand just how much banks are willing to lend you. This amount depends heavily on your serviceability, a number determined through the serviceability agreement.
If you’re worried about how much you can afford or how to improve your serviceability, contact Debt Busters on 1300 368 322 today. Our team has over 15 years of experience helping Aussies make big strides towards financial freedom.