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Why having a lot of equity doesn't mean you can borrow more.

January 4, 2018

It seems one of the hardest things to understand as a consumer, why your maximum loan amount has relatively nothing to do with the equity you have.

 

"Why cant I borrow more, I have loads of equity", in lending it sounds like which of these apples is more lemony? The two things are entirely unrelated.

 

And yet I see where you are coming from - you figure there's no way you won't make your repayments because you have too much to lose, and even if you did the bank wouldn't be out of pocket. I hear you. I get it.

 

But none of that means you can *actually* afford your repayments. It doesn't say where the money is coming from to make them and it doesn't say that the repayments won't put you into hardship.

 

Affordability (can you actually meet the repayments without discomfort) is one question - equity (the bit you own) is a different thing.

 

The absolute tone of 2017 (and it isn't going to change) is lenders having to meet increasingly stringent criteria around proving you can actually afford the loan you are being offered.

 

Did you know that most lenders test your affordability allowing for significant rate rises? Last year most of these buffer or reference rates were increased to 7%+, in cases they're using 8% as a test!

 

 

To give you a very quick summary, the lender takes:

  • Your gross (pretax) income from all acceptable sources

  • deducts your tax

  • deducts living expenses based on your advice or the average for your suburb, income and family size

  • deducts your existing commitments, which includes allowing for full repayments on your credit card in case you happen to max it out

and whatever is left is potentially all you have available for the new repayments, factoring a 7-8% interest rate.

 

While the method is unchanged, the increased living expenses and buffer rates has led to a significant reduction in what most borrowers can show they can afford.

 

And because the average living expenses is a moving target; and typically increases every year; you can actually find you don't qualify for your existing lending as you move down the track despite nothing changing in your circumstances. This is pretty frustrating, I know. Thats the unfortunate bi-product of some of the industry changes which are being overseen and very much enforced by government regulators and makes moving lenders more challenging. Equally, where you maybe have got a little trouble with credit cards and would like to combine them into your home loan (carefully and cleverly) to get them under control, you maybe won't be able to despite actually meeting much higher repayments every month. I am of the opinion there needs to be something developed around this exact scenario.

 

So there you have it, hopefully this makes more sense as frustrating as it might be.

 

 

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