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Understanding Bank Servicing Criteria

A question we often get asked as advisers is how bank servicing criteria differs to what you may be looking at in your own budgeting & forecasts.

It can be an extremely frustrating experience for clients when they initially review their current position only to find out the way banks go about looking at things completely differently!

Typically, what many people may do in a standard situation is assess your net income (After tax, KiwiSaver, student loans if applicable, etc.), deduct their current living expenses, and arrive at a surplus (or deficit!). Logically, they will then look on different mortgage calculators and have a play with different loan amounts and current market interest rates, and make a judgement (sometimes conservative, other times bullish) on what may be affordable for them in their current position, and then assume that they would be able to borrow this much from a bank.

The problem with this method is that is not how banks view servicing at all. Typically, what lenders do is work out your net income, and they then deduct the HIGHER of either your current living expenses, or the "bank minimum" for a borrower in your situation (e.g. single adult, couple, couple with X number of children, etc.). Therefore in many cases, particularly in the current market where bank minimum expenses have increased dramatically, clients who are more prudent and cautious with their spending habits - are actually not benefitting this from the way the banks calculate their serviceability.

Further, any proposed new mortgage debt is not calculated on what the repayments will be, but rather they are calculated on much higher rates known as "qualifying rates" or a "stress test". Across the main banks these range from 8.50% - 9.50% at the time of writing, and they always calculate on a principal & interest basis - for both your existing, and proposed mortgage debt.

This can make it incredibly hard for first home buyers to get into homes, even if they have actually saved up the required deposit amount!

Further this way of calculating things causes even greater disparities for property investors! What ends up happening as you grow your portfolio, two main things occur:

  1. You generate rental income, which supports further borrowing (and the opex of owning a property)
  2. Some of your debt is put on an interest only basis.

What banks tend to do in these situations is take 70%-80% of the gross rent into account (on average, bank dependent) and disregard the other 20%-30% of the rent. The logic behind this is to have a blanket rule to allow for additional expenses of owning a property (vacancy, rates, insurance, property management, maintenance, etc.) You can imagine for larger portfolios what it does to clients when disregarding up to one quarter of their total rental income! It's worth noting here that because of the current interest deductibility rules - new-builds are often more favourable in terms of rental income (in some banks eyes) and so a higher proportion of rental income is used for assessment purposes.

While you may be reaping the benefits of increased cashflow in reality from interest-only lending, the banks always look at things on a principal and interest basis, and typically on the remaining "principal & interest term". So for example if you have a 30 year mortgage with 5 years interest only, and go to the bank with a new loan, they will assess the existing debt on one of the rates mentioned above (8.50% - 9.50%) but over 25 years - which makes servicing even harder.

To put that in perspective, imagine you had $500k of lending on 4.25% interest only, with a 30 year loan term of which 5 years was interest only, on an investment property returning $600 per week in rent ($31,200 per annum), which had $5k per annum in opex.

The difference between how you view your property and how the bank does, is drastically different:

Your view would be that the property has $5k of opex and $21,250 of mortgage repayments (interest only). For you, that property would be cashflow positive by $4,950 p/a or just over $95 per week.

The banks view would be $7,800 of opex (25% of gross rent) and repayments of $48,312 per annum (assuming 8.50% - the lower of the bank qualifying rates). For the bank, that property would be cashflow negative by $24,912 per annum or $479 per week.

As you can imagine, as a portfolio grows this makes things a lot harder to meet serviceability requirements as you grow.

The best plan of attack would be getting in touch with one of our advisers early to determine your serviceability (and therefore borrowing capacity) before you spend time hunting for property. This could save you a lot of time and disappointment!

If you've got queries about this or anything else property finance related, please feel free to

Ryan Smuts