A great many people, particularly those who are refinancing, are bullish about their prospects of getting a better loan deal. They look at
- the equity they have in their property
- the size of their income and
- their ability to service their existing loan
and wonder why brokers are concerned about their serviceability.
Banks use an index called HEM (Household Expenditure Measure) to calculate expenses. HEM was developed by economic research group the Melbourne Institute. It is based on the borrower’s income, location, family size and type of lifestyle (student, basic, moderate or lavish). It uses these to determine an estimate of your expenses. Prior to the Royal Commission, while this was supposed to be used as a guide for “minimum” expenses, some banks used it as the basis for all borrower’s expenses.
This does not make sense if you are comparing families with the same income that have different spending.
e.g. one family has children in a public school versus another with children in a private school. This is a clear example where education expenses will be markedly different.
While the borrower is putting up an asset (the house) as collateral for the loan, the lender really doesn’t want the asset. Their income from a loan paid on time is a much better deal for them, particularly if there is a possibility that the asset value could drop in the future.
Serviceability is looking at your ability to repay the loan, not just at the current interest rate but a rate greater than they are currently offering (2% or more greater than the current rate). It takes into account the borrower’s income, the expenses they declare (with detailed explanation!) and the amount they need to pay. This is much more important than equity in the property, as borrowers cannot use equity to repay the loan.
It is the major hurdle most borrowers struggle with at the moment.