Serviceability buffer and what does it mean?

In these times of greater cost of living pressures coupled with higher interest rates, those looking to obtain housing finance or refinance their existing loan can face a stricter test from lenders to secure that mortgage.

Lenders are required to examine a borrower’s ability to repay a loan at a higher interest rate than those currently on offer. This is known as the serviceability buffer.

The banking watchdog, the Australian Prudential Regulation Authority (APRA), expects lenders to add three percentage points to new and refinanced loans from their current level. That means a new customer offered a 6.0 per cent variable interest rate would be assessed to see if they can still repay the loan at 9.0 per cent.

A finance broker can assist borrowers to ensure they are able to pass the serviceability test by making sure their finances are in order. Brokers can examine your income and expenses and recommend any changes you should make before making a loan application.

In some cases, the higher serviceability buffer could reduce a loan applicant’s borrowing capacity. APRA has said its recommended increase in the buffer would curtail the borrowing capacity of a typical customer by 5 per cent.

Mortgage serviceability is calculated by taking a borrower’s income, subtracting expenses, household expenditure, and adding in the new loan repayment. Factors that contribute to an individual’s financial situation can include the number of children or dependents. Typically, an individual’s income is balanced against their expenses, liabilities, and other outgoings.

Many lenders use the serviceability calculation as well as the debt service ratio – the proportion of the applicant’s income that can go toward paying off a loan – to assess the borrower’s capacity to pay off the loan. The maximum acceptable debt service ratio typically ranges between 70 and 90 per cent, though this varies between lenders.

With lenders applying tougher standards, it will pay to talk to a broker first before applying for a new home loan.