If you’ve decided to buy a house, you’re probably searching for the right home loan to finance it. While there’s no guarantee you’ll qualify for a home loan, there are certain steps you can take to improve your chances of approval by highlighting yourself as a responsible borrower.
1. Build your savings
A 20% deposit can improve your chances of qualifying for a mortgage. However, lenders are not just interested in your deposit; they also want to know how you saved it. Most lenders want to see proof of genuine savings, which refers to money saved by you from your income over time.
A regular savings habit shows that you can live within your means and still save something towards your future goals. It also demonstrates financially responsible behaviour, and such borrowers are considered less likely to default on their mortgage repayments. Putting away some money in your bank account towards your deposit can thus increase your chances of approval and help you reduce costs by making a larger down payment.
Coming to the question of how much you need to save – you can use an online calculator to crunch the numbers and find out how much money you’ll need to make your dream come true in a certain timeframe. If you are just getting started with your savings, you might want to try the 50/30/20 rule that requires you to save at least 20% of your income and use the remaining for your basic living expenses (50%) and some non-essential requirements (30%).
2. Reduce your Debt-to-Income ratio
Your Debt-to-Income ratio or DTI refers to the amount of your income that’s used to service your overall debts. It is calculated by dividing your recurring monthly debts by your gross monthly income and expressed as a percentage.
Lenders use your DTI to determine whether you can afford a home loan or not. It also helps them calculate how much money they should lend to you if they find you a suitable borrower.
A DTI over six is generally considered risky, but some banks allowed a maximum DTI of up to nine until recently. However, with the Australian Prudential Regulatory Authority (APRA) issuing warnings against risky loans, most banks have cut down on high DTI loans. This means you should work towards reducing your recurring debts before applying because a high DTI could lead to your mortgage application getting rejected.
You can do two things to reduce your DTI: increase your income or reduce your debts. Perhaps you could check if you can get a raise at work or start a side-hustle to augment your income. You should also examine your expenses to figure out where you can save and use that money to pay off debts.
3. Use buy now pay later (BNPL) services responsibly
If you plan to take out a home loan, be prepared for lenders to closely scrutinise your expenses, including how often you use buy now pay later services like Afterpay.
Even though BNPL services can sometimes help you budget your expenses by breaking them down into smaller, interest-free instalments, they can also lead to you racking up debts if you are not careful about spending limits. This can happen when you use more than one BNPL service or use a BNPL service to pay for things you cannot afford. If you fail to repay your BNPL debt on time, it can also affect your credit score.
Using a BNPL service could also impact your home loan serviceability. If you regularly use a BNPL service like Afterpay to pay for goods, lenders are likely to factor this amount in their serviceability calculation, impacting your borrowing capacity adversely. Besides, using BNPL to manage your expenses each month can give the impression that you cannot live within your means, or you can’t manage your money. This can raise a red flag for lenders, especially when you default on repayments regularly, which can be found out by any late fee on your bank statement.
4. Review your credit score
Your credit score plays an important role in deciding the fate of your home loan application. A good credit score indicates you are creditworthy and are less likely to default on your home loan. Unsurprisingly, lenders prefer borrowers with a high credit score and offer them better rates and discounts compared to other borrowers.
If you are wondering what a good credit score is, it could differ between the three main credit rating agencies in Australia, but a score of more than 725 is generally considered good. Anything above that is even better. Many websites allow you to check your credit score for free, which can help you keep a tab on your financial health.
If you find your credit score is low, you can do a few things to improve it before applying for a home loan. These include positive financial behaviours, such as paying your bills on time, reducing your credit card limits, paying off your debts, etc.
You should also go through your credit report at least once a year to check if any incorrect information is listed on it. While it’s not common, errors can sometimes creep into your credit report and potentially hurt your credit score. So make sure you check your credit report before applying for a home loan to remove any incorrect information that might be listed on it.
5. Get pre-approved for a home loan
A home loan pre-approval means a lender has agreed to lend you an amount of money for purchasing your home, but the approval isn’t final. It is conditional upon certain requirements – such as the property passing the lender’s evaluation and your financial situation remaining largely the same as at the time of pre-approval.
Applying for a loan pre-approval is not a mandatory step in the home buying process, but it makes your life simpler by giving you an estimate of how much money you might be allowed to borrow. This helps you narrow your property search and bid more confidently if you attend an auction. However, not all mortgage pre-approvals work in the same manner.
The pre-approval process depends on the lender you apply with. Some lenders offer instant online pre-approvals, which might only help calculate your borrowing capacity to an extent. Others require you to fill out an application and provide supporting documentation, including identification, proof of income, savings, and debts. This helps the lender to carry out a credit assessment before pre-approving your mortgage. As the lender has already reviewed your financial situation, you are likely to receive the final approval for your home loan if your property meets their valuation criteria and your financial situation hasn’t changed for the worse.
If you are confused about the pre-approval process or need some help finding the right home loan, speaking to a mortgage broker could help. A mortgage broker is an expert who can make the process of applying for a home loan simpler for you. They can help by suggesting the best home loan options for you and supporting you in organising and filing your application.
