Income Requirements

It is not surprising that every borrower has to prove they have sufficient income to comfortably meet the loan repayment requirements.

Nevertheless, this is a complex area for banks and a lot of their credit policies contain extensive conditions that apply when assessing a person's income. The overriding concern is that a borrower should be able to make loan repayments without any significant difficulties, taking into account the everyday living expenses that everyone has to pay.

There are a number of techniques that banks use to work out whether an applicant will qualify for a loan on the basis of their income.

Here are some of the general considerations and approaches.

The Henderson Poverty Line. As mentioned previously banks are obliged to consider everyday living expenses that have to be met over and above loan repayments. The Henderson Poverty Line is a measure of minimum living expenses that everyone has to meet in their day-to-day living and some banks will add this amount to the loan repayments to determine whether or not the income is sufficient to meet the most minimum of living standards. This is not a completely accurate way of describing the entire lending policy of a bank but it is a good indication of how banks take into account everyday living costs before deciding whether a borrower meets the right standards.

Debt Service Ratio. Sometimes known as the DSR this is simply a percentage calculation of debt as a percentage of net income. In other words the bank calculates how much the loan repayments will be and then adds on any existing and continuing debts that will have to be serviced during the period of the home loan. This total amount is then expressed as percentage of net income after tax. As long as this resulting figure is within policy guidelines the loan can be approved on income grounds. For example an applicant with a gross monthly income of $5000 applies for a loan of $400,000. The minimum monthly loan repayments would be $2779.49 based on interest rate of 7.5% over a 30 year term. Provided there are no other existing debts the DSR would be 56%. Most banks policies, including mortgage insurers would accept a DSR of no more than 40%.

Net Service Ratio. This is a similar calculation to Debt Service Ratio as mentioned above but in this case the debt is expressed as a percentage of net income. Once again, every bank has their own policy and the percentages vary from bank to bank.

Debt Cover Index. This is a calculation where the bank determines that net income should be sufficient to cover the anticipated debt repayments by a previously determined factor.

You don't have to concern yourself about the details about how these calculations are actually made, rather, they are just listed to give you an idea of the various ways in which banks can assess whether a person qualifies for a loan or not.

The bottom line is that there can be significant differences between lenders when it comes to assessing a person's capacity to repay a loan, and that is why it's important to check your eligibility with as many lenders as possible.

Here are some more examples.

A couple with a combined income of $80,000 per year and no existing debts would qualify for a maximum loan of $302,000 from Lender 1, but only $280,000 from Lender 2.

The same couple with an existing personal loan requiring $200 in repayments per month would qualify for a maximum loan of $272,000 from Lender 1, but only $121,000 from Lender 2.

These differences provide dramatic evidence that checking your eligibility with different lenders can really pay dividends.

One thing to consider from a personal point of view is that although banks may be more or less generous than you would like, at the end of the day you are the one that has to make the repayments and even though a bank may consider that it will be comfortable for you to make the repayments, only you can decide.

The fact is everyone has a different lifestyle and we each have expectations of how we want to live our life. It is always important to factor in expenses that we want to be able to cover for instance holidays, a possible new car, or even an addition to the family! If you explain your plans to the bank or mortgage broker you may get a completely different response as all lenders should adopt a responsible lending policy and not recommend a loan that is unsuitable for you.

The fact is everyone has a different lifestyle and we each have expectations of how we want to live our life. It is always important to factor in expenses that we want to be able to cover for instance holidays, a possible new car, or even an addition to the family! If you explain your plans to the bank or mortgage broker you may get a completely different response as all lenders should adopt a responsible lending policy and not recommend a loan that is unsuitable for you.

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