Saving for a home? We tell you what you might need to know to put you in the best position to get the best loan out there for you. We show you what the lenders might be looking for, and how they calculate risk by looking at your credit history.
By Graham Doessel, Founder and CEO of MyCRA Credit Rating Repairs and www.fixmybadcredit.com.au
In the 21st Century, being approved for a mortgage is a complicated affair. Not only are savings, income and debt level all taken into consideration, but also how your credit rating appears. It is all about risk calculation. The lender is gauging the likelihood you will default on your repayments. Banks have tightened their belts in the wake of the global financial crisis, so risk assessment plays a big part in home loan approval.
8 things you need to know before you apply for a home loan
The first three on the list are generally viewed together. The trifecta of savings, income and debts….
Many people are saving 5-10% deposit prior to applying for a home loan. In many areas of Australia houses are so expensive this can take years to achieve. In fact, it was revealed in The Australian newspaper last month, it takes the average first home buyer in Australia a long five years to save up enough deposit for a home.
In the same paper today in the story ‘Savings the key to first home – survey’ we see that most buyers are in fact saving up to 10% deposit before entering the market:
RAMS head of brand and marketing Chris Thornton said first home buyers appeared to be saving more now for a deposit than in previous years.
“A few years ago deposits were around five per cent for the average first homebuyer, and now it’s often more than 10 per cent that people are saving for,” he said.
“People are really very serious about saving before they jump in.
“In the past, people have really squeezed themselves to get over the line, but now, they’re just being a bit more cautious.”
Living with parents and using high-interest savings accounts appeared to be key in the savings process, Mr Thornton said.
If your income isn’t high or if you have more debts you may actually require a higher deposit of say 10% to ensure approval.
2. Income amount.
The amount of income required is generally determined by the amount of income earned relative to debts and expenses.
So, the more you earn, and the fewer debts you have – the more you will be able to borrow. If you have a lower income, it may be worth paying off existing debts before applying for a home loan. Also, the more deposit you have saved, the lower the income requirements on the same loan.
According to Homeloanfinder.com.au in its article ‘How Much Salary Should You Have for a Home Loan,’ lenders use two different formulas to determine how much people can borrow:
1. Front end ratio. “The front end ratio method will determine how much of your income will be used on the repayments of the home loan. Most people will agree that when using this method you should not exceed 28% meaning only 28% of your income should be used paying off your home loan.”
2. Back end ratio. “The back end ratio method will consider all debts when determining how much money you will have free to pay off the loan. When using the backend method, most people will agree that you will only want about 36% of your income going on debts and expenses,” the article says.
3. Debts and credit limits
The lender will generally assess your debt level to determine the amount you are able to borrow. So reducing debt can increase borrowing power.
Part of this debt calculation also includes the credit limits which are present on any credit cards or line of credit loans you may hold. This credit limit will be used to determine the debt amount based on the amount of money you have access to, rather than the actual amount the loan or card currently has owing on it. So if you have a credit limit of say $20,000 on your credit card, the debt amount on that card will be stated as $20,000 – even if the actual amount you owe on that card is only $5,000.
So seek to reduce the credit limits on any cards or loans prior to applying for a mortgage.
4. Stable employment.
Generally lenders are requiring 6-12 months with the same employer. So think twice about changing jobs if you also want to buy a home in the future, even if the wages are significantly better in the new position.
5. Credit checks.
When you put in your application for a home loan, the lender will perform a routine credit file check on you to make sure there are no adverse listings present. An adverse listing can be a default, clear out, Judgment, Writ or bankruptcy which is placed on a person’s credit record by a creditor.
The most common type of adverse listing is a default, which can be placed on a person’s credit file if they fail to make repayments on any form of credit past 60 days. This includes telecommunications and utilities bills.
Defaults need not be for big amounts – late payments on bills for as little as $100 can be listed on people’s credit files. Defaults and Judgments remain there for 5 years, with clear outs, Writs and bankruptcies remaining for 7 years.
Any adverse listing, even an unpaid phone bill will have a huge impact on a person’s home loan approval. Most of the major lenders will refuse to lend to someone who has an adverse listing. In fact, that person would probably have difficulty even getting a mobile phone plan.
6. Excess credit enquiries.
Whenever a person other than you makes an enquiry on your credit record – that enquiry is recorded against your credit file. Currently there is no way of seeing on someone’s credit report if the loan was approved or not, only that the application was made.
Some lenders are refusing applications due to too many credit enquiries, such as two enquiries within thirty days or six within the year.
If you decide to shop around for the best deal, beware of excess credit enquiries. You could find too many enquiries can mean you blow your chances of approval – even if you would have been approved for every deal. So while it is great to talk a variety of brokers or lenders prior to making an application, you must stress to them that they are only gathering information and are not wishing to make an application until you have decided on a lender.
7. Obtain a credit report
If you intend to purchase a home within the year you should request a copy of your credit file. This report is free for the credit file holder every 12 months – and tells you what the lender will see about you when you apply for credit.
There are 4 credit reporting agencies in Australia, Veda Advantage, Dun & Bradstreet, Tasmanian Collection Services (if in Tasmania) and new entrant Experian. You can request a report from all of these agencies. The report will be mailed to you within 10 working days of your request.
There is the potential for creditors to make mistakes when adding credit listings to credit files. So regardless of how diligent you think you may have been with your repayments, it is important to get hold of a copy prior to applying for a loan.
Adverse listings can sometimes occur due to identity theft; some people are caught in issues over separation from their spouse; some have been disputing the bill which went to default stage and many people are just victims of the fallout from inadequate billing procedures – wrong names, wrong addresses errors with creditor computer systems, and sometimes human error.
Many times people are unaware they have adverse listings on their file until they apply for a home loan. Unfortunately at that time it can be stressful, and they can lose the home, or be forced to choose a different loan with a higher interest rate.
8. Dispute any inconsistencies on your credit file.
If you find inconsistencies on your credit file, or a credit listing which is wrong, unfair or you believe it simply should not be there, current legislation allows for you to have those inconsistencies rectified.
If you have settled the account, it can be updated to ‘paid’ status, but this may not be enough to ensure finance approval.
Credit listings are not removed by creditors unless you can provide adequate reason and lots of evidence as to why the listing should not be there. Credit repair also requires knowledge of the legislation and perseverance. But for those people whose financial freedom is hindered because their credit file contains errors, it is a point worth fighting for.
Most people have neither the time nor skills to get up to date with the full barrage of credit reporting law if they want to fight a credit listing which has been placed on their credit file. They are also unwilling or unable to attempt to negotiate with creditors on their own behalf.
Often a credit repairer is the best person to give you the best chance of having inconsistencies completely removed from your credit file, because similarly to trying to fight your own case in Court, if you don’t get it right, often you don’t get another chance to clear your name, and can be stuck with the bad credit for the term of the listing (5 to 7 years depending on what it is).
A clear credit record can allow you the option to choose the best loan to suit you, with the best interest rate so it is vital it reads as best as possible to allow as many options as possible – and ultimately save you money.
For more information on credit repair, contact our Credit Repair Advisors on 1300 667 218 or visit our main site www.mycra.com.au.
N.B. This post is intended as information only, and should not replace seeking professional financial advice for your situation.
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