The home of your dreams…it’s just a serviceability test away

Lenders don’t use the loan’s advertised interest rate to assess your application and whether you can afford to repay it – they have much higher hurdles for you to jump over. This is your InfoChoice guide to home loan serviceability and buffer rates.

By Jonathan Jackson

The current interest rate set by the Reserve Bank of Australia is its lowest in Australian history.

While the RBA held steady at 1.5 per cent for close to three years, (August 2016 to May 2019), last month’s decision to slash rates to 1 per cent was a reaction to rising unemployment and a slowing economy.

Commenting on the cut, RBA governor Philip Lowe said, “It will assist with faster progress in reducing unemployment and achieve more assured progress towards the inflation target.”

The decreasing interest rate has had one further effect: it has led to the Australian Prudential Regulation Authority (APRA) releasing new guidance on serviceability assessment for home loans.

In other words, APRA relaxed its interest rate serviceability test and it’s borrowers who could benefit.

What are serviceability and buffer rates?

Serviceability and buffer rates are used by authorized deposit taking institutions (ADIs) to assess whether borrowers have the capacity to repay their home loans should interest rates rise.

Essentially, you could have $100,000 deposit to put into a brand spanking new home, only to find that it’s not enough to meet a bank’s overall serviceability requirements.

It’s a rare case where size doesn’t necessarily matter.

Linda Veltman, General Manager Credit Risk for ME says, “Serviceability is the ability to meet loan repayments based on the loan amount, your income, expenses and other commitments. Lenders add a margin to the offered home loan rate to arrive at what is known as an ‘assessment rate, to check you can continue to repay your debt in the event of higher interest rates.”

With interest rates declining, Veltman says, “Regulators have allowed banks to lower the assessment rate because we are in a lower rate environment. This will enable more borrowers to meet the serviceability requirement, and some borrowers may be able to borrow more.”

That’s good news for banks and better news for borrowers.

How does a mortgage buffer rate work?

A home loan buffer rate has nothing to do with your computer or how fast you can download stuff. A buffer rate is an extra interest rate added to the advertised rate. It is used to assess your ability to repay your loan, if rates were to rise.

Previously, borrowers applying for a mortgage with an interest rate of 4.2 per cent were assessed on whether they could repay the loans at an interest rate of 7.25 per cent or a 2 per cent buffer, whichever is higher.

Many banks have now reduced their serviceability rate to between five and six per cent, whilst increasing the buffer to 2.5 per cent.

So which bank has the lowest serviceability rates?

ME, previously known as ME Bank or Members Equity Bank has announced a very low floor serviceability rate.

“ME Bank has decreased its serviceability floor rate from 7.25 per cent to 5.25 per cent p.a. and increased its buffer rate from 2.20 per cent to 2.50 percent p.a. above the offered interest rate, for all home loan applications.

“Whichever rate is higher is used as the minimum for assessing home loan application serviceability,” Veltman told InfoChoice.

“The change appropriately reflects Australia’s new low rate environment and should have the effect of opening up lending to more home loan customers.”

Which lenders have very low loan serviceability and buffer rates?

Prior to ME Bank lowering its serviceability rates, Macquarie Bank had the lowest criteria, with a serviceability rate of 5.30 per cent, undercutting the big four banks.

NAB lowered its interest rate floor to 5.5 per cent, the last of the big four banks to do so. It is in line with ANZ. The CBA and Westpac reduced their rates to 5.75 per cent. Each bank increased its buffer to 2.5 per cent.

“Westpac Group takes its responsible lending obligations seriously and is committed to supporting our customers into their homes,” says Will Ranken, Westpac General Manager Home Loans.

A CBA spokesperson told us, “APRA’s decision to update its guidance relating to serviceability assessment rates will provide lenders with greater flexibility to set their own serviceability floors, while maintaining a measure of prudence.”

Suncorp, MyState Bank, Bendigo and Adelaide Bank, The Bank of Sydney, and Auswide Bank, also adjusted their serviceability and buffer rates.

Know your limitations

As Dirty Harry (Magnum Force – do yourself a favour and watch it) once said, “A man’s got to know his limitations”. The same rule applies to borrowers.

Just because the banks have relaxed their serviceability criteria, doesn’t mean that you can or should borrow beyond your capacity to repay the loan. You can still get knocked back, although you may seek out a different lender for a second opinion.

Whilst Ranken says, “The new serviceability assessment rates may have a positive impact on the borrowing capacity of qualified borrowers,” Veltman tells a more cautionary tale.

“Always buy affordable. That means having a mortgage you can comfortably repay over the long term regardless of changes to interest rates, your lifestyle, and without having to rely on less dependable sources of income like bonuses. The benefit is that you’re less likely to be forced to sell a property because of short-term financial difficulties, which in a property downturn could mean selling for less than you’d like. While banks test your ability to service a loan, you need to set your own limit. Buying affordable and giving yourself some breathing space allows you to think long-term.”

If you do get knocked back, it may be worth taking the lender’s criteria into account before approaching another. Usually that means paying off your debts, reducing household expenditure and increasing your savings. You should also keep in mind that if you apply for several loans in a short space of time, your credit rating may be negatively affected.

At your expense

Borrowers should keep in mind the Household Expenditure Measure (HEM), a formula used to assess their living and household expenses. You can begin to assess the HEM question by using this borrowing power calculator. This Budget Planner is also ideal to determine what your household expenses actually come to.

The Australian Securities and Investments Commission (ASIC) claims that Westpac has breached the responsible lending provisions of the National Consumer Credit Protection Act 2009 by using a computer operated loan approval system that relied on the HEM to calculate potential borrowers’ living costs.

This claim is the subject of an ongoing action in the federal court. An initial decision by Justice Nye Perram found that the ‘mere fact that a consumer has declared living expenses is not necessarily relevant to whether the consumer will be unable to comply with their loan obligations, because it is always possible that some of the declared living expenses might be foregone by the consumer in order to meet repayments’.