You’ve got the deposit, you’ve found the house you want, but have you made your mortgage application perfect?
Banks want to give you money. They really do. They make their money from interest, which you’ll be paying on your mortgage. But, before they give you a loan, they want to make sure you are a good risk. If they loan you money and you default, it’s their bottom line that suffers. Also, they don’t want you to get yourself into a tough financial situation where your ability to service your mortgage is way beyond your means.
To get your mortgage approved, you need to know what the bank is looking for, and provide it. You want the bank to see you as a responsible, upstanding member of society who will pay their mortgage on time, every time.
What Are Banks Looking for in Your Mortgage Application?
The list might seem endless- a LIM, builders report, guarantors. But what you really need to focus on is proving you’re a great credit risk. Banks will heavily scrutinise your financial situation, even the things that you think don’t matter. They’ll ask for:
- Information about your spending habits
- A list of income and expenses
- Your bank statements for three months (if you’re employed) or much longer (if you’re self-employed)
- Credit card and loan statements
- KiwiSaver information
- Credit history
They will likely perform a stress test on your application. This uses a bunch of complicated math to calculate if you will be able to afford paying the mortgage if the interest rate rises. They look at your principal and interest payments over the length of the mortgage. Typically, the servicing rate they use to stress test is much higher than the current floating and fixed term rates available – around 6% to 7%. If you look in good financial shape repaying the mortgage at 4.5%, can you still afford that at 7%?
Banks also look at what’s called your unencumbered income. This is income that isn’t already dedicated to essentials and therefore it’s discretionary how you spend it. Basically, unencumbered income points to how well you can survive if something goes wrong with your finances. Say one half of a couple lost their job. Or your flatmate moved out and you couldn’t find a suitable replacement. Your car breaks down. If every cent is accounted for, when things go wrong something will end up not being paid for. Banks want to be certain that that ‘something’ isn’t your mortgage.
Getting Mortgage Application Ready
If you want your mortgage application to be approved, there is plenty you can do to give yourself the best chance. At the heart of it you need to prove to the bank that you’re sensible, you have enough money to support a mortgage even if something changes, and that you have great money habits.
Be Mindful of Your Spending
Your bank statement shouldn’t have a bunch of frivolous expenses and a list of different takeaways every night. Responsible lending rules means that banks are now going through your statements with a fine tooth comb, even if you have a mortgage already. Sort out a budget and stick to it. Remember that a budget shouldn’t have to be punitive; plan to have a certain amount of spending money each month, but work within that amount. No splurges on the new boots, expensive concert tickets or tools you think you need.
The added bonus of this is that you’ll save money, which helps with the next steps.
Reduce Your Debt
It probably seems like every financial guide says this, but that’s because debt sucks up your money, especially high interest debt such as credit cards. Focus on paying off that debt and try to get it down to nothing before applying for your loan. Once you have reduced your debt, look to reducing your credit limits too. If you have a credit card limit of $10,000 but only owe $1,500, the bank will assume your monthly repayments will be based on the higher $10,000 limit. At a standard minimum repayment level of 3%, this equates to $300 a month less money available to pay your mortgage. As such, the amount you can borrow will be significantly reduced – approximately $45,000 less on a 25 year term!
Get rid of old credit facilities. That Farmers account you haven’t used in six years with $0 owing but not closed will still be taken into account when assessing your ability to service a loan. Ditto excess credit facilities. Got five different Afterpay type facilities? Pay them off and get rid of them. While it’s easy credit to get, it demonstrates you’re willing to take on a lot of short term debt rather than save. It’s a mind-set lenders are less than fond off.
Also, while you’re sorting out your debt, check out your credit score. A strong credit rating will help your cause. You can check it through Centrix, Illion or Equifax. Make sure the information on your credit record is accurate. Incorrect information could jeopardise your loan application.
You can improve your credit rating by:
- Paying all your bills on time. Set up that direct debit so you get any prompt payment discounts too.
- Don’t apply for any credit cards or any new lines of credit. These are noted on your file.
- Ask to have any entries that are incorrect removed from your report.
- Pay off your credit card and debt. Yes, we said it again, because it’s really important.
You may wish to look at your debt levels compared to your income too. Lenders apply a debt-to-income ratio test to ensure that not too much of your money is being spent on paying off debt. You can use this free calculator to work yours out: https://www.interest.co.nz/calculators/debt-income-ratio-calculator. Banks hear alarm bells at any debt-to-income ratio at 40% or more. Aim for less than that.
Savings are important because they should be able to provide you a buffer of three to six months should something happen. They’re also necessary for that crucial deposit. Any deposit less than 20% of the property value will result in you paying a higher interest rate, assuming you can get an approval at all; a deposit of less than 20% may automatically put you in the too risky basket for some lenders. (Investors will likely need a much higher deposit).
If you’re trying to decide if you should be paying off debt or saving, look at the interest you’ll be making, compared to the interest that you’re paying. If your credit card is racking up 25% each month, get that down. Then, save.
Get Some Professional Advice
Does this all feel a bit overwhelming? Make is easier by getting good financial advice from an expert like Sam Kodi. A professional financial adviser knows all the options available to you, they know exactly what the banks are looking for, and they will help you get your finances into shape to be application ready.