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What is lending criteria? The factors that may help you get a home loan

What is lending criteria? The factors that may help you get a home loan

Banks and mortgage lenders want to make sure that they provide home loans only to borrowers who can comfortably afford the repayments. With this in mind, most home loan deals require borrowers to fulfil certain eligibility criteria in order to successfully apply.

The best rates for the best borrowers

Whenever a bank lends money, it’s taking a risk that the borrower might not pay them back. This is one of the reasons why banks and mortgage lenders charge interest and fees on their loans. The higher the risk that a borrower may not pay back the loan, the higher the interest and fees the lender may charge.

But if you can prove that you’re a low-risk borrower, a bank may feel more confident about lending to you, and may even offer you lower rates, lower fees, and/or more flexible features and benefits to help attract your business.    

What can help you qualify for a better home loan?

Aside from providing your basic identification documents (e.g. driver’s license, passport etc) and similar proof of age, identity and residency, fulfilling the following requirements may be able to help you qualify for a home loan that better suits your needs:

A high deposit of genuine savings

Most home loans require the borrower to pay a minimum deposit amount as part of the lending criteria. A common benchmark is 20 per cent of the property value, which is enough to avoid the extra cost of Lender’s Mortgage Insurance (LMI) in most cases. If you can afford to pay more than the minimum deposit amount upfront, thus reducing your Loan to Value Ratio (LVR), you may qualify for a lower interest rate on your home loan.

Keep in mind that lenders may have other requirements regarding your deposit. Many lenders prefer that most of your deposit is made up of ‘genuine savings’ – in other words, money earned from your job and put aside. While part of your deposit can still be made up of money from First Home Owner Grants, sale of assets e.g. shares, or gifts from family and friends, genuine savings help provide reassurance to a lender that you’re a responsible borrower who can manage their finances.

A steady income

It may surprise you to learn that having a high income may not be as important to a mortgage lender as having a steady and consistent income. Proving that you’ve held a steady job for a significant length of time can help give a lender greater confidence that you’ll be able to afford your mortgage repayments, now and in the future.

If you’re a freelancer, contractor, sole trader or small business owner who doesn’t receive payslips from an employer, you may not be able to easily provide the income paperwork necessary to qualify for some low-rate home loans. Some lenders may offer low-doc or alt-doc home loans for these borrowers, but these mortgage offers may have higher interest rates to help offset the higher risk to the lender.

Manageable expenses

Household expenses such as utility bills, telephone and internet, petrol, groceries, entertainment subscriptions, council rates, childcare and so on can all add up. If a significant percentage of your income is already spoken for, it may not leave much left over for your mortgage repayments. This could put you at a higher risk of ending up in mortgage stress if interest rates were to rise, or if you experienced a sudden change to your personal or financial circumstances, such as losing your job or suffering a serious injury.

Finding ways to reduce your household expenses may help to improve your chances of being approved for a home loan. You’ll need to provide proof of your income and expenses such as bank statements as part of your home loan application, so making some lifestyle changes today could make a difference to a home loan application taking place months down the track.

A respectable credit score

Your credit score measures whether or not you’re a risky borrower. If you’ve successfully applied for and repaid loans in the past, you may have good credit. But if you’ve had money troubles in the past, such as a payment default or bankruptcy, you may have bad credit.

Because home loans are secured by the value of the property being purchased, your credit score doesn’t play as large a role in determining the interest rate on your mortgage as it would when applying for other types of credit. That said, your lender will still conduct a credit check as part of processing your mortgage application. Bad credit borrowers may find it easier to be approved for a home loan if they approach a specialist lender, though there may be less choice available when it comes to interest rates, fee, features and benefits.

A record of your assets and liabilities

A mortgage lender will want to know more about what you own and what you owe when you apply for a home loan.

Valuable assets such as cars and other vehicles, fine art, jewellery, shares, cryptocurrency, and other properties may all be taken into account when calculating your potential borrowing power, as selling these assets could be an option if you ever experienced mortgage stress.

Similarly, the lender will want to know about any personal loans, car loans, credit cards and other outstanding forms of credit you have in your name. If you already owe money to other lenders, a bank may be hesitant to lend you more money to buy a property, as this could leave you unable to repay any of your loans if you experienced financial problems.

Keep in mind that if you have a credit card, the lender may be more concerned about the maximum credit limit than how much you currently have owing. This is so they can calculate if you could still afford your loan repayments in a “worst case scenario” where you’ve maxed-out your card and are being charged interest on this full amount. Reducing your maximum credit limit and/or cutting up unused credit cards could help to improve your position.

An accurate valuation

Even if you’re preapproved for a home loan, it’s not automatically guaranteed that the lender will sign off on a mortgage when you buy a property. For example, if after you’ve made an offer on a property (either at auction or privately) your lender’s valuation comes back significantly short of your purchase price, this could increase your LVR, requiring a higher interest rate, or an alternative loan.

A short valuation could occur if prices in the area have fallen dramatically, the property has major issues, you’ve overbid for the property, or there’s not enough recent sale info to compare it to. Whatever the reason, you may not receive your final loan approval until everything is sorted out.

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This article was reviewed by Personal Finance Editor Alex Ritchie before it was published as part of RateCity's Fact Check process.

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