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From: Mike .


Servicability Questions
From: Ethann
Date: 8/22/00
Time: 2:08:21 PM

Hi,

I'm about to get started in this game and I figure that servicability is a road block I will come up against sooner or later.

Can someone please explain how lenders determine whether or not you are able to service a loan repayment ?

I assume they look at your overall position i.e. total mortgage payments for home plus IP's and then compare this to a percentage of your income. Can someone tell me what the percentage is ? I've heard figures ranging from 25 - 40%.

What else do they take into account ? If you are on an interest only loan do they calculate on this basis or do they calculate on a P&I basis on the assumption that eventually you will be paying P&I ?

How do they factor the rent from an IP ? Do they have a standard formula e.g. assume 40 weeks rent from the IP a year ?

I'd also be interested to hear about others experience with servicability limits.

Thank you.
 
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Pierre

Reply: 1
From: Mike .


Re: Servicability Questions
From: Pierre
Date: 8/23/00
Time: 6:45:51 PM

Ethan,

There is no hard and fast rule for how financiers calculate debt serviceability. As you have identified, some will allow you to borrow to a level where your DSR is 25%, others 40% or more. Again, you are right in saying that some don't look at that - they just look at how much net income you have left over to service debt.

In my opinion though, the most important difference between lenders is how they view rental income. Some will simply add rent to your income. Others will subtract the rental from your debt. There is a huge difference, and if you intend buying many properties, it will make all the difference. Let me give an example or two ...

Assume: Your income=$50000 Rents are 10000 per annum Interest is 10000 per annum per property

Add rent to income method

Buy first IP Income=$60000 ($50000 + $10000 rent) Committment=$10000 (interest only) DSR=6:1 (or 16%)

Buy second IP Income=$70000 Committment=$20000 DSR=7:2 (28%)

Buy third IP Income=$80000 Committment=$30000 DSR=8:3 (37.5%)

At this stage, you begin to have trouble obtaining finance for further purchases.

Now, if you use the second method where the financier deducts the rent from your committment when calculating serviceability, look what happens ...

Income=$50000

1st IP Income=$50000 Rent=$10000 Committment=$10000 Net committment=$0 DSR (not applicable)

2nd IP Same deal. You commit to a further $10000 and deduct $10000 rent from the committment leaving a net committment position of zero.

Using this calculation method, you can theoretically purchase properties until the cows come home, and never have problems with DSR.

Of the Big Four, I think only Westpac use this method. most of the second-level (smaller) banks such as St George, Adelaide Bank and others use the dedection from committment method.

My advice - seek finance through a broker who will put you in touch with a lender that will meet your requirements. A good mortgage broker should know which lender uses which method, and will able to set up finance in the best manner possible.

Pierre
 
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DuncanM

Reply: 1.1
From: Mike .


Re: Servicability Questions
From: DuncanM
Date: 8/22/00
Time: 3:42:13 PM

My experience is:

Most banks will let you use 30% of your gross (ie before tax) PAYE income to service your debt which includes ALL of your consumer debt as well. Some banks will go as high as 35%.

Some originators, credit unions etc (my advice is steer clear of CU's and Originators if you want to do a lot of business, they dont understand it) dont use a percentage of gross income figure but just expect you to have $X left over each month + $X per dependent.

Most banks will let you use a high percentage of your rental income to service your debt, as an example the National (in Adelaide at least) will allow 100% of rental income to be used where a formal lease is in place, if no lease is in place or you are PLANNING to rent the property they will use 60% of the planned income to service your debt.

With cashflow positive investing, serviceability is rarely an issue. Needless to say, keeping your Consumer debt at next to nothing can only help both your serviceability and overall financial health.

Regards, Duncan. IP Record Keeping Software. www.otter-software.com.au
 
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