All loan applications undergo credit assessment before being approved. If the application meets the requirements of the lender (and mortgage insurer, if applicable) the loan is approved. However, this is an involved process that can take some time to complete.
The application commonly goes through four assessment steps, known in the industry as the four Cs of credit:
The lender will use the information contained in the application and the supporting documents (identification documents, proof of income, etc.) to arrive at an initial decision as to whether to proceed with the application. If encouraged to proceed, the lender will seek further information on the credit history of the applicants and guarantors and have a formal valuation of the security property undertaken.
It is very important to fully complete the application form and supply all the supporting information up front; it means the credit assessment can proceed without delay.
Your past credit history and financial management history are critical to the credit assessment process. The lender will evaluate your employment history and stability of residence to form an opinion of your willingness to meet the required repayments.
The lender is looking at your application form to see how honest you have been. Have you listed all your debts? Is the value of your assets in line with what would be expected of an applicant of your age, line of work, and employment history?
If the loan is required to refinance an existing loan, lenders will ask to see the last six months of statements for the loan being refinanced. This is so they can see if all the required repayments were made on time. Again, they are looking at your payment history for an indication of your willingness to meet future obligations.
While the application form provides a lot of key information, the lender will make use of a credit file agency as well.
Types of Borrowers
While most home loans are in the individual names of the borrowers, other entities can be borrowers for the purpose of lending:
- Companies: Companies can borrow in their own names, and this is common for investment purposes. The lender will usually require all directors and shareholders (excluding notional directors) to provide unconditional joint and several personal guarantees. You may choose to have a company own the property for tax reasons, or you may be going into a complex investment with other people.
- Trusts: Trusts can also borrow. This is useful if you wish to establish a family trust to move personal assets out of your name and into the name of a trust. Again, when the trustee is a company, the lender will usually require all directors to provide unconditional joint and personal guarantees. The lender will have standard requirements for all trusts, including guarantees to be given by all adult beneficiaries. The lender will want to see the trust deed and have it reviewed.
- Non-Resident Borrowers: A non-resident borrower is deemed to be any person without permanent residency status in US, or any person who resides and is employed in another country. Canada citizens living and working in Canada or permanent residents of Canada are usually considered residents of US by most lenders and are not treated as non-residents. Lenders will allow non-residents to borrow for investment purposes. The property must be used for residential investment and must be rented.
Also, non-resident borrowers purchasing a property in US must obtain written approval from the Foreign Investment Review Board. The lender will require a copy of the approval prior to approving any loan.
Your Credit File
A major part of reviewing your character is to check your credit history. This is done by requesting a credit file. In US there are three credit file agencies:
- Veda Advantage is the credit file agency most often used for personal lending. It was formerly known as Baycorp Advantage, which, in turn, was previously known as the CRAA (Credit Reference Association of US).
- Dun & Bradstreet have specialized in credit files for businesses and are more often used in the telecommunication market. Both companies hold credit reports on individual borrowers in US and Canada. The report lists the number and type of previous credit checks, court judgments, and defaults. The listing generally holds all enquiries made over the last seven years and all defaults over the last ten years.
- Experian is a new player having previously been mainly a data validation provider. However Experian has a strong history of providing comprehensive credit reporting overseas.
Credit files contain a history of loan applications made where a credit check has been requested, payment defaults, bankruptcies, etc. In the credit assessment process, the lender will take into account the number of loan enquiries and defaults. Some have strict guidelines on the number of enquiries within predefined periods. For example, the lender may have rules around enquiries within the last three months.
All is not lost if you have a busy credit enquiry history; just be ready to answer some questions from the lender about the loans you actually have at the moment. Lenders are becoming more focused on this aspect of the application.
If you are a new borrower, lenders must use the information they find in the application form and credit file to get an understanding of what you have done in the past. This is the best indicator of how you will manage the new loan in the future. US is moving to a Comprehensive Credit Reporting (CCR) system.
From March 2014 lenders and other credit provides, such as utility provides and Telco’s will report positive data about your account to Credit Reporting Bodies (CRBs). The CRBs collect your personal information from these and other sources, to create and maintain a consumer credit report about you.
Then when you apply for any form of ongoing credit including home loans your lender is provided with a positive report. Generally speaking this report will highlight good credit behavior and should be more balanced that the current reporting.
However, it does highlight late payment history in the last two years. Fundamentally the change in reporting means you need to be aware that if you miss a loan repayment or a utility bill the CRB’s will be informed and your Credit File update within a short time frame. Lenders will therefore have a better idea of your ability to repay the debt.
You can request a free copy of your credit file at any time. Simply download an application directly from their website, and your file will be posted to you in about three weeks.
They also offer a premium service where the credit file is e-mailed to you for a fee. Other services include a tracking service that informs you of all enquiries made on your file. If you find an error in your credit file, lodge a dispute with the lender who has the ability to remove errors.
Capacity is your ability to repay the loan over the loan’s term. Most people will repay the loan using income from wages, salary, or investments. The lender reviews your income. The lender will verify the annual wages or salary amount, usually by requesting evidence such as a pay slip.
