Credit History:
Banks review an applicant’s credit history to assess their creditworthiness. A good credit score and a history of responsible borrowing and repayment can positively impact the loan approval process. You can review your own credit history and score before going to the bank. The benefits of doing this are you are aware of what the bank is going to see, and if it needs repairing, you can mange this before you go for a loan application, not after.
In Australia, there are several credit reporting agencies where individuals can check their credit history and credit score. Some of the prominent ones include:
Equifax (formerly Veda): Equifax is one of the largest credit reporting agencies in Australia. They provide credit reports and credit scores that detail an individual’s credit history, including repayment history, credit inquiries, and public records.
Experian: Experian also offers credit reports and credit scores. They provide detailed information on credit history, including credit accounts, repayment history, and any defaults or infringements.
illion (formerly Dun & Bradstreet): illion provides credit reports that include information on an individual’s credit history, credit inquiries, and public records. They offer credit scores that reflect an individual’s creditworthiness.
Credit Savvy: While not a credit reporting agency, Credit Savvy is a service that provides free access to credit scores and credit file information from Experian. Users can access their credit scores and receive regular updates without impacting their credit score.
GetCreditScore: GetCreditScore provides free access to credit scores and credit reports based on Equifax data. It’s a service offered by Finder, allowing individuals to check their credit score and report online for free.
It’s important to note that under Australian law, individuals are entitled to access their credit report for free once a year from each credit reporting agency. Additionally, some services offer free ongoing access to credit scores, while others may require payment or a subscription for detailed reports and continuous monitoring.
Income and Expenses:
Lenders analyse your income sources to determine your capacity to repay the loan. They also consider your existing financial commitments and expenses to ensure that the loan won’t strain your finances. Banks and lenders review various sources of information to assess your income and expenses as part of a loan application. Here are the primary ways they gather this information:
Income Verification: Pay Slips: Applicants typically provide recent pay slips or income statements from their employer to verify their regular income. Tax Returns: For self-employed individuals or those with non-standard income sources, tax returns and financial statements are often required to confirm income.
Bank Statements: Lenders may request several months of bank statements to analyse income deposits and outgoing expenses. This helps in understanding spending patterns, regular expenses, and the stability of income.
Expense Declaration: Loan applicants are generally required to declare their monthly expenses. This includes rent or mortgage payments, utilities, insurance, loan repayments, credit card payments, living expenses, and discretionary spending.
Credit Reports: Credit reports may show existing loans, credit card balances, and repayments. Lenders use this information to calculate existing debt obligations and assess the applicant’s ability to take on additional debt.
Other Financial Documents: Additional financial documents might be requested, such as statements for other assets (investments, properties, etc.) or liabilities (other loans, outstanding debts).
Employment Verification: Lenders may contact employers directly to verify employment status, income details, and the likelihood of continued employment.
Affordability Calculations: Banks and lenders use their own calculations and assessment criteria to determine an applicant’s borrowing capacity based on income, expenses, and existing financial commitments. By examining these documents and information sources as listed above, banks can evaluate an applicant’s financial situation, assess their ability to repay the loan, and determine the level of risk associated with lending to the individual.
It’s crucial for applicants to provide accurate and comprehensive information to facilitate a smooth loan application process. Its also crucial that you know the above areas listed so as to put your best foot forward when putting an application into the banks. Review these first, make sure everything is in order or get a review by a savvy mortgage broker before submitting an application to the bank.
If you do your own homework on your own financial background, you can make changes that could impact your application in a positive way, rather than getting rejected over a late payment, or having too many credit cards.
Other areas the banks will assess your Employment and Financial stability are:
Deposit Amount:
The size of the deposit you can provide affects the loan-to-value ratio (LVR). Higher deposits often result in better loan terms and a lower LVR, reducing the lender’s risk.
Debt-to-Income Ratio:
Banks calculate your debt-to-income ratio, comparing your total monthly debt payments to your gross monthly income. A lower ratio indicates a healthier financial situation and enhances your chances of loan approval.
Employment Stability:
Apart from the duration of employment, banks consider job stability. Consistent employment in the same industry or job role demonstrates reliability and strengthens your loan application.
Savings and Financial Reserves:
Having savings or financial reserves beyond the deposit is advantageous. It serves as a safety net and shows the ability to manage unexpected expenses. See below in the next section for more on this.
