In this section we deal with the critical topic of getting finance which, for most of us, determines what we can afford. Getting finance is a complex and specialist topic – it’s important that you seek professional advice.

For the purpose of this guide, we’ll focus on the basic elements and the outcome of the search for finance – which is “how much can I borrow?” – this may well affect the type of home you go looking for.

When being assessed for finance, there are a two key areas that a lender will scrutinise: -

Equity    A lender will want to know how much equity you have. Ideally this will be in the form of cash that you can use as a deposit against the cost of buying your home. The more equity you have, the lower risk you present to the lender. A figure commonly quoted is a 20% deposit, which means that you are borrowing 80% of the cost of your new home. If you are selling an existing home, and using the proceeds to buy another, then it’s possible that you have substantially more than a 20% deposit – in which case it’s easier to pass the ‘equity test’.

It’s commonly quoted that, in Sydney, home affordability makes it very difficult for new buyers to enter the market. With house prices so high, it means that you’ll normally require substantial funds set aside to meet the equity test. Alternative forms of equity can be used – for example, equity may be presented as money tied up in another property – this is often used by investors that have one or more properties that are ‘equity-rich’ (they are worth more than the loan that has been borrowed). You may use your parent’s property as a security against your own home loan (though this places your parents home at risk should you default on payments).

Serviceability    This is another key area that a lender will assess. Serviceability is the ability for you to meet the monthly repayments. Consider the scenario where you sell your existing home for (say) $1,000,000. You repay your loan of $400,000, netting you $600,000. If a lender were to consider only equity, they may be happy to lend up to 70% of the purchase price of a new property – in theory this could mean that your deposit of $600,000 would allow you to purchase a property worth $2M This would leave you with a loan of $1.4M. The repayments on this amount are clearly outside the reach of most. So, serviceability is a critical factor in determining how much you can be reasonably expected to afford. Your lender will look at you total sources of income, balance this against outgoings (cost of living expenses, existing loans, etc.) and calculate what you’d have left to make repayments.

Each lender has their own set of criteria which is used to determine a buyers serviceability. The lender will want to keep their risk as low as possible, whilst not making the criteria so rigid that they fail to compete. Nevertheless you may often find that the lender’s assessment of your ability to pay is significantly lower than your own assessment – i.e. they may not be willing to lend you what you were looking for.

There are a number of things that you can do to increase the amount of finance that you are eligible for: -

Ability to save Lenders are keen to see a track record of savings. Your ability to save a consistent amount of cash (proven by bank deposits) indicates more financial responsibility and reduces your risk profile.

Wipe out debt Any debt that you have can dramatically reduce your serviceability rating – Don’t rush out for a loan on any major purchase (boat, car, overseas trip, home improvements, etc.) if you intend to buy a home!

Credit Cards The very fact that you own a credit card will work against you – Credit cards typically have a limit that you’re allowed to borrow up to. Your lender may automatically assume that you will borrow to this limit (even if there is a track record that you pay it off monthly) – So, that $20,000 limit you may have on your card may be seen as a $20,000 debt!

Loan Period You may want to increase the life of a loan to 30 years. Whilst in the long run the cost of the loan would be higher, you will have lower monthly repayments.

Your Job Changing jobs just before you apply for a loan can work against you. The lender (and their underwriter) will want to see a regular stream of income. They are concerned with stability and predictability. Changing jobs may represent an increased risk (what if the job doesn’t work out etc…). Also, if you receive regular overtime, commissions, or bonuses, you’ll want to show a track record (several years) of this income stream. Your lender may not determine that these represent a dependable source of income, especially if you change jobs. Same is true if you are considering self-employment – get the loan first!

Shop around Lenders (Banks and Independents) are fighting for your business. Make sure that you shop around.

You may find that Lender B will offer you significantly more than Lender A.

Lenders offer different products, the headline interest rate is the most obvious (which determines how much your monthly repayments will be), but there are also products that allow you to establish offset accounts. An offset account is useful if you believe that you can repay more than the base repayment – by placing the surplus into an offset account you can reduce the overall debt and increase the rate at which the loan is repaid.

You may be able to attract a “honeymoon rate” where the rate for the first year is significantly lower than the ongoing rate.

You may be more interested in fixed-rate loans rather than variable, or ‘hybrid loans’ where a proportion is fixed and the remainder is variable.

There are lots of different ‘features’ that are offered, so familiarise yourself with them and decide which loan is best for you.

Talk to a Broker You may consider the services of a broker in helping you secure finance. Brokers usually cost (you) nothing – they make their commission from the lender. A broker can often present you with a range of options and can talk you through the criteria that you’ll be qualified against.

If you’re serious about buying a home, it’s important that you determine your borrowing capacity early on. Failure to do so can lead to any of the scenarios below: -

You find the perfect home, only to find that it’s outside your price-range. In fact ALL the homes you’ve been looking at are beyond your reach – you’ll have wasted a lot of time and may now need to reassess whether you even want to buy (in the price range that you can afford). If you decide to go-ahead with a home purchase you may need to restart the process, looking in different neighbourhoods that are within your budget.

You may find yourself in a position that you need to secure finance in a hurry and you don’t have time secure the best deal. This could cost you $000’s in the long run (higher interest rates and/or fees).

You may lose 0.25% of the home cost if you secure a property (exchange contracts) before you have secured your finance ….. More on this later.

When determining your borrowing capacity you should get written confirmation from your lender. You should look for a “pre-approval” letter, which means that you have passed the lenders criteria and can borrow an agreed amount. This gives you a high level of comfort, and means that you can confidently ‘go shopping’ for your dream home. Pre-approval is, however, not the same as “unconditional approval”. Pre-approval typically means that you can borrow the agreed amount if you are paying a fair market price on a property (i.e. the lender still wants to confirm that they can get their money back if a forced sale becomes necessary). Once you have found a home, the lender will typically want to value the property, and, if the valuation confirms the price paid (or at least that the lenders investment is safe!), then the loan becomes “unconditional”.

Another benefit of going through this process is that you’re also better placed to secure your home. If a vendor has a choice of who to sell the property to, then you will be in a much stronger position if you have pre-approval – it could make the difference between securing your dream home vs losing out.