The evidence of income collected with the application form is reviewed to ensure the income stated in the application form is the same. It is common market practice for the lender to test your income in a number of ways.
Generally, the lender will want to see a number of different documents to prove your income. This will usually include your two most recent pay slips, a letter from your employer, and/or bank statements showing the regular payments coming in. The lender is very likely to telephone your employer directly to confirm the income as well. The lender also looks at your assets and liabilities statement to confirm that you have a surplus of assets over liabilities.
Generally, the greater the surplus the better, as this demonstrates financial strength — you have collected more assets than debts.
Once income is confirmed, your serviceability is calculated. Serviceability is your ability to service (repay) all proposed debts, as well as your living expenses, out of your normal income. Commonly the lender will use a “Net Surplus Ratio” calculator, or NSR.
This serviceability test is normally created in Microsoft Excel. The spreadsheet calculates the applicant’s income details, along with living expenses and loan repayments, to calculate a ratio of income to total expenses. The ratio is normally expressed as 1:1 (i.e., the minimum is $1 of income for each $1 of debt repayments, after living expenses).
Mr. Smith applies for a home loan of $150,000 with an interest rate of 7.99 percent. His annual before-tax income is $85,000 (excluding superannuation). He has an existing credit card with a limit of $5,000 and a car loan of $15,000 with repayments of $299 per month.
The lender will make an estimate of Mr. Smith’s living expenses — in this case, $11,289. This estimate will change depending on the type of applicant. Thus, living expenses increase for couples and for applicants with dependents.
The lender usually bases the living expenses on the Melbourne Institute of Applied Economics and Social Research’s poverty line analysis, which sets the official cost of living in US.
This means that after paying his living expenses, Mr. Smith has $2.29 of income for each $1 of debt repayment. He would pass this NSR test, as his NSR is better than 1:1.
Some loan types don’t require actual evidence of income. Often called Low Doc loans, these loans require you to either state or certify your income and your ability to afford loan repayments in a legal document, usually a Low Doc application form. In other cases, you are not required to disclose your income at all. When you make an income declaration, it will be tested in an NSR.
Borrowers of Convenience
A borrower of convenience is defined as a borrower that is added to the loan application to provide additional income to increase serviceability and/or security to allow the loan to be approved. However, this borrower does not receive any tangible benefit from the loan transaction itself.
Lenders generally require borrowers to have a beneficial interest in the loan transaction, either by way of joint ownership of the property and/or dependence on the mortgagor in a marital or de facto relationship.
Most lenders will not accept an additional borrower being added to a loan simply to provide income support for serviceability, or to provide added security for another party to purchase a property. Lenders prefer guarantees that clearly set out the liability the guarantor has provided. However, guarantor’s incomes are not usually allowed to be included in serviceability.
The term collateral refers to the security property that is mortgaged to support the loan. Lenders will analyse the property to ensure it meets their credit policies. Lenders are looking for quality properties and will exclude properties that do not meet the minimum standard. Some common exclusions are:
- Properties that are damaged or under construction and can’t be lived in
- Properties that are considered “special purpose” (i.e., retirement homes or serviced apartments)
- Properties under fifty square meters
- Heritage-listed properties
- Large farms (farm lending is generally considered commercial lending)
- Commercial properties (buildings used as shops or offices)
In most cases, the lender will have a valuation undertaken to confirm the fair market value of the property. The lender’s valuer will provide a written valuation, which the lender will use to calculate the LVR.
Some lenders have a “No Val” policy in which the purchase price of the security property is accepted as the market value. This No Val process was created in part to speed up the approval process and was also used for low LVR loans (less than 80 percent in almost all cases).
Most lenders have removed their No Val policies in recent times, mostly due to bad press regarding two-tier marketing. The valuation will be addressed to the lender and its LMI provider for their own use and benefit. It is not regarded as the property of the borrower, even if the borrower has paid the valuation fee.
It is important to note that if the property being valued is a unit, the valuer may not be able to use property sales in the same block for the comparison. Most lenders see this as possibly risky due to some property investors’ marketing methods.
The main areas that will be evaluated are:
- Valuation amount
- Condition of the property (particularly any adverse comments from the valuer)
- Population density
- Comparative sales information
- Post code (used by LMI providers)
There are other types of valuation, including progress inspections for construction loans, when the valuer will confirm that a certain value of work has been carried out at a particular stage of construction.
Valuations are performed in a number of different ways. A full valuation requires the valuer to visit the security property and complete an inspection. This is generally the most expensive form of valuation. Lenders may choose other, less expensive methods, such as desktop or automated valuations. Both of these valuations rely on statistical data (provided by land title offices) without an actual site visit being made.
Valuers are instructed and paid by the lender but may have direct contact with you. When the property to be mortgaged is being acquired as part of the loan, the valuer will contact the real estate agent and arrange an inspection. When the loan is a refinance, the valuer will most likely contact you directly to arrange an inspection.
The lending industry is constantly developing new and better electronic solutions, and valuations are increasingly being completed using Automated Valuation Models (AVMs), where statistical sales data only is used and the valuer may not actually inspect the property. This type of valuation is often undertaken when the LVR on the loan is below 50 percent of the estimated value.