Property Valuation:
Banks conduct a property valuation to determine its market worth. The valuation influences the amount they’re willing to lend against the property.
Loan-to-Value Ratio (LVR):
The LVR is the loan amount divided by the property value. Lower LVRs typically result in more favorable loan terms, as they represent lower risk for the lender.
Loan Purpose and Property Type:
The intended use of the property (investment or owner-occupied) and the property type (house, apartment, commercial property) can affect loan terms and eligibility criteria.
Regulatory Requirements:
Banks adhere to regulatory standards set by authorities such as the Australian Prudential Regulation Authority (APRA) and the Australian Securities and Investments Commission (ASIC). Compliance with these standards shapes their lending policies. These regulatory standards can change, due to the state of the economy and/or market condition, and the banks policies can also change. You savvy mortgage broker should be able to keep you up to date with any chances in regulations or banking policies.
It’s important to note that each bank may have slightly different criteria and policies. Meeting these criteria doesn’t guarantee loan approval, but understanding what lenders consider can help applicants prepare a stronger loan application.
Always consider seeking advice from a savvy mortgage broker for personalized guidance regarding your specific financial situation and loan requirements.
2.Savings and Financial Planning
Do you have a financial safety net?
Banks require a deposit of around 5-7%, and it’s crucial to demonstrate responsible money management. Whether it’s in a savings account, investments, or liquid assets, having a financial buffer is essential.
Emergency Fund and Financial Buffer: Banks also look favourably upon applicants who have established emergency funds or buffers. This indicates a prudent approach to finances and preparedness for unforeseen expenses, assuring the bank of the applicant’s ability to manage loan repayments even during unexpected circ*mstances.
The acceptable level of a buffer when purchasing a property can vary based on individual circ*mstances, risk tolerance, and lender requirements. A buffer is essentially an additional amount of savings or financial cushion set aside beyond the required deposit to cover unexpected costs or changes in financial circ*mstances.
Typically, a buffer of around 5% to 10% of the property purchase price is considered a prudent level. However, the specific amount for an acceptable buffer can depend on several factors:
Lender Requirements: Some lenders may have specific guidelines or recommend a minimum buffer amount as part of their lending criteria.
Market Conditions: In a volatile or uncertain market, having a larger buffer can provide greater financial security against potential drops in property value or unexpected expenses.
Personal Financial Situation: An individual’s personal financial situation, stability of income, existing savings, and other financial obligations will also determine an appropriate buffer level.
Property Type: Different types of properties may come with varying levels of maintenance costs or unexpected expenses. For instance, older properties might require more maintenance compared to newer ones.
Risk Mitigation: A buffer serves as a safety net against unexpected life events, such as job loss, health issues, or changes in interest rates that may impact loan repayments.
It’s essential to consider these factors and assess one’s own financial situation when determining an appropriate buffer. While a buffer provides financial security, it’s equally important not to stretch finances too thin by overcommitting to a property purchase.
Ultimately, a buffer should offer peace of mind and financial stability when navigating the costs associated with property ownership.
When banks review an individual’s savings and financial planning as part of a loan application or property purchase assessment, they typically will also focus on several other key aspects as well.
Consistent Savings History: Banks look for evidence of consistent savings habits. They assess if the applicant has been regularly setting aside money over time, indicating financial discipline and the ability to manage finances responsibly.
Deposit Source and Stability: They scrutinize the source of the deposit for the property purchase. Banks prefer deposits from genuine savings, indicating the applicant’s ability to accumulate funds over time rather than relying solely on gifts or windfalls. Stability in the source of the deposit is essential to demonstrate financial stability.
Debt-to-Savings Ratio: Lenders assess the ratio of an applicant’s savings to their existing debts or financial commitments. A healthy savings balance compared to debts shows financial responsibility and capacity to handle additional financial obligations.
Demonstrated Affordability: The bank evaluates whether the applicant’s savings align with the property’s affordability. They want to ensure that the individual has sufficient funds not only for the deposit but also for other associated costs like stamp duty, legal fees, and potential future expenses related to property ownership.
Financial Planning and Budgeting: While not always explicitly assessed, banks appreciate applicants who have a clear financial plan or budget. Showing an understanding of personal finance, having a well-thought-out budget, and demonstrating awareness of future financial goals indicates responsible financial planning.
