What are the Banks looking for in loan Applications

[Keithw]

In another thread banker Roseneath Rat gave this reply, which I think is valuable info & worth further discussion.

"Your other question, what I look for when assessing loan... well credit assessment boils down to Five C's:
Character (who you are lending to, reputation, credit track record, employment history)
Cause (reason for seeking finance, eg- purchase of asset better than funding tax arrears)
Cashflow (affordability assessment, sensitivity analysis including losing income, rental reliance, interest rate changes)
Capital (how much 'hurt' money is in the game, genuine savings vs equity)
Collateral (what assets back up the loan in the case of default) "

RR feel free to expand on these as much as you like in this thread.

What are your experiences with recent loan applications and data that you have had to provide to progress them ?

[Keithw]

in another thread TPR brought up some recent experience

http://www.propertytalk.com/forum/showthread.php?t=19846&page=6

"Banks now also factor in a ratio of rental income vs salary, i.e are you earning more rent now than your salary, if so they will factor back the DSR ratio's on lending,"

What are the numbers they use for DSR ?
My bank used to say they only relied on only 70% of the value of your annual rent - has that changed (assuming you reach the point where rent exceeds salary)
__________________

They have not bought it in yet but there is discussion.

So firstly they will decline you if you are rent reliant. I remember my brokers here in NZ asking me what this red flag is that came up on the software I created to calculate borrowing capacity, in NZ it was just not heard of in 2004. It was a big issue in Oz which is why my BC calculator had it written in as a red flag.

secondly and this is the new one if your rental income exceeds your salary they will drop that 70% number down to the same figure as salary, i.e 30 to 35%

So the second one is the one being discussed right now. Not a good scenario if they bring it in. My aussie business partner who was the first female branch manager in QLD for St George says she remembers when that was part of the criteria in 1989.

[roseneath_rat]

Part 1 of 5 of the C's: Character Assessment

The Character part of any loan submission may be one of the most subjective but also one of the most important aspects of any loan application. In essence the lender is trying to establish that the borrower is of good moral character, is reliable & willing to repay the loan, has the financial street cred, stability and history to support a long term financial commitment. Its the easiest section of a loan application to fail... in that if your lender doesn't trust you then you can be sunk at square 1.

Some of the questions the lender will be asking themselves:
Does the borrower have a history with my organisation?
Are they of reputable occupation and in an industry of good standing?
How long have they been in employment? Is there a pattern of skipping from job to job?
Have they lived in the same place for significant periods of time, or do they jump from place to place?
Do they have a budget?
Do they have the financial understanding of their situation, realistic about what they can afford and commit to?
Do they appear to be presenting the facts, or do you get the impression they are concealing something?
Have they had adverse credit events in the past, and if so have they learned from the experience?

This is certainly not an exhaustive list, but you get the idea. A lender is trying to figure out that even if you have the means to repay a loan, do you have the will to do so.

In credit assessment one gets to rely on "Lenders Gut" ... the gut feeling as to whether a deal feels right or whether there is something a bit shonky. For example someone seeking finance to buy a house for themselves to live but really its intended as a short term renovation & onsell for profit.

Next step - Cause.

[Davo36]

Interesting RR, will await the other Cs.

[mortgage broker]

One of the 5 c's - Capital

This one is interesting now as lenders really are back in the game of giving serious savers the credit they deserve. Don't forget there is sometimes a consideration made for the rent you might be paying as well.

Although some savers might be holding out to save that little bit more to get to 20%, I have lenders who will still seriously consider savers with less. Also if a parents home has some equity we can use guarantees to make up the shortfall. If you are doing this be sure to limit the guarantee to the amount of shortfall.

[crashy]

how long must you have a job before meeting criteria?

Im relocating from overseas so obviously wont have employment history. How long would I need to wait?

If I can show Ive made heaps tax free renovating property in Oz over the last 3 yrs would that help?

[roseneath_rat]

Part 2 of 5 - Cause

This one is rather straight forward. Lenders need to make sure that the purpose of loan is fit-for-purpose (not necessarily under the definition of the fair trading act) and that the borrowing requirement is legal & legitimate. Cause of borrowing is also an indicator of a prudent borrower or not, for example IRD arrears, debt consolidation, poor management of cashflow, payment of court fines... not ideal!


Obviously lenders are not supposed to fund illegal enterprise. True story- one if my colleagues had a funding request for a hydroponics setup in the basement. It was all above board (allegedly).

Borrowing cause also determines the most appropriate structure of finance. EG- A loan for buying a car or other depreciating asset probably shouldn't be funded in the same way as a bridging loan for the sale & purchase of two properties or a business acquisition.

I'm surprised by the number of people who are reluctant to provide this simple information.

Borrower: I'd like to borrow $50,000
Lender: OK, what do you need it for?
Borrower: Uhh... why do you want to know?
Lender: Its important information for me to approve your loan.
Borrower: It's confidential, I'd rather not say. It doesn't make your job any easier.
Lender: That makes my job easier than you think.

I've seen some good ones in my time... fund a stomach stapling operation, bail a son out of a martial separation (never liked her anyway apparently), repairs of arson damage...

[roseneath_rat]

Crashy,

Its a bit subjective, but in normal situations a lender would want to see a stable employment history or business management. Given that you are no longer in Australia it will be a tough sell to get funding in NZ without any track record here.

Its probably exactly the wrong time to try to borrow money for reno-type projects if you have no local track record. Talk to your lender & explain your specific situation and see what the story is.

[Keithw]

Will they not take into account his overseas work history ?
Although if he has been self employed doing renos full time I guess that wouldn't impress them.

thanks for your posts RR

[Playachicken]

Will they not take into account his overseas work history ?
Although if he has been self employed doing renos full time I guess that wouldn't impress them.

