Looking to borrow some money? Whether it’s for a car, a long-awaited home renovation, or the wedding ceremony you’ve always dreamed of, the first thing your lender will want to check is your ability to repay the loan and still meet your other commitments.
That’s called ‘debt servicing’, and here are some important things to know about it.
It’s key to the success of your loan application
No matter how frugal you are with your budget, the all important ‘debt-servicing’ ratio is one of the key factors that lenders consider when assessing a new loan application.
Every lender has a slightly different calculation or allowance for costs, but the net effect is the same; can you demonstrate you have the financial ability to meet your living costs and your fixed debt repayments?
How ‘debt servicing’ is calculated
‘Debt servicing’ calculations show your ability to repay a loan with the amount of money you get in the hand. While some lenders may consider how much of your income is committed to debt repayments, most lenders work on an affordability basis.
This means they add up all your debt repayment obligations (and if you are a homeowner, your fixed costs associated with that too, such as rates and house insurance) and then work out how much money you have left over each month.
Debt servicing and ‘responsible lending’
Even if on paper you think you can show you have sufficient left over, debt servicing has become ever important in recent years as lenders take a more cautious approach to lending money.
All lenders in New Zealand have an obligation under the Responsible Lending Code, and Credit Contracts and Consumer Finance Act, to make sure they don’t lend more than what the borrower can realistically afford to pay back, as well as maintain a minimum lifestyle.
Future-proofing your affordability
When calculating how much money you have available for debt repayments, lenders usually factor in repayments at a higher interest rate than you are likely to be on; this means they are ‘future-proofing’ your future affordability.
Increasing interest rates, for example, may affect your budget in the future. So even if you can comfortably afford the current rates, lenders will run the numbers and check what your situation may look like should things change.
It’s not just about what you owe
If you’re trying to work out your own affordability, or how much you have left over after meeting your fixed financial commitments (debt repayments), you’ll need to make sure you are working off the limit of credit and store cards, not just what you owe.
Lenders will base their calculations off the limit, because that is the maximum that is available to you, and if you used all the limit, your minimum repayments would be based on that. So, if you have a limit you don’t use, you might want to reduce it or get rid of it altogether.
We take your financial future seriously
Debt servicing calculations are important to ensure you don’t over-commit yourself financially.
As finance brokers, we take our responsibilities very seriously and don’t want to put you in a position of financial hardship. So if you are preparing to apply for a loan, get in touch with our team. We can help you check out your debt servicing calculations, and even recommend some steps to improve it if needed.