In a fluctuating market it can be difficult to decide whether to cash in on your equity (maybe upgrade your home or take that long dreamed for holiday) or leave it well alone! This is a decision made even more difficult by the fact that lenders no longer value equity as highly as they did back in the 80’s and 90’s.
While the equity in your home will likely have increased over the years, consider that your living costs will have increased over this time too, while statistics show that income has not increased at nearly the same rate.
Millennials will know that the Responsible Lending Code (RLC) didn’t used to be a ‘thing’ – it was just the basic guideline that lenders generally followed. Now the premise is clear: lenders must exercise care, diligence and responsible lending skill when advertising, before making an agreement to provide finance, and in all subsequent dealings with borrowers and/or guarantors.
In the instance of providing finance, lenders are legally obliged to consider more than just your equity. You still need to be able to prove your ability to service any increased loans – which means your income must be given generous consideration too.
Increasing debt levels
The Reserve Bank’s November 2015 report on the financial stability of New Zealand found that around 40% of residential home loans were issued at more than five times the gross income of the borrower(s). This is a staggering debt-to-income-ratio increase over the last 20-odd years, prior to which lenders were approving loans of no more than around two times gross income. The dramatic increase is a culmination of a number of significant factors – increased housing demand, higher property values leading to increased demand on lending, and fierce competition between lenders.
This provides a little more understanding around why equity no longer holds such high value for lenders. Equity is dependent on the value of your home, and in an ever-changing market, is not a value that can be ‘banked on’ so to speak. Equity still has some importance – obviously the more of your home you own, the better – but the true value lies in your ability to repay any borrowings.
How is your income looking?
Depending on the time it has taken to increase your equity, you would likely have seen an increase in your income. This is something lenders look at closely. Your ability to increase your income and any potential to increase your income are highly valuable bargaining tools. Stable income that has growth potential has a far greater value proposition than equity alone based on the sole fact that income is tangible cash and equity is a figure based on a value that has potential to change (even go down).
The RLC clearly stipulates that is the responsibility of the lender to ensure that undue hardship will not be caused by entering into an agreement with a borrower/guarantor. This means it is their responsibility to fully investigate your finances, lifestyle, debt level, and ability to service these financial obligations before agreeing to establish or extend any loan.
It’s always best to consider your financial position before you look into borrowing of any kind. If you are able to fulfil all of your existing monetary commitments and still have spare funds at the end of the week/month, you will be considered a more viable candidate to increase your borrowing – especially if you intend to reinvest it into existing or new property. However if your income in already a little stretched and you find yourself having to reprioritise essentials too often, now may not be the time to extend your finances further, even if you have markedly increased equity.
Basically, it’s all about affordability. Equity aside, show that your budget allows for your debt level to be increased with little risk to your lender, and you will be more likely to be approved.