When customers are considering an application for a loan they seem to be primarily focused on how much they can borrow based on their current financial position. In reality this is only one important consideration that is taken into account when assessing your loan application. When assessing a loan application, credit assessors take a holistic approach in determining their decision for approval. To give you an insight into how loans may be assessed we will take a look at what is usually referred to as the 5C’s of lending:
Focused primarily on the applicant’s financial character, this would include savings and/or rental history, previous or current loan repayment history and credit report assessment. When reviewing a credit report, lenders are not only interested in default or bankruptcy listings, the number of debt applications over a period of time are also considered. Many lenders today have systematic credit scoring that is designed to assess some of the abovementioned quantitative and many other qualitative aspects of a loan application. For instance, this may include, and is not limited to, how many times an applicant has changed addresses or employers in recent years.
Capacity measures your ability to repay your proposed loan after considering your income and allowing for current debt commitments and living expenses. Also a buffer is added to the current interest rates to allow for repayment increases due to future interest rate increases. It’s also important to factor in any future lifestyle changes that may impact your ability to make repayments. For instance, when planning a family will this entail a reduction or removal in a partner’s income for a specified period of time.
For home loans this mainly relates to your contribution to the purchase. The larger your deposit the more strength your application will have. For loans over 80% of the value of the property this will require Lender’s Mortgage Insurance (LMI). LMI means you will have capacity issues to consider if you’re adding the cost to your loan and also meeting specific conditions set by the insurers. For instance, this may include strict guidelines concerning your ability to demonstrate that your contribution has been genuinely saved.
In respect to home loans, collateral represents the house you are purchasing. This is sometimes referred to as the security. Once you have purchased your home, the lender arranges an independent valuation of it. The value of your security is based on this assessment and not the purchase price. In some cases the lender will use the purchase price if the valuation has a greater value.
This usually relates to conditions that are external to the loan, such as market conditions. For instance, during the global financial crisis lenders and mortgage insurers tightened their assessment criteria by removing or limiting an applicant’s overtime income when assessing their capacity. Also lenders may place limits to how much they will lend based on the type of security you are purchasing. For example, a maximum Loan to Value Ratio (LVR) of 80% for company titled units.