For the past 6 months we have seen a rapid tightening in the lending market. This was reflected in not only interest rate increases, but behind closed doors, an increase in Bank Test Servicing Rates. This has made it significantly harder to get a loan approval from a bank, something that you may have been told was possible 6 months to a year ago, when interest rates were cheap.
So, what are Bank Test Servicing Rates?
In a nutshell, they are the rate in which a bank assesses (also known as 'Stress Testing') the lending amount the borrower/s requires, which are generally 2% higher than the bank’s carded floating interest rate. This is a risk mitigation calculation which the banks use to ensure that the borrower can continue to afford the loan if interest rates were to increase by 2%.
For example, today if you wanted to borrow from the bank, they may use an interest rate of 7.6% (ANZs current test rate) to 'stress test' your servicing capabilities, meaning you would need to be able to afford to repay your mortgage if prevailing rates were 7.60%.
If you can tick this box for the banks, then the lending is approved.
How does this affect you?
Recently the people we have seen most affected by the increasing Bank Test Servicing Rates are those who have either;
- received a pre-approval to purchase but have been unsuccessful in purchasing for a significant amount of time.
- committed to buying a turnkey/ new development property anywhere from 6 months to 2 years ago who are now needing to arrange finance as the development comes to completion and they need to settle the funds.
People have been forced to make drastic changes to their plans, goals, and circumstances to either increase their affordability/ servicing to secure a bigger pre-approval, or alter their settlement funds by further savings, selling down assets, or most commonly, getting cash gifts from family members.
In our experience
I have been working with a client for a while now who was looking to secure a home loan. We were able to secure a pre-approval for her in Dec 2021, however we had to reapply to the bank in Mar 2022 even though there were no significant changes to the client’s circumstances (required to be declared to the bank). She was then approved for $35,000 lower than the Dec 2021 approval.
We have now recently (Jun 2022) gone back to the bank to get an extension on this approval, and again with no significant changes to the client’s circumstances, she was approved for $50,000 lower than the last approval!
This works out to be a 13.70% drop in lending within a 6-month time period based on the original offer given by the bank back in Dec 2021.
In simple terms, that would be the equivalent to a $130,000 drop in lending capabilities of a client who was approved for a loan of $1,000,000! A significant drop and sting to any buyers wishing to buy in today’s market.
Combating Bank Test Servicing Rates
Now that we know what Bank Test Servicing Rates are and how they can impact buyers, you may be thinking, "Well there must be a way we can combat these?" and there is! However, it's not likely that we will see Bank Test Servicing Rates start to fall until inflation is under control. This is because the Reserve Bank sets the OCR (Official Cash Rate), which is simply the rate at which banks can borrow money from the Reserve Bank. It’s the same thing that the Reserve Bank increases and decreases to help control inflation. So, if the OCR increases, it costs the banks more to borrow money, which in turn means the banks increase their interest rates to buyers to cover the increased cost of borrowing. This is to protect the banks from too much risk exposure from buyers taking on more debt than they can afford.
There are some ways in which you as a consumer can help to mitigate the effects of Bank Test Servicing Rates on your affordability, which are;
- Lower expenditure. As mentioned in previous blogs, dropping your monthly expenditure helps to increase your lending capabilities.
- Repay or consolidate consumer debts. In relation to lowering your monthly expenditure, repayment of consumer debts, or consolidating the debts into your home loan is a good way to reduce expenditure and increase lending.
- Increase income. This is somewhat self-explanatory, but if you are able to increase your gross household income, whether that’s salary/ personal income, rental or boarder income, this will help to increase your lending capabilities as you have more disposable income to cover an increase in lending costs.
- Increase deposit or equity contribution. By increasing the amount of equity you put into a property purchase, this will reduce the amount of lending required meaning that the banks will test you on a lower lending amount.
As long as interest rates continue to climb, so too will the Banks Test Servicing Rates. Until we see a drop in the OCR and in turn a decrease in the banks interest rates, we can expect the Banks Test Servicing Rates to stay high as they mitigate their risk. But this is not to discourage you from jumping on the property ladder.
As always, whether you are buying to live in the property or buying to invest, there are ways in which the Lateral Partners team can help to assist and think outside the box to meet your lending requirements, so feel free to get in touch.
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