Home Loan Basics

The Home Loan Approval Process

Following the lodgement of a home loan application, hopeful borrowers are often keen to know what will happen next and how long it will take for them to receive the verdict. The bad news is that there is no one-size-fits-all answer. The good news, however, is that a solid application is the key to keeping the approval time short.

The amount of time it takes for you to receive a response to your home loan application can vary. An answer is usually received between two days to two weeks, depending on a range of factors.

“For a reasonably straightforward application, it’s 48 hours to a final approval. But, depending on how complex the circumstances are, it can take longer than that,” explains Aussie General Manager Strategy and Product David Smith.

Before offering conditional approval, your potential lender will need to make an assessment of your application and conduct a valuation of the property. Of course, having a valuation that is acceptable to the lender done in advance will expedite the process.

“With valuations, the intention is to support an application rather than to make or break it,” Smith says. “There are a few things that can result in an application not being approved based on valuation, like zoning, property size, or if the condition of the property is poor enough that major repairs would be required before it could realise its market value.”

The lender will also assess your capacity to repay the loan amount you have requested. This is where all of the information about your salary and liabilities come into consideration, and where accurate and complete information is essential.

“The credit review by the lender can include a bit of to-and-fro between the customer, the broker and the lender due to the lender’s request for further information as that credit review takes place,” Smith says.

Your potential lender makes an overall judgement of you as a borrower and the complexity of your financial history will affect how long this takes.

“It’s best to be full and frank in disclosure from a borrower’s perspective. The biggest red flag is non-disclosure of liabilities or adverse information on a credit history, whether it is included in documentation or not,” Smith says.

“The complexity of the application process is a great reason why you would sit down with a reputable broker, as they can just explain all of that to you.”

Following the submission of an application, you can expect your finance broker to be in touch with you to update you on progress, and to notify you of the outcome. If your application is approved, your broker will also advise you of when to expect a formal letter of approval from your lender.

What Type Of Loan Is Right For You?

The array of mortgages available helps a good finance broker to tailor a package to suit your needs. Here are just some of the options.

Fixed-rate mortgages

With a fixed-rate loan, you know exactly how much you’ll pay per fortnight or month for the fixed period of the loan (usually one to five years).

Variable rate mortgages

Repayments can change during the life of a variable-rate loan, so you may pay more or less as interest rates rise or fall. If you’re fairly sure that rates are set to fall, this is a good option.

Principal and interest mortgages

In this mortgage, you are paying the amount lent to you plus the interest.

Interest-only mortgages

With interest-only, you are paying just the interest on the loan – you are not paying off any of the original principal.

Split home loan (fixed and variable)

You can choose to have part of your loan at a fixed rate and the other part can be at a variable interest rate. If rates do fall, the interest will go down on the variable part of your loan, but you aren’t taking as big a risk should rates rise.

Redraw facility

If you have a variable-rate loan and you make extra repayments, then you can withdraw that additional money when you need to (you can’t do this on fixed-rate loans).

Land loan

A land loan lets you buy a block of land without the pressure to build on it as soon as possible. Land loans are usually variable interest for up to 30 years.

Construction loan

For buying land, building or renovating your home, a 12-month construction loan can be the best way to go. Usually, up to 90 per cent of the property value can be borrowed.

Non-PAYG loans

For self-employed people, a home loan can still be arranged using differing supporting documentation that shows your ability to service a loan and might include BAS and bank statements. You self-certify your income, which will need verification. You may be able to borrow up to 80 per cent of the property’s value.

Equity release

This loan type allows you to convert a portion of your residential property ‘asset’ into cash or an income stream while still allowing you to continue to live in your home.

What are the basic elements of a loan or mortgage?

Here we explain a number of the basic terms and definitions used in home loans, mortgages and business finance:

• Principal
• Interest
• Term
• Repayments
• Amortisation

Loan principal

“Principal” is the amount of money you borrow from the Lender when you take out a home loan, mortgage, or other finance.

Loan interest

“Interest” is the fee the lender charges you for the use of their money. The interest charge on your loan depends on the amount of money you borrow, the interest rate, and the term of the loan.

Loan term

“Term” is the agreed period you have to repay your loan. For some loans, this could be a year or less, while for most home loans it is 25-30 years.

Loan repayments

Over the term of the loan, you make repayments on a regular basis – typically monthly. These repayments generally cover the interest charge and a portion of the principal.

Loan amortisation

This is a scary sounding term but it’s just another way to describe the repayment of your debt. Over the term of the loan, your regular repayments are said to “amortise” the loan.

How Lenders Work Out Whether You Can Afford A Loan?

Different lenders use different formulas to work out how much you can borrow, but the biggest loan isn’t always the best idea.

