Knowing what to expect when applying for a home loan will make you more prepared for the process.
You’ve decided it’s time to take the plunge and settle down with a home of your own. This is probably the biggest investment you’ll ever make so it’s important to get it right. Here at TMQ we’re always mindful that our readers appreciate good guidance, and we hope that this will point you in the right direction when it comes to getting a roof of your own over your head.
The main point to remember with a home loan is that you’re trying to convince a lender that you are a good risk for them. They’re lending you a huge sum of money and you must be able to assure them that you can pay it back over around 25 years. Think of it this way: would you lend hundreds of thousands to yourself?
…you’re trying to convince a lender that you are a good risk…
First Step – The Deposit
As the recipe books say: “First catch your rabbit”. If you want to get a home loan then you’re going to have to save up. We’ve talked about strategies to save money here, here, and here. And, you’re going to have to save up a lot as banks will want to see a minimum of 5% of the value of the property you want to buy, and it’s even better if you have more than that. At the time of writing the median house price in Sydney was $1,000,000 and in Melbourne $750,000. Saving takes some real discipline and hard work, especially with inflation biting and energy and housing costs rising across the nation. It gets spoken of now and then and it’s currently not allowed but, generally, it’s probably not a good idea to dip into your superannuation, tempting as it may sound. There is, of course the First Home Super Saver Scheme which may be worth looking into but carefully read the details so you don’t make a mistake with it.
Having a deposit shows the lender, usually a bank, that you’re serious about home ownership and that you have the tenacity to put money away regularly and to make the necessary lifestyle and spending adjustments to knuckle down and save. Your lender is going to want to see that you can own a good chunk of your home from the first day. These days a lender will prefer to see that you’ve been able to save a large part of your deposit from regular income as what could be termed “genuine savings”. You may be lucky enough to have the Bank of Mum and Dad to help with your deposit but the lender will prefer to see that you can do most of it on your own.
Don’t overlook the other costs of buying a house which can include the dreaded stamp duty, conveyancer’s fees, removalists, getting gas and electricity connected and many others. Also remember to tell your lender if you’re a First Home Buyer, as there may be special government incentives available to you.
Second Step – Applying for the Loan
When you’ve got your deposit organised you can start applying for a loan. You can go to a bank directly or – as is more prevalent, and often easier – you can go through a home loan broker. Some brokers can arrange loans with only a single bank while others may have access to a whole menu of lenders which could broaden your horizons and give you the best of a range of options. These home loan brokers get paid by the lenders in the form of a commission when the loan is drawn and an ongoing fee as you pay it off. You won’t have to pay anything to these brokers from your own pocket. They’ll work on your behalf to try to get you the best deal.
Any lender will want you to prove two things to them, both with the purpose of protecting them in case you fail to repay the loan. After all, they’re lending you a huge lump of money for around 25 years and they want to be certain that you can pay it back to them. The first thing they want to see is the deposit that we mentioned above. They’ll make a calculation called the Loan to Valuation Ratio (LVR). The LVR is the amount of money the bank is lending you as a proportion of the value of the property. If you have 10% as a deposit then the LVR is 90%: they’re lending you the other 90% of the value of the property. Banks like the lowest LVR possible, so if you can save 20% or more of the property’s value they’re going to like that. The bank wants you to prove that you’ll have a good amount of equity in the property you want to buy.
Lender’s Mortgage Insurance
If you have a deposit less than 20% (that’s a LVR of 80%) many lenders will require that you pay for Lender’s Mortgage Insurance (LMI). LMI is an insurance policy taken out by the bank that will ensure that, if you fail to pay your loan, they will get all their outstanding money repaid. They make you pay their insurance premium. It’s important to note that LMI covers the lender, not you, in case of your default. If there’s a claim, the insurance company pays the lender the outstanding amount on your loan. The insurance company then sells your house to try to recoup the money it paid the lender. If the sale price is less than the amount that they paid then the LMI insurance company will sue you for the difference. Make no mistake about this, especially if house prices have fallen substantially. You will still be on the hook for any shortfall between the sale price of your former house and the loan amount.
If the sale price is less than the amount that they paid the lender then the LMI insurance company will sue you for the difference.
The other thing the bank will want to be sure of is your capacity to repay the loan. This will be a function of the prevailing interest rate, which determines your repayment amount, and your income and expenditure. They’ll want to see a good surplus of money left over after you’ve paid for your regular bills like food, clothing, cars, entertainment and energy bills. Not only will they look at this equation at current interest rates, but your lender will also test your borrowing capacity by adding an extra 3 per cent on top of the current interest rate to gauge whether your income will still cover the cost of the repayments. Since May 2022 the Australian authorities have raised interest rates substantially, making this stress test important but possibly inadequate. At TMQ we suggest that you stress test your repayment ability at 5%, or more, above current home loan rates just to be sure. As rates rise your surplus cash gets smaller. If they rise too far you might find that you haven’t got enough money to pay for essentials.
A lender will look at your commitments to figure out your capacity to repay their loan. This will include things like the number of children, any other loans (such as a car loan) and any credit cards you have. If you’re thinking of applying for a loan don’t take on any new commitments which will curtail your cash surplus. Put off having a baby or getting a new car loan, credit card or anything that will require you to commit money from your income. The lenders will look at all your commitments – including credit cards that you haven’t spent money on – so keep an eye on your outgoings.
A lender will want to take a good look at your Credit Rating so make sure you have a clean bill of health there. Consider the number of lenders you apply for a loan with, because the more activity on your credit file, the lower your credit rating could be. If you’re going to shop around for a home loan, consider how many loan applications you wish to make. You can enquire with multiple lenders, but apply for only one loan.
The Third Step – Approval and Drawdown
Once your application has been approved you can go ahead and buy your house. This is when the fun bit starts because you’re now well on your way to the day you move in. We’re not going to discuss how to do the actual buying here. The lender will want to understand the property you’ve bought and will want to ensure that it will be able to support repayment of the loan if you default. They’ll probably send their valuer around to check it out after which you’ll be given final approval of your loan. The rest of the deal will be handled by a combination of your conveyancer, your home loan broker (if you’re using one) and your bank.
We’ve written previously about how your home loan works and why it’s a good idea, if you can afford it, to pay off more than your minimum payment. Getting ahead on your loan may help to ease the burden in the future if rates rise or if your income takes a hit due to illness or job loss.
So there you have the steps involved in getting a home loan. The next bit – paying it off – is up to you.