Catherine Mapusua -
General Manager, Inception Finance
Have you ever wondered how the banks work out how much money you can borrow? They don't simply assess your borrowing capacity based on the advertised standard variable rate. They actually assess you at a higher rate to build in a safety net in case the interest rates were to suddenly rise. Not all lenders apply the same serviceability rules. So choosing the right lender is something you need to seriously consider and explore all of your options, as this can have a significant impact on your ability to borrow the amount you need.
So let's have a look at how an assessment rate works. First of all, decisions on bank's standard variable rates are driven by changes to the Reserve Bank of Australia cash rate. The bank will then normally add on an extra two to three percentage points to the official cash rate, in order to arrive at the standard variable rate. This is to cover the cost of funding the loan plus a margin, so they can earn a profit. Obviously, the risks associated with your application will also determine the margin applied to your interest rate.
When assessing your ability to afford your home loan repayments or serviceability, most lenders will also add in an extra buffer, known as a benchmark assessment rate or floor rate. This will typically be two to 3% above the bank's standard variable rate and it's applied when assessing a customer's income and asset position for serviceability. The reason that the assessment rate is applied is to determine whether you could still make your mortgage repayments in the event that the interest rates were to rise. Think of it like an earthquake test for your financial situation.
The banks won't tell you, but your broker can. Assessment rates or floor rates aren't known to the general public, so it can be very easy for applicants to fail the bank's serviceability test. That's because banks don't advertise them. With the recent changes, we know that some banks are using a floor assessment rate as low as 5.3%. Previously, most banks used 7.25%, while some lenders, who have been historically conservative, are still using an assessment floor rate of 8%. This is unlikely to change.
By speaking with an Inception Finance mortgage broker, we can help you choose a lender that will allow you to borrow the amount you need.
If you would like to contact one of our team about the above, please click the following link.