Steady Accumulation of Assets: Apart from liquid savings, banks may consider other assets an applicant has accumulated, such as investments, shares, or property. These assets can positively impact the applicant’s financial profile and demonstrate a stable financial position.
Banks aim to gauge an applicant’s financial responsibility, stability, and capacity to manage the financial commitment of property ownership. Having a strong savings history, a well-managed budget, and evidence of prudent financial planning can enhance an applicant’s credibility and increase their chances of loan approval.
3. Budget Assessment
Understanding your financial landscape is key. Creating a comprehensive budget helps assess your financial commitments accurately. Listing all expenses, from housing and utilities to lifestyle expenses, provides clarity on what you can afford.
When banks review budgets and Statements of Financial Position (SOFPs) as part of a loan application or property purchase assessment, they are looking for specific details and key indicators that demonstrate an individual’s financial stability, responsibility, and capacity to manage a loan. Here are the elements that banks typically focus on when examining budgets and SOFPs:
Income and Expenses: Banks analyse the breakdown of income sources and the consistency of income. They assess whether the income is stable and sufficient to cover regular expenses and loan repayments.
Living Expenses and Financial Commitments: Lenders examine detailed listings of living expenses and financial commitments, including rent or mortgage payments, utilities, insurance, groceries, transportation costs, loan repayments, credit card bills, and other recurring expenses. They look for accuracy, completeness, and realism in these expense categories.
Debt Servicing Ability: Banks evaluate an applicant’s ability to service debt by comparing total monthly debt obligations to their income. This debt-to-income ratio is crucial in determining whether an individual can comfortably manage additional loan repayments.
Discretionary Spending: While essentials are important, banks also consider discretionary spending. They may look for evidence of prudent spending habits and an ability to save by evaluating non-essential expenses like entertainment, dining out, subscriptions, etc.
Consistency and Stability: Consistency in the budget is key. Lenders want to see a history of consistent financial management, with regular savings and responsible spending patterns over time. This stability demonstrates financial reliability and responsible budgeting.
Accuracy and Realism: Banks assess the accuracy and realism of the budget. They look for comprehensive, detailed, and realistic budgeting that aligns with the applicant’s lifestyle and income level. An accurate budget reflects an understanding of one’s financial situation.
Assets and Liabilities: In the SOFP, banks examine an individual’s assets and liabilities. This includes assets such as savings, investments, properties, and liabilities such as loans, debts, and outstanding obligations. A positive net worth or healthy asset-to-liability ratio can strengthen an applicant’s financial position.
Demonstration of Affordability: Ultimately, banks want assurance that the loan applicant can comfortably afford the mortgage repayments without significantly impacting their lifestyle or risking financial stress. A well-structured budget and SOFP should demonstrate this affordability.
Overall, banks review budgets and SOFPs to assess an applicant’s financial discipline, ability to manage finances, and readiness for the financial responsibilities associated with property ownership. Providing a detailed, realistic, and well-organized budget and SOFP can positively influence the loan approval process.
4. Thorough Research
Before property hunting, research the location extensively. Consider factors like capital growth, vacancy rates, demographics, and crime rates. Understanding these aspects helps in making an informed decision about where to start to look to buy.
For a comprehensive guide to Property Research, see my previous bloghttps://usulproperty.com/index.php/2023/11/27/common-mistakes-property-investors-in-australia-make/ outlining the property research and due diligence to do before your purchase.
5. Property Ownership Structure
Determining the right ownership structure is crucial. Whether it’s purchasing in your name, a trust, or a company, each has different implications for taxes, financing, and long-term gains.
In Australia, various property ownership structures are commonly used for residential properties. These structures have different legal and tax implications. Some of the primary ownership structures include:
Sole Ownership: Sole ownership, as the name suggests, involves a single individual owning the property. This structure offers simplicity and complete control over the property’s management and decisions. However, it doesn’t provide asset protection or tax advantages available in other structures.
Joint Tenancy: Joint tenancy is common for couples or family members purchasing property together. In this structure, each owner has an equal share of the property, and in the event of one owner’s death, their share automatically passes to the surviving owner(s). It’s essential to note that joint tenancy overrides a will; hence, the property doesn’t form part of the deceased’s estate.
