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How do banks approve my home loan?

  • Yellow Loans
  • Jan 13, 2022
  • 7 min read

Updated: Jan 30, 2022

Home loan lenders and banks consider a number of things when deciding on if they should approve your home loan. Lenders assess your home loan on what are the five C's of the credit analysis. They include:



CHARACTER Character is the moral obligation that a borrower feels to repay the loan. Since there is not an accurate quantifiable measure to judge character, the lender will decide subjectively whether or not the applicant is sufficiently trustworthy to repay the loan. This involves investigating the applicant’s past payment experience, reviewing a credit bureau report, and considering the applicant’s educational background and (if relevant) experience in business.


The quality of references and the background and (if relevant) experience of employees will also be considered.

Lenders will look at these and your income sources (salary, investments, dividends) to assess how much money they’re willing to lend to you. Use our borrowing power calculator to get a rough estimate of how much you may be able to borrow.

CAPACITY Lenders need to determine whether the applicant can comfortably manage the repayments. Past income and employment history are good indicators of ability to repay outstanding debt.


Income amount, stability, and type of income may all be considered. In the past, banks were prepared to place greater reliance on the strength of the security offered for the proposed loan. This, however, is contrary to the responsible lending provisions of the NCCP Act, which are designed to ensure that repayments can be made without financial hardship, with selling the family home normally being regarded as a circumstance of financial hardship.


Further, banks have found that it can take a considerable amount of time and money in realising the security in satisfaction of the amount of the outstanding loan. Consequently, lenders have moved their emphasis from lending against security to lending against cash flow.

CAPITAL Capital refers to the capital contribution that the borrower proposes to make in the total investment. An investment is usually financed partly by loans and partly by the capital contribution of the borrower. With housing loans, banks usually require the owner to contribute at least 20% of the total investment.


That way the value of the property will be less likely to fall below the value of the loan, thereby giving rise to a “negative equity” situation, with the loan being worth more than the property value and the borrower consequently being less inclined to keep up payments.

COLLATERAL Collateral consists of property or other assets that have been given as security for a loan. Collateral, and sometimes third party guarantees, are forms of security a borrower can provide.


Collateral is regarded as a secondary source of payment that can be relied on if the borrower’s cash flows are insufficient – a “second way out”. In the case of personal loans, the collateral is likely to be the asset being purchased, with the asset being seized on and sold by the bank if the borrower defaults. The literal meaning of collateral is “along side”. A security exists alongside a loan.

CONDITIONS “Conditions” refer to external conditions, mainly national and local economic conditions. It is usually not a strong consideration with housing finance.

How are the five C’s assessed for the purpose of getting a home loan? It is not possible to point to everything that might be considered when assessing a housing loan. However, some of the points that are more frequently looked at are considered below.

CHARACTER Character is assessed by looking at: · credit history using a credit reference agency report: and · employment and residence history.

The credit check is always likely to be inevitable. Applicants should disclose and explain any instances of past credit impairment when they apply for a loan. Some lending institutions are prepared to go ahead with credit-impaired loans, but only when there has been complete honesty on the subject.

· Employment and residence history are sought as indications of stability. Examples of indicators of acceptable status are: · P.A.Y.G. employment – a minimum 6 months in current employment. If less than 12 months in your current employment, previous employment must have been for at least 2 years and in the same field. · Self employed – at least 2 years trading in the current business. · Residence – preferably at least 2 years at current address (address changes will be considered, but usually more than three addresses in the previous two years will be scrutinised heavily by the lending institution).

CAPACITY Lending institutions need to determine whether the applicant can comfortably service the repayments.

To do this, they will use current income figures (not expected income) and perform a calculation called serviceability. Each lending institution has its own method of calculating serviceability, and hence total lending capacity varies depending on the lending institution.

An assessment of serviceability begins with an examination of income and expenditure. Income The following table provides an indication of how a lending institution may access different forms of income or different types of employment.

The lending institution will perform various checks with the applicant’s employer, or previous employers, to verify the information he/she provides to them.

Income and Expenditure Assessment of different forms of income

Wages

Lenders usually accept 100% of this figure.

Bonuses

Lenders may accept bonuses if they have been consistently earned during the last two years

Rent

Lenders usually accept up to 75% of the rent received as income (this makes allowances for vacant periods)

Interest

Lenders may accept interest income if it has been regularly paid over the last two years, otherwise it is usually disregarded.

Dividends

Lenders may accept dividend income if it has been regularly paid over the last two years, otherwise it is usually disregarded The following table provides an indication of how a lending institution may access different forms of income or different types of employment. The lending institution will perform various checks with the applicant’s employer, or previous employers, to verify the information he/she provides to them.


Assessment of different forms of expenditure


Existing Loans

Monthly repayments are required for all loans.

Credit Cards

A nominal repayment may be applied. If, however, the applicant has a record of paying off such debts promptly, they may be ignored.

Rent

The lender makes allowances for continuing rental commitments

Maintenance

Monthly maintenance expenses are included in serviceability calculations

HECS/PELS

Higher education debts are included in serviceability calculations

Cost of living

Each lender calculates the applicant’s cost of living, based on family size, number and type of motor vehicles, educational expenses etc. Tables provided by the Australian Bureau of Statistics (ABS) may be used.

New Loan repayments

Each lender calculates expected loan repayments, and with a loading added to the interest rate (1.5 - 2%) as a buffer for future interest rate rises. This buffer helps the loan provider feel more content that in the event that interest rates rise in the future, the applicant will be able to make the required increased repayments.


Measures of capacity

The traditional way to measure an applicant’s capacity to repay a housing loan is to calculate the applicant’ “surplus” after all income and outgoings, including loan payments, have been taken into account.


CAPITAL

Capital, which is the third of the “five c’s” we are looking at, refers to the capital contribution that the borrower proposes to make in the total investment.


For credit assessment purposes, capital may be considered in two ways. The first way is to consider the financial strength of the client by examining their net worth by subtracting their liabilities from their assets.


The second way is to measure capital as a measure of the contribution the applicant will make to the purchase of the property.


This is achieved by using the loan to valuation ratio (LVR), which is calculated as: Loan amount / Property value = LVR (as a percentage) The LVR determines the maximum amount the client can borrow on a property and, consequently, the minimum amount they must contribute themselves. In the case of housing loans, for example, it is common for lenders to expect an LVR of at least 80%, although some are prepared to go as high as 95% if lenders’ mortgage insurance is in place.


COLLATERAL

Collateral is also referred to as “security”. In the case of mortgage lending, the property being purchased is normally accepted as adequate security for the loan, provided that the borrower has been able to make an adequate equity contribution. Real estate mortgages are registered with the appropriate land titles office (or equivalent) in each State or Territory.


*information sourced from The Five C’s of Credit Analysis - PETER ANDREWS, MBA, CPA, B.ECONOMICS, B.ARTS Former lecturer at Macquarie University


Below you will find some useful links that will provide you with all the information you need to make the best loan decision. In the meantime if you want some free professional assistance, you can contact a loan specialist on 1300 199 964

or

SYDNEY | Level 21, 133 Castlereagh Street Sydney NSW 2000 |

MELBOURNE | Level 11, 456 Lonsdale Street Melbourne VIC 3000 |

BRISBANE | Level 10, 95 North Quay Brisbane QLD 4000 |


 
 
 

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