You may think it’s pretty easy to work out what you can afford to borrow. After all, there seem to be plenty of online calculators available where you plug in your details and voila, out spits a figure that a faceless lender will theoretically lend you. We’re here to tell you there’s a little more to it than than.
Sure you may have worked out how much you can afford to pay in repayments each month, and decided it’s well within the budget. But in terms of officially qualifying for a loan with a specific lender, a bit more analysis is required.
Because by the time a lender adds in their buffers and applies lending policies to your financial situation, it can be quite a different story.
To find out more about loan serviceability and how a lender determines whether you can service the loan you’re applying for, you can find more details here.
What we want to talk about here though, is one small (but critical) element of these serviceability calculations – is the ‘interest rate buffer.’ There are some changes to this rate you may not be aware of.
What is the Interest Rate Buffer?
The ‘interest rate buffer’ is a rate that lenders add to the actual lending rate, to determine whether you can meet repayments of the loan you are applying for.
You may have found a super low rate and can easily meet the estimated repayments – great!
But what’s more important (if you actually want to be approved for the loan) is that you can meet the repayments if they were calculated at the ”actual rate + interest rate buffer”.
How much is the interest rate buffer?
The Australian Prudential Regulation Authority (APRA) mandated changes to lenders last month, insisting they use a an interest buffer of 3%p.a (this is up from 2.5%p.a) in servicing calculations going forward.
The reason for this increase is an attempt to ease lending growth. With household debt levels increasing faster than household income growth, APRA believes this action will help to reinforce the stability of the financial system.
With all else being equal, an increase to buffer rates typically means that the loan amount you qualify for now, won’t be as high as the amount you may have qualified for six months ago…. but there’s no cause for alarm just yet…
What does this mean for you and how much you can borrow?
Often a borrower’s purchasing capacity is limited by how much cash they can contribute to the purchase. So whilst an increase to the buffer rate will impact servicing for some borrowers, for others it may not have so much of an impact. It really depends on how far you’re trying to stretch your borrowing capacity/purchase limit.
Lenders typically have minimum “floor assessment rates,” as well as servicing metrics and other ratios built into their calculators. It’s a matter of satisfying all of these metrics in order to meet servicing requirements.
Something else to note – not all lenders were created equal with regards to servicing capacity. This means you may qualify for a loan with one lender, but fall short on qualifying for the same loan amount with another.
In previous instances where APRA has changed servicing requirements, some lenders took the opportunity to completely overhaul their servicing calculators. Whilst we’re not expecting lenders to do that this time, the new servicing calculators are yet to be released. Updated qualifying metrics will become available soon, with the changes to impact all applications lodged from November onwards.
If you’re keen to get an idea of how much you could borrow to purchase your next home, you can get started here.