Being able to secure your ideal loan amount can seem like a battle of balances. Once you’ve worked your budget and finances through a spreadsheet, there’s still the one issue left to deal with: assessment rates. This is also known as an ‘interest rate buffer’.

Getting in while the going’s good and securing your loan while interest rates are low doesn’t change the fact that lenders are compelled to ensure that you will be able to make repayments if interest rates fluctuate.

Matching the features of a loan to your financial position is important, and often requires a third-party expert to help guide you through.

“What is very important is that people understand the ramifications of exposing themselves to debt,” says Andrew Crossley, Homeloans Business Development Manager and best-selling author of Property Investing Made Simple.

“When modelling costs, an adviser would be wise to be very conservative in the figures they are using.”

Assessment rates add a margin to the variable or fixed interest rate of your loan. The assessment rate provides added protection that you will be able to repay your loan when interest rates rise, because they are sure to rise and fall throughout the life of your loan.

“APRA is clamping down on lenders exposing people to too much debt and not preparing them for interest rates as well as they could have,” Crossley says.

The assessment rate can be anything from 1.5-2% above the variable rate, depending on the lender, and many are currently using rates of approximately 7-8%. Mortgage assessment rates vary from lender to lender, which is why different lenders may offer people in the same financial situation different loan amounts.

In some cases, the difference in loan amounts offered by different lenders can go into tens of thousands of dollars, but the biggest loan isn’t always the most suitable. Ensuring that you can pay your loan, whether rates stay low or rise, requires a bit of know-how.

What Documents You Need To Apply For A Loan?

Applying for a loan is a very big step, and it’s not always straightforward. To help make it simple, here is a handy list of the documents you are likely to need when you meet with your finance broker .

You are ready to buy a home, you just need a mortgage. Before you go rushing off to meet with your local finance broker , be sure that you have a few documents on hand to prove your identity, income, assets and liabilities.

Identity

You will need two of the following three:

• passport;
• driver’s licence; and
• photo identification, such as a university identification card or proof of age card.

If you don’t have two of these, you can also provide one, plus a birth certificate, Medicare card, citizenship certificate or similar documentation.

Income

If you are employed on a full-time basis, this is a fairly easy part. You will need to prove your income by providing your most recent PAYG payslip, including YTD income of at least three months. If your payslips don’t list your YTD income, you will need to provide previous payslips, your employment contract, an ATO tax assessment, a PAYG summary or a professionally prepared tax return.

If you are self-employed, you’ll need to provide your individual tax return and ATO assessment notices for a year, as well as your business’s financial documents: one year’s tax return, profit and loss statement, and balance sheet. You may need BAS statements or other documents from your accountant, too.

Whether you are self-employed or not, any other income you receive will also need to be documented. For example, if you own an investment property, provide a current lease, tax return listing the rental income or a letter from the leasing agent; if you own shares, bring a statement, investment record or tax return; and if you receive any government benefits, bring a statement from Centrelink.

Assets

You will need to prove your savings with bank statements, as well as be able to provide details and values of any other assets, such as cars, stock, term deposits and property.

Liabilities

By the time you are applying, you should have paid down your debts and reduced the limits on credit cards to give you the best chance of approval and improve your borrowing capacity, as lenders assess your ability to make repayments on your credit limits, not just the amount you owe.

You will need current statements for your credit cards, store cards and loans.

Construction Loans explained

If you are thinking of building your own home, you will need to be familiar with the ins and outs of construction loans.

Construction loans are just not as straightforward as simple home loans. There are additional decisions to be made about the structure of the loan, additional documentation is required and the funding is released in an entirely different way.

Documentation

In addition to documentation about your finances, income and identity, your application for a construction loan needs to include contracts or tenders for the construction, as well as the plans so that a valuation can be performed.

Further documentation will also be required before the first payment is made from the lender to the builder, including a schedule of the payments to be made (called drawdowns), the builders’ insurance details and the final plans that have been approved by the local council.

Structure

To avoid having to contribute your full deposit and being charged interest on the entire loan amount from the moment the land purchase settles, you can split your mortgage into a land loan and a construction loan. At settlement of the land purchase, you pay lender’s mortgage insurance (LMI) on the land loan, if LMI applies, and start being charged interest and making repayments on the balance of the land loan. The interest and repayments on the construction portion then kick in only as each drawdown is processed.

Funding

The drawdown schedule is very important, as you don’t start paying interest on each portion of the loan until it is paid to the builder – you, the lender and the builder need to be satisfied with the schedule.

For the lender to make each payment to the builder, you will need to fill out a drawdown request form from your lender, and submit it to your builder. The builder can then send the lender your form with an invoice for that part of the payment and, after the lender is satisfied that the work has been completed and is up to the standard expected in the valuation, the drawdown can be completed with a payment to the builder.

