Thinking Like Bankers: Part 1 – Understanding Loan Servicing and the Loan to Value Ratio

As a former employee of three of the big four banks in New Zealand, I have a wealth of experience in understanding how banks assess mortgage applications. Two key factors that banks consider when evaluating your loan application are:

1. Servicing: Banks want to ensure that you will be able to service the loan and meet your day-to-day financial obligations without putting yourself in a difficult financial situation.
2. Loan to Value Ratio (LVR): The LVR is a critical factor for banks as they have to comply with guidelines set by the Reserve Bank. Generally, different criteria apply to different types of applications. For example, if you're looking to purchase an investment property, the bank will typically only lend up to 60% of the purchase price. If you're buying an owner-occupied property, the bank will lend up to 80% of the purchase price.

In situations where you have an existing owner-occupied property, you can leverage its equity to purchase a new investment property. This is called cross-collaterization and is a common practice. Let's look at an example:

• Current loan: $500,000
• Current owner-occupied property: $1.5 million
• As this is an owner-occupied property, you can lend up to $1.2 million (80% of the property value) on this property.

This means if you have a loan of $500,000, there is $700,000 of equity you can use towards purchasing your new property.

When it comes to cross-collaterization, there is no set maximum LVR. The general rule of thumb is that as long as the lending for owner-occupied property is 80% or less and investment is 60% or less, then it falls within the LVR restrictions.

It's important to note that even though you have enough equity and meet the LVR guidelines, you still need to be able to service the loan. Banks will complete a new application to assess your serviceability.

There are two main parts banks look when they consider your servicing:

1. Your liabilities: Banks take into account your existing facilities such as home loans, personal loans, credit cards, and store cards. They determine the monthly obligations for these facilities and calculate the repayment based on the approved limit, even if you pay off your balance in full each month.
2. Expenses: Banks are particularly strict with your expenses, especially fixed commitments and essential expenses. Fixed commitments include property rates, house insurance, personal insurance, and private school fees. Post-CCCFA changes, banks include these expenses in the application which can affect your servicing levels.

In the next part of our series, we'll explore how banks assess your income and credit history. Stay tuned!

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DISCLAIMER: The information contained in this blog is general in nature. We cannot assess anything about your personal circumstances, your finances, or your goals and objectives, all of which are unique to you. Before making financial decisions, we highly recommend you seek professional advice from someone who is authorized to provide financial advice.