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It happens to almost everyone eventually.  You walk into the bank, ask for an amount of money, either to buy a car, house or business and the bank declines you.  Today we’ll look at what to do if the bank declines you for a home loan because, according to their calculations, you don’t have enough income.

Typically, the three main questions a bank will ask is : 

The Income Hurdle

All Mortgage Lab Advisers are taught to answer two income questions:

  • Does it pass the banks income test? and
  • Does it pass the adviser’s internal test?

In other words, even if the bank says yes, can the Adviser sleep at night knowing this mortgage is in place?

Fortunately, these days, the answer is very rarely yes to the first question and no to the second. This is because the banks have some very conservative requirements on income for mortgages. 

To understand why a bank might say no to you purchasing further investment properties, you need to understand how the banks calculate how much they think you can afford. 

What are the different ways the banks look at my income?

  • Your mortgage payments calculated somewhere between today’s 2 year rate (currently 4.99%) and 7.65%
  • One bank includes additional monthly expenses per car in the household
  • Varying amounts of costs per dependent (child) that you have
  • Several banks take KiwiSaver payments off your income even if the intention is to stop those payments

The list goes on from there and all of this results in clients being able to borrow $x amount at one bank and quite possibly >$100,000 more or less at another bank.

Anticipating future interest rates

The banks calculate the amount of mortgage you can afford at, or around, the mid 7% interest rate. They are (obviously) aware that interest rates are currently much lower than that, however they need to know you can afford interest rates at a higher level.  

Some argue that rates have been higher than that in the past (much higher if you were around in the 80’s).  Shouldn’t they be calculating the mortgage affordability at 11%?  The theory is, if interest rates start to head north again, you’ll have a few years notice to remedy the situation (ie; sell the property) before it goes significantly above the 7%/8% mark.

Rental income

Every Mortgage Broker knows, the banks perform “shading” on all rental income received for investment properties. Typically this is 25% meaning if you earn $20,000 of rental income per annum, they will count it as $15,000 actual income. 

Doesn’t seem fair, does it? The first thing clients say when they hear this is there’s no way an investment property is going to be vacant for 3 months (25%) every year. If it is, it’s a terrible rental property!

But this shading includes additional costs such as repairs and maintenance, rental management fees, and sometimes rates and insurance. Given that, 25% shading of income is actually about right. 

Credit Cards

As we have seen in previous blogs, Credit Cards can have a major affect on the amount you can borrow. The banks must assume you’re going to max out the cards so often take the limit, not the actual amount you owe when calculating your income. 

Number of cars

One bank in particular adds a cost of ~$500 per month per car that you own. This can add up, especially once you own 3 or more cars and can significantly reduce how much you can borrow. 

What to do if the bank says no because of income?

So you’ve applied to the bank and been told no because, according to the bank, you can’t afford it.  Here are some things you might want to investigate:

Reduce unused Credit Card limits

As we’ve seen, these are just eating away your “useable income” at the bank. If you’re not using the limits reduce them and get confirmation letters from the companies to show the bank.

Get a rental appraisal on the new property

Real Estate Agents and Property Managers will supply you with a rental assessment that shows what you’re likely to rent this property for.  It might be more than you think.

(Pro tip: if the assessed rental is a range – eg; $300-$330 – the bank will use the lower of the range, in this case $300)

Consider getting Boarders into your home

Do you have a spare bedroom?  Get a Boarder (otherwise known as a flatmate) in.  The banks will usually allow up to $150 per week of boarder income which raises your annual income by $7,500.  The banks usually allow a maximum of 2 Boarders so don’t go overboard with this!

Remove your Student Loan

Only have a couple of hundred dollars left on your Student Loan?  It may be worth paying this off beforehand.  As long as, by paying it, you don’t end up using too much of your deposit (and creating a “Equity Hurdle”, you will free up a significant amount of income by removing the Student Loan payment from your payslip.

Pay off any HPs that are almost finished

Much like Student Loans, the banks have to take any Hire Purchase payments off your income; even if you only have a few payments left.  If you only have a small amount left and it’s not going to affect your deposit, get rid of them!

Increase rental on existing rental properties

Are you under-renting your existing rental properties?  A $20 per week rental increase is an additional $1,000 per annum.  This can make a surprising difference to how much mortgage you can borrow.

Sell a car

As we saw above, at least one bank takes the number of cars that you own into account.  If you have an excess amount of cars, consider selling one.  This may also help your deposit!

Ask the boss for a raise

Most clients think we’re joking when we suggest this but a $2 per hour raise is the equivalent of an additional $4,000 per annum increase in income assuming a 40 hour per week job (it’s best not to point that out to your boss though!).  This can help you get to where you need to be.  It’s worth the question!

https://www.youtube.com/watch?v=ybkADx3Wkgw

Time to reassess

If you have tried every option above, at this point it is time to reassess.  Is the bank correct?  Is it possible that you have completed your budget incorrectly and you can’t afford the new mortgage?  If so, that’s ok.  Start to adjust the price level you’re looking for down and see what else is available in the market.  If you are still sure you can afford the mortgage you have one more option.

Consider using non-bank lenders

There are finance companies that will lend on a purely “asset only” basis.  Typically they lend up to a maximum of 70% of the property and don’t ask any questions about your income.  They assume that you have done your homework and can afford the mortgage.

What to expect from non-bank lenders

Firstly, the interest rate will be higher than the banks.  The companies are taking a big risk by not assessing income so they need to be compensated.  Expect interest rates to ranges from 6.5% to 14% depending on the lever of risk that you bring (bad credit, LVR etc).

There may also be fees, some annual, some one-off.  They can typically range from 2-3% including the broker fee (we aren’t paid commission by these companies so we have to charge a fee).

Finally, have an exit plan.  The non-bank lenders don’t typically want to be your mortgage provider for more than 2-3 years.  They want to understand what you’re going to do with the property that will enable them to be removed as lender.  In this article, we’ve been looking at a shortage of income.  Perhaps you’re going to renovate the property so it brings in more income (at which point you will refinance back to the banks).  Perhaps you’re expecting a major pay rise in the next few months, or one of you is on maternity leave and will be returning to work.  These are all good reasons to pay a higher interest rate for a short amount of time to secure a good property.

Bringing in friends is not a great option

This is going to be hard for some people to hear but bringing in your friends as “co-borrowers” is not the bank’s favourite answer to an income shortage.  It sounds, on the face of it, like a great idea.  Bob is a mate and has spare income; why not bring him on board?  The problem is, friendships are tenuous and can fall apart.  And nothing puts a strain on friendship like money.  

What happens when Bob want his income to purchase another property?  Will you be able to raise the finance to pay him out.  If you can’t do it now, it seems unlikely.

The banks refer to this as a “borrower of convenience”.  You don’t have enough income so you grab a friend in from off the street.  These days, the banks simply decline these applications.

You have options

There are many ways to fix an income shortfall.  The key is to:

  • Find out how far you are from the bank saying yes
  • Fix the low-hanging fruit (Credit Card limits, Student Loans, Has etc)
  • Consider non-bank lenders and put a plan in place to refinance back to the banks in the future

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