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How Lender Qualifying Rates Have Changed!

The Banks have increased their ‘qualifying’ interest rate for assessing debt serviceability. As a result loans that would have been secured earlier are now being rejected so preparation is key when applying for a mortgage.

How The Banks Assess Debt Servicing

Here is an example of how the banks look at debt serviceability….

Bob Smith had properties worth $1.25m and he was getting a 6% gross return or $75k rent per annum. He had a 80% mortgage or $1m of debt and since mid 2013 had the debt locked in for 3 years at 5.50% on an Interest Only basis. This was costing him $55k per year in actual mortgage costs (expenses).

Bob’s properties were also costing him roughly $10k per annum in (expenses) e.g. rates, insurance property management etc.

Therefore after subtracting the expenses from the revenue Bob had a pre tax profit of $10k per annum from his property portfolio.

Please note the Banks look at this structure differently when assessing the borrowers ability to service the loan. – The banks assessment is on a principle and interest loan (not Interest Only) and they are currently using the 7.5 percent interest rate which is 1 – 1.5 percent above the average.

Therefore from the Bank’s viewpoint this is Bob’s property portfolio…

Rental Income $75k x 75% = $56,250 per annum
$1m mortgage at 7.5% on principal and interest = $83,904

The Banks view Bob’s property portfolio as negative – i.e. it is costing him circa $28k out of his own pocket to run.

While this is not Bob’s actual situation remember he is positive $10K (pre- tax). The Banks are assessing Bob on his ability to service the debt when interest rate is at 7.5 percent and on a Principle and Interest loan.

Now we know Bob would contact us to find the best loan structure so it’s unlikely he would incur the costs based on the Banks assessment his property portfolio. However it’s important to understand exactly how debt servicing is calculated and prepare as best as you can.

Contact Kris at Kris Pedersen Mortgages