I'm thinking they won't be impressed!! I've been trying to get an Aussie investor financed who has good income and equity in Oz, and all the NZ banks are saying they will only stump up 70%.

So, I suspect if Crashy has been self employed, it's going to be a bit like being a realtor or car salesman or any other commission based person, none of which are in the good books for financing these days.

Good luck Crashy!

[roseneath_rat]

Part 3a of 5 - Cashflow

Simply put this is an analysis of Cash In versus Cash Out. Lenders want to know that a borrower has the means to meet their financial obligations on a timely basis and be able to repay the loan in full over the normal term. Missed loan repayments are time consuming to deal with for a lender and if a loan has a heightened level of repayment risk its likely a loan application will be declined or provided on different loan terms.

Income should include salaries & wages, investment income, business income, benefit payments, rental income. Because loans are paid from future earnings, not historical ones the lender will be trying to estimate what the borrowers prospects are. While the best indication of future earning potential is what has been earned in the past, it is certainly no guarantee.

The main source of income will also determine the appropriate channel in the lending institution examines the application. Salary and wage earners have low volatility in their incomes so are less risky as borrowers and can be handled by consumer focused channels. Business borrowers are more complicated to manage and have numerous additional risk factors involved, so should deserve more specialised and experienced staff.

Confirmation of earnings is a given, wage earners should supply payslips or tax returns, business owners should supplying their financial accounts etc. The quality of the infomation should be considered... is the individual running their own company? In which case a letter from their "employer" confirming a steady wage may be treated with a grain of salt. A set of financial accounts supplied now for the Year Ended 31 March 2008 is on average 18 months out of date. Year-to-Date earnings and forecasts may be sought.

While this may seem straight forward, it is an area that is subject to the most risk... and should be subject to a 'sensitivity analysis' ... or basically "What If...?"

A lender will consider a number of scenarios... a selection of questions they may ask themselves for a particular borrower:
How regular is the income source? EG- a commissioned sales professional may have large lumps of income but infrequently. What if the borrower does not receive any income for the next 2 months, do they have the cash behind them to sustain repayments?
How confident am I that the income will continue in the forseeable future? EG- is the individual working in an industry facing significant downturn.
How long with the income continue for? EG- are the borrowers planning to start a family or retire within the term of the loan.
Are the rules changing? EG- governments change policy & benefit levels often, sometimes with little warning.
How stable is any investment income? Interest rates are volatile, share dividends fluctuate, finance companies fail.

Rental income will be treated different by lender, but the most typical approach is to 'scale' rental income by a percentage. EG- a lender may consider 75% of your gross rental income to support debt repayments to take into account expenses such as city rates, insurance and vacancy. Borrowers who are heavily reliant on rental income from a small number of rental sources are riskier, as if the tenant defaults the borrower may not have the ability to make their repayments.

[roseneath_rat]

Part 3b of 5 - Cashflow (continued)

Cash Out should allow for any regular obligations that a borrower currently has, or could reasonably believed to assume in the near future. This may include mortgage repayments, rental payments, HP or consumer loan payments, child support, repayments of fines or penalties, tithes to church, repayment of family loans, credit card payments and any one-off or lump sums due in the near future.

Depending on how close an application is to loan affordability criteria it may warrant sensitivity analysis as well. A borrower at the moment raising funds at 6% may struggle in two years time if interest rates increase again to 10% or worse. For a typical borrower with say $200,000 of debt this equals $8,000 per year or $667 per month. Many borrowers were in exactly this position a year ago.

Different lenders will have their own method of qualifying loans but will really be looking for the same answer- that the borrower can meet all obligations in a timely fashion. They may measure total repayments as a percentage of income, look at surplus cash each month after payments, look at the amout of uncommitted income. EG- a lender may want to ensure that your total repayments are no more than 35% of pre-tax earnings, and leave cash surplus of no less than $1,800 per month for other expenses. The larger the borrowings, the more conservative the criteria gets. For small consumer home loans some lenders will consider as little as $1000 per month in surplus after making all loan payments (most of us would personally struggle to live on this level of income!).

Credit cards can be treated in different ways also. I have found the most common approach to calculate what the minimum repayments are if the cards are maxed out. This should be about 3% of the limit per month, or 36% of the total limit on an annual basis. For this reason it pays not to have high credit limits if you are seeking substantial borrowings or if you are close to the line.

Example 1: Couple seeking to buy first home

Combined incomes before tax $80,000, after tax $65,000
One credit card of $5,000 limit, no other debt.

Maximum of 35% x $80,000 = $28,000 per year
Subtract 36% of credit card limit = $1,800 per year
Net available for repayment of home loan $26,200 or $2,183 per month.
Over a term of 25 years @ 7% this repays a loan of about $309,000

Work it backwards from a net income perspective:
Net income $65,000
Less Loan payments $26,200
Less Credit Card allowance $1,800
Net per year $37,000 per year or $3K per month.

This is probably an acceptable proposal assuming all other aspects stack up. $309K of debt seems like quite a lot for this level of income at 3.86x gross earnings but probably ok.

[alhoon]

Hi Roseneath_rat,
Thank you for taking the time to post all this info, very interesting
Allan

[Keithw]

thanks RR
very valuable

In 3a you mention company accounts in the case of the self employed.
What happens in the case of LAQC which has a manufactured loss or a real loss.
Is it just subtracted from your other income, or is the reduced tax liability also considered ? ie an allowance higher than the standard 35% of gross income.

[roseneath_rat]

Keith, in the case of a simple LAQC for an otherwise salaried worker, the company accounts are probably unnecessary unless it is part of a larger and more complicated structure.

Often the reduced tax liability created by depreciation is not considered with negatively geared property unless you provide a physical personal tax return and full accounts showing the actual tax liabilities.