Private Property issue #139 - How do banks decide whether to give you a mortgage or not?

How do banks decide whether to give you a mortgage or not?

There are 3 tests the banks run your mortgage application through:

In simple terms, the banks calculate how much you can borrow under these 3 tests.

Then, they’ll give you a mortgage based on the lowest amount from those tests.

The investor can borrow a lot from an affordability (UMI) perspective in this example. They could go up to $1.56 million. 

They’re also looking good from the deposit (LVR) side. If they only had to meet this test, they could borrow $1.33 million.

But the new Debt to Income Ratios are holding them back. They can only borrow $1.24 million under this test.

That’s the lowest amount from the 3 tests. So that’s the mortgage this investor can get –$1.24 million.

Is there a bit more to it than that? You bet. 

But these are the main points you need to know as an investor. Because that lets you ask your mortgage broker: “What’s holding me back? Is it servicing, DTIs, or LVR?”

What exactly are these 3 tests?

But you might also wonder, how are these tests calculated? Let’s dive in.

#1 – The ‘Uncommitted Monthly Income’ (UMI) Test

The bank wants to make sure that you can afford your mortgage – even in a worst-case scenario.

So, they look to see if you can afford a new mortgage under a few stress tests. 

Things like:

• What if interest rates go up?
• What if you maxed out your credit card?
• What if you only get 75% of your rental income?
• What if all your loans were on principal and interest (even if you’re on interest only)?
• What if you only get half of the commission/bonuses you got over the last 2 years
• and many, many more.

They then come up with your Uncommitted Monthly Income. Which is just your income minus your expenses (under the bank’s stress tests).

They want to see that your UMI is positive (or above a certain number, like $50 a month).

It’s important that the banks do this. Because no one wants to see people struggle with debt they can’t afford. 

To borrow more under the UMI test, you can use strategies like:

• Commitment Issues: Reduce or restructure your existing debts.
• Earn, Baby, Earn: Increase your income through a raise, side hustles, or restructuring your pay. 

#2 – The Debt-to-Income Ratio (DTI) Test 

DTIs limit how much you can borrow and tie it to your income. 

For investors, you borrow up to x7 your income.

If you earn $100k a year. And you want to buy a property that rents for $25k a year. 

Your income is $125k. 

Multiply that by 7. You can borrow a maximum of $875,000.

Just keep in mind that New Builds don’t have to follow these rules. So, if you buy a New Build, this test doesn’t apply. 

You only have to meet the other 2 tests. 

To improve your DTI, consider these strategies:

• Mortgage Buster: Pay down existing debts to improve your DTI.
• Earn, Baby, Earn: Again, increasing your income makes a big difference.

#3 –The Loan to Value Ratio (LVR) Test

Then comes the obvious one. How much deposit you have.

Remember, you usually need a 20% deposit when buying your home or a New Build investment property. 

Or, it’s a 30% deposit if you buy an existing investment property. 

Most investors borrow the money for this deposit against the equity in their own home. You don’t need to have this in cash. 

To improve your LVR, consider: 

• Split banking: Use different banks for your loans to access more equity.
• Reno to Hero: Renovate your property to increase its equity

What happens if the bank won’t let me borrow?

If the bank says no … ask your mortgage broker which test you fall short on. 

Once you know the test(s) holding you back … you can start working on them.