Do you want to get a mortgage approval but your existing debt stopping you?
It is quite a common situation where existing debts and other financial commitments mean the banks will not provide a mortgage approval, or an approval that is not enough to buy you the first home that you want or need.
It can be pretty frustrating when you know that you can make the repayments.
Why is it so hard to get a mortgage approval?
There are a couple of key issues that you need to understand to realise why the banks seem to make it hard to get a mortgage approval.
Interest Rates vs Bank Test Rates
Firstly, if you look at interest rates and pop those into a mortgage calculator, you might think that you can really afford the payments, and they may not even be more expensive than the rent you’re paying currently. You might use an interest rate of 5.79%, and then you might add the low equity margin which the banks charge if you have less than a 20% deposit (ie 0.75% if you have a 10% deposit) and that would give you an interest rate of 6.54%.
So those repayments seem quite realistic, BUT what you may not realise is that when the banks are assessing your affordability they do not use that interest rate, but instead use what they call a test rate.
As an example, the test rate might be 7.50%, and then they add 0.75% on top, making an interest rate of 8.25% and that makes quite a difference to the affordability. That means that the bank is testing at a rate that’s a lot higher – 1.71% higher.
The other point that I want to make is that the banks do not use the financial snapshot as it is today. That means you might have a loan that only has a few months to go on it, but they use the repayment that you are paying today. They do not calculate that it will be paid off soon and he same goes with expenses.
With expenses they generally will use what has been going out of your bank account, unless you can specify otherwise. If you’re doing a mortgage application in the early part of the year, it’s important to remember that the banks go back and assess the average expenditure over the last three months which may include Christmas. Even at other times of the year there may be specific one-off events like birthdays, weddings, holidays, etc. where you might spend more. If you don’t specify this on your application, the banks will use what has come out of your bank statements.
Real Life Example: First Home Buyers with Debt
So I thought I’d share an example that we had this week.
We were approached by a couple who wanted to buy their first home, and they had slightly under a 10% deposit. They had some debts: three credit cards, a small bank overdraft, and a personal loan, plus both of them had student loans.
When we initially looked at the application, this would have been declined due to two issues:
- Firstly, the deposit was going to be slightly under 10% ($8,000)
- Secondly, the repayments on all of the debts meant they didn’t have enough money to service the mortgage at the banks test rate.
When we had another look at this, the wife was the biggest earner, and she had a student loan with just over $12,000 remaining on it. But because of her income, that was costing over $1,000 a month. So as you can see, it would be paid off in 12 months, and being a student loan, it was interest-free.
This was one of those situations where we had to look outside the box and see what could be done.
They were a young couple, recently married, and really determined to get into their first home. We were determined to make that happen for them too.
To make that work, we had to take a two-step approach.
Firstly, we arranged a new loan to consolidate their existing debts, including her student loan. The reason we included her student loan was that it was a significant repayment, and overall we could ensure that the repayment on the new loan would meet the bank criteria for servicing.
When we did the debt consolidation loan, we also rounded it up a little to ensure that they had some extra cash to go towards the deposit (the $8,000) and that gave them 10%. Our clients understood that they were converting the $12,000 student loan, which was interest-free, to a loan that was going to charge them interest. Over the course of a year, that might cost them an extra $1,500. But they were quite willing to accept that on the basis that they could buy a house now, rather than wait 12 months until that loan was paid off, when the house prices might be more expensive.
Once we consolidated those debts, we then put the mortgage application together and got them a pre-approval so they could go and buy a property for up to $850,000. This was successful and we were able to get them a pre-approval with a bank. In this case we used SBS Bank which has a great deal for first-home buyers with an interest rate of 4.89% and no low equity margin.
Our clients went out looking at properties and found one that suited for $845,000. They have now satisfied all the conditions for the purchase of this property and will be moving into it in February.
The mortgage repayments are just over $900 per week, which for this couple is quite affordable, given they were paying $750 a week in rent previously. With the debt consolidation that we did, they have saved over $200 a week compared to what they were paying too. Combine what they were paying in rent and the debts they are actually paying less for the mortgage!
It’s important to understand that if these clients had gone to a bank directly, they almost certainly would have been declined for the mortgage. That would have seen them resign to renting for at least another 12 months until the student loan had been repaid.
By coming and seeing us at Mortgage Managers we looked at a range of options for them, asked how we could make this work for them, and we’re pleased to say that we did manage to get a mortgage approval for them.
Sometimes we need to look outside of the box to get the result for our clients, and that’s what we do.
We know there are probably thousands of people out there in similar situations who have resigned themselves to the fact that they cannot get a mortgage, but we would suggest they possibly could if they looked outside of the box.
Contact one of our team and we can help you get a mortgage approval.