Tenants in Common: Tenants in common ownership structure allows multiple owners to hold unequal shares in a property. Each owner can hold a specified percentage of ownership, and their share can be passed on to heirs through their will. This structure is flexible and allows owners to have different levels of investment.
Trust Ownership: Trusts, such as discretionary trusts or family trusts, are also used for property ownership. The property is held by the trust on behalf of beneficiaries. Trusts offer asset protection, tax advantages, and flexibility in distributing income among beneficiaries. They are often used for estate planning and asset protection purposes.
Company Ownership: Some individuals or entities purchase residential properties through a company structure. The company becomes the legal owner of the property. This structure can provide liability protection and tax benefits, but it may have stricter lending criteria and tax implications.
The choice of ownership structure depends on various factors, including tax implications, asset protection, estate planning, and individual preferences. Consulting with legal and financial advisors is crucial to determine the most suitable ownership structure based on individual circ*mstances and long-term objectives. Each structure has its advantages and considerations, so it’s essential to weigh these factors before making a decision.
6. Purpose of Purchase
Identify the purpose of the property—whether it’s for personal use or investment. Deciding on the intended duration of ownership, whether for flipping, renting, or long-term investment, impacts the overall strategy.
Understanding the purpose of the property—whether it’s for personal use or investment—plays a significant role in shaping your future strategy and has several implications:
Investment/Home Owner Goals and Strategy: Personal Use: If the property is for personal use, such as a primary residence, the investor’s primary goal may be to fulfill housing needs, stability, and lifestyle preferences. The focus is on finding a property that meets personal requirements rather than maximizing financial returns. Investment: For investment purposes, the goal shifts towards generating returns. Different investment strategies, such as flipping (buying, renovating, and selling quickly for profit), renting for ongoing rental income, or long-term holding for capital appreciation, require different approaches and considerations.
Duration of Ownership: Short-Term (Flipping): Properties intended for flipping are typically held for a short duration, often less than a year. Investors focus on improving the property’s value quickly through renovations or improvements to sell it at a higher price. Long-Term (Rental or Appreciation): Long-term investments involve holding the property for an extended period, often years or decades. Investors aim for steady rental income or anticipate property appreciation over time.
Risk and Return Profile: Flipping properties can offer potentially higher returns but also involve higher risks and more active involvement in renovations, market timing, and sales. Long-term investments generally provide more stability and passive income through rent or potential appreciation, but returns may accumulate gradually over time.
Tax Implications and Financing: Different property purposes may have varying tax implications. Taxation on capital gains, rental income, deductions, and deductions for expenses differ based on the property’s use and ownership structure. Financing options and interest rates may vary for properties used as a primary residence compared to investment properties, influencing the overall cost of ownership.
Market Conditions and Location: The choice of property purpose and duration of ownership may be influenced by prevailing market conditions and the property’s location. Some markets may be more conducive to short-term gains (flipping) due to rapidly rising prices, while others may be more suitable for long-term investments with stable rental demand and potential appreciation.
Understanding the purpose of the property and the intended duration of ownership is crucial as it shapes investment decisions, risk tolerance, financial planning, taxation, and overall investment strategy. It helps property purchasers align their goals with the appropriate property type and strategy to achieve their desired outcomes effectively.
7. Defining Property Preferences
Understand your wish list for the property.
Determine your property criteria and then make a list with your priorities at the top and your lessor needs at the bottom of the list.
Determine realistic expectations within your budget and considering factors like :
- Size – what square meterage of house are you looking for
- # of bedrooms and bathrooms you require
- Single story or double story
- Double garage or carport, parking
- Big or small yard
- Pool or no pool
- What amenities do you want to be near as a priority.
- Do you need a catchment area for a particular school?
- Do you need to be close to public transportation.
- Consider what lifestyle factors you want to be next to?
- Shopping precincts
- Restaurants
- Bars/nighclubs
- Beach or parks, bike tracks, walking paths.
- Inner city living or quiet suburbia
Your wish list will look different depending on the type of property purchase, but all should be based upon your upfront research and due diligence, your property goals, sticking to your plan, getting professional input, and educating yourself.
In conclusion, once you’ve confidently evaluated these areas and gained a clear understanding of your requirements, assessed your own financial landscape, you’re closer to making a well-informed property purchase decision.
Seeking professional advice is recommended, especially if you’re new to property investment.
Happy house hunting, and may your property endeavours be successful!
