By Bhavesh Malani

Let’s talk about how lenders assess loan applications, and what that means for you as a potential borrower. Note that we’re only going to discuss the big picture here: each lender has their own internal criteria, which is beyond the scope of this article (and above my pay grade!). The general criteria are referred to as the 5 C’s or 5 Canons of Lending (that’s canon as in laws or criteria). 

This refers to your ability to repay the debt, not whether you’re still using the Covid Tracer app (side note: use the Covid Tracer app!). This usually involves a credit check, as well as things like your assets and savings relative to your age; your occupation; residency status and stability, spending patterns, etc. If there are any red flags e.g. unarranged overdrafts, missed payments, multiple trips to the casino or a decreasing savings balance, the lender may request more information or refuse credit entirely. 

If you are planning to apply for a loan soon and have less than ideal account conduct, you should focus first on repaying your existing debts and improving your savings habits. A home loan is the biggest financial responsibility most of us will ever undertake, and lenders want to be assured of timely repayment. 

 This tests your financial strength and ability to repay the loan. Lenders take your total net monthly income and deduct your fixed commitments, such as existing and proposed loan repayments, rates, superannuation, etc. They then deduct your essential and discretionary expenses and assess the remaining surplus. If there is enough money left over at the end of the month, the lender is satisfied that you will be able to meet your proposed loan commitment. The proposed loan repayments are tested at an interest rate that is far higher than what you would actually pay, so there is a fair degree of conservatism in the numbers used by the lender. This ensures that in case rates increase or your circumstances change, there is enough buffer for you to continue making repayments. 

Your capacity is the most controllable of the 5 C’s on your part, as it relates to your spending habits. Obviously, if you reduce your spending, you’ll increase your surplus income and be able to service a higher loan. Keep in mind, however, that banks maintain a standard living expense schedule based on the number of adults and dependents in your application. If your family only spends $1,500 per month, but the bank’s standard figure is $2,300, the higher number will be used when calculating your surplus income. Beyond a point, reducing living expenses on things like food, transport, utilities, does not affect your borrowing capacity (although it still improves your actual cash flow!). However, reducing discretionary costs e.g. private education, donations, gym memberships, cable TV, etc. can make a dollar-for-dollar difference in your monthly surplus!  

You can also consider reducing the limits on your credit cards and/or overdraft facilities, because as far as the lender is concerned, it doesn’t matter if you have anything owing against them, or if they’re paid off in full every month. The lender will consider a percentage of the limit (usually 3-5%) as a fixed monthly expense to cover interest payments on those facilities. For example, if you had a credit card with a limit of $10,000, the lender would assume you spend $300 in credit card fees every month! If you only ever spend $2,000 on the card every month, you could easily reduce your limit to $5,000, increasing your monthly surplus by $150 while still leaving sufficient buffer in your credit card limit for unforeseen expenses. 

The availability of credit depends on the regulatory and economic climate, as well as monetary policy. At the time of writing, the Reserve Bank has reduced the Official Cash Rate (OCR) to an all-time low of 0.25% and introduced a Funding for Lending Program (FLP), both of which have enabled banks to lower their short-term mortgage interest rates to near 2% per annum.  

However, the massive increase in house prices over the past year has also caused banks to require higher deposits in anticipation of the Reserve Bank reinstating the Loan to Value Ratio (LVR) limits. Uncertainty around the sustainability of the post-Covid economic recovery is likely also to inform future credit decisions made by the banks.  

Although you can no longer promise your first-born child to the lender (PC gone mad, I say!), you still need to provide some form of security so that, in the event you are unable to repay your loan, the lender can recoup their investment by selling the security. Most commonly, the house you purchase is the security. It should be noted that lenders in New Zealand are extremely reluctant to foreclose on homes: it is far better for them to earn interest for 30 years than to go through the process of a mortgagee sale for close to break-even value. It is precisely because of this reluctance (and the Responsible Lending Code) that the main banks are as conservative as they are in assessing potential borrowers. While it may be frustrating for a lot of people looking to get their feet on the property ladder, it does also mean that once you meet the criteria, you are in a very strong position to repay your loan over the long term.  

Show me the money! Lenders require a minimum deposit (capital) depending on the type of dwelling (existing property, new build, leasehold, vacant land, apartment, etc.) and the purpose for purchase (own occupation, rental investment, development, etc.). An applicant’s capital and collateral represent their “skin in the game”. If the lender perceives a higher chance of the borrower being unable to meet their obligations(such as with an investment property), they will require a higher deposit to cover this risk.  

As you can see, lenders have a great deal of discretion in assessing a borrower’s ability to repay the loan and their final decision often rests on issues of character or conditions. Lending criteria are constantly changing, and it can be difficult for most to stay abreast of developments. That’s why it helps to speak to a mortgage adviser. It’s our job to stay in the know and to advocate for our clients when seeking lending. If you have any questions or just want to know how much you could borrow, get in touch with me for a no-obligations consultation! 

Disclaimer: The above is an opinion of the author and must not be construed as individualised financial advice. In all cases, before making any financial decisions, it is recommended that you seek individual advice relevant to your situation.