Any changes to the contract and plans can trigger a reassessment of the loan, so be as sure as you can be that the plans and contracts the lender sees are final, and it is also worth trying to pay for any small amendments from your own pocket, rather than changing the loan and risking a reassessment.

Problems can also arise when other work on the site that isn’t completed by the builder needs to be paid for, as some lenders only make the remaining funds of the mortgage available after the completion of construction. While some builders will include subcontractors as part of the main contract, meaning that they can be paid by the builder as stages of work are complete throughout the drawdown schedule, others will not do this. Again, this may make it necessary to pay from your own pocket.

How To Pay Off Your Mortgage Faster?

When was the last time you looked closely at your loan, the progress you are making on paying it off and how it compares to others in the market? Analysing your mortgage could mean savings for you, as well as the opportunity to pay it off more quickly, invest in other assets or reach financial freedom sooner.

1. Make smaller payments, more often

To cut the size of your payments, make more of them. This could even see you pay off your loan faster, and therefore pay less interest overall.

If you pay your mortgage monthly, consider changing to fortnightly repayments. For example, if your mortgage equates to $2400 a month, cut this in half and pay $1200 each fortnight. As well as having more manageable payments to make, by the end of the year you will have paid off $31,200 rather than $28,800.

2. Pay just a little bit extra

A minimum repayment is just that – for most loans there is no reason you can’t pay more, whether here and there or regularly.

By rounding up to a full number or contributing an extra $100 or even $10, you’ll significantly reduce your mortgage. It may also be worth considering putting all bonuses, tax returns and gifts into your mortgage.

3. Don’t decrease repayments when interest rates fall

Even if your repayments are lowered when fees and interest rates decrease, it doesn’t mean that’s all you have to pay and, by keeping your repayments at the same level when interest rates are lower, you will pay down more of the principle with each payment and make speedy progress on your loan.

4. Offset it

If you can, use an offset account. A mortgage offset account is linked to your loan and the interest payable on the loan from month to month is calculated by deducting what is in your offset account from your current loan. For example, if your mortgage is $500,000 and your offset account has $10,000 in it, you will only pay interest on the remaining $490,000.

An offset account will save interest while still giving you access to your savings. It also means investors can preserve the tax deductibility of the mortgage.

5. Find a better deal

Ultimately, your mortgage needs to suit you and your circumstances, or you will wind up paying too much. If you think your current loan no longer matches your situation, speak to your finance broker. They will be able to find the right product for you, as well as negotiating appropriate rates on it.

Of course, it is important to make sure that your lender doesn’t charge fees for extra repayments, refinancing, or any other steps you take in an attempt to save on your loan. Your finance broker will be able to provide details and make sure you have a loan that lets you pay down your balance sooner.

What is Home Loan Pre-Approval?

For those getting ready to stride into the world of home ownership, the uncertainties of pre-approval can cast a shadow of doubt over an otherwise exciting time. When is it necessary? How long does it last? And what does it involve, exactly?

Pre-approval is a lender’s assessment of your likelihood of being approved for an otherwise suitable loan. The appraisal is made on the basis of your ability to service a loan by looking into your living expenses and liabilities, your credit history, your employment circumstances and how often you have moved home or employment in the recent past.

As it is performed prior to a property being found and chosen, it does not take into account the particulars of a specific property and valuation, which is why uncertainties can arise.

Pre-approval is helpful for those who want to know how much they can borrow before attending open homes, and can be reassuring for new borrowers.

“When someone gets pre-approval they can start looking at properties knowing how much they can borrow. They know what their price range is,” explains Homeloans Ltd Senior BDM Rodney Cottam. “People take comfort in knowing that a lender has looked at their application to make sure it meets policy.”

Pre-approvals are usually valid for up to 90 days but, depending on the lender, may be renewed to allow more time to find a property.

It is very important to note that a pre-approval is not a guaranteed loan. It is your potential lender’s way of signalling how much they expect to lend you. This may change on your official application.

“Policies are changing day-to-day, week-to-week at the moment,” Cottam says. “For anybody with a conditional approval, it’s a good idea to speak to their broker to find out if any policies have changed.”

Another thing that may cause a lender to decline your loan application after pre-approval is a change to your pre-approval circumstances.

“We need to make sure the applicant has not gone and got another credit card or car lease, or any other debt that may affect their income and serviceability,” Cottam says.

Your pre-approval will also usually be conditional on a property valuation. If your lender does not deem the property a marketable asset, they may not approve a loan.

“We want to check that it is a readily saleable property. That’s the biggest thing. To make sure the actual security itself is acceptable,” says Cottam.

Potential lenders need to be wary of the changes that can affect their ability to take out a loan, regardless of pre-approval figures, to ensure they don’t overcommit without a guaranteed source of funding.

Pre-approval is not a guarantee, but is a very useful tool for anyone looking for a property. Contact us about pre-approval before you lock in your Saturday open home schedule.