Serviceability is arguably the most important factor when building your investment portfolio because it can limit your ability to achieve your financial freedom goals, writes Lloyd Edge.
With limited serviceability, your portfolio growth will be limited and you will be stopped in your tracks from achieving your long-term strategy.
So, what is serviceability and how can it help me grow a portfolio?
Serviceability is your borrowing power. This is the amount lenders are willing to lend you to buy a property.
No matter whether it is your first property, or your fifth, serviceability is always the place to start to see what you can afford, which forms the basis of your investment strategy. This is because your budget will restrict the type of property you can afford and/or the location you can buy your property in. In this way, serviceability can be the cornerstone to your investment strategy.
Knowing where you want to end up is your long-term goal, but your serviceability will determine the journey (i.e. your investment strategy) that you need to take to get there.
It’s not always about your current serviceability
If you really want to buy an investment property like a professional, it is crucial to also consider your future serviceability. This means what you will be able to borrow after you purchase the investment property. Whenever I purchase a property, I will always consider how the property will help me to move forward and help me grow my portfolio as a whole.
What your future serviceability will be after the property purchase is something that I have seen even experienced investors, investment professionals and even other advisers overlook and not consider, which only restricts your portfolio growth later down the track.
How is serviceability calculated?
Most lenders use the same basic formula when calculating your borrowing power.
Gross income – tax – existing commitments – new commitments – living expenses – buffer = your monthly surplus (i.e. the amount you have left over to help repay your mortgage).
The factors in the calculation can change slightly from lender to lender, but generally speaking, lenders look at:
Take note that lenders will also be asking you to prove your income. This can include your two most recent payslips, two latest tax returns and your BAS statements (if you run a business). They can also request your bank account and credit card statements.
If you already own a property or properties (including if it’s your own home), the lenders will look at the rental income and all the costs and liabilities like your mortgage repayments, bills, utilities and rates. However, lenders will typically only consider around 70 per cent of your rental income when calculating your serviceability.
How can I improve my serviceability?
Having a basic knowledge of how serviceability is assessed by lenders will help you to understand how you can easily improve it by reworking your finances and spending habits, or even just through cutting back on some non-essential spending.
1. Consider your employment status
Ensuring that you’re in full-time work and waiting to apply for a loan once you have passed your probationary period will help with your serviceability as you can prove you have a more stable income stream, which is seen as less risky by lenders. Or if you are self-employed, you need to show consistent BAS statements and bank statements.
2. Reduce your credit card limits and cancel lines of credit
Obviously, reducing your liabilities will improve your borrowing power, so reducing your existing debts as well as your potential debts (meaning credit card limits and lines of credit) will help to improve how attractive you are to lenders.
Credit cards are a big hindrance. My clients are always surprised when I tell them that their larger credit card limits are restricting their borrowing power even if they don’t use their card!
Some people assume that having a large limit shows to lenders that they are able to get access to credit if they need it, or because they were offered large credit card limits in the first place, this shows they are good customers.
It often comes as a shock that the banks consider your credit card limit a liability, and it is assessed as if your cards are being used at their limit.
Similarly, if you have any lines of credit in place, they will be looked at as if it were fully drawn down even if it hasn’t been!
My top advice here is to cancel all credit cards that you do not use, lower any credit card limits that you do not need, and cancel any lines of credit you’re not using. For some people, this small change can have a significant impact to their borrowing power.
3. Stop buying Uber Eats!
Lenders will request bank and credit card statements to see where your money is going, so it’s best that you get in first and do a health check of your accounts. Look at the last three months of statements and see where you can reduce your spending, even if this means temporarily eating out less, reducing Uber Eats orders, and cutting back on after-work drinks.
By making these small changes, your account statements will look a lot better to lenders, but it will also help you on your way to better spending habits. You’ll be surprised how much you’re actually spending!
4. Get a mortgage broker on board
My last tip can actually make the biggest difference!
Possibly one of the greatest ways to improve your serviceability is to go through a mortgage broker. I always advise my clients to use an experienced mortgage broker because they are familiar with all the different lenders and understand how their varying serviceability calculators can produce different results.
Mortgage brokers are familiar with many lenders and can help you find the right lender for your circumstances.
By Lloyd Edge, director and founder of Aus Property Professionals and author of new book Positively Geared