What is serviceability? Investment terms explained

Serviceability is a crucial part of obtaining finance. Essentially, it dictates how able you are to meet repayments of your loan.

To banks and lenders this is crucial as it determines whether or not they can lend a certain amount to you - the less serviceable you are, the less you can borrow.

It is defined by a number of criteria. Largely, it looks at your income and financial situation against your debt and liabilities, as well as living costs. They’re trying to work out how much you can afford to set aside for a mortgage each month. Think of this as your “in” and “out” columns.

Your income covers money that you bring “in” from all sources – your salary, any child support you receive (if you provide child support, this will fall into your “out” column), any money you receive from rental properties or other investments, and so forth.

Your “out” column, or your outgoings, includes all repayments and current debt, such as for credit cards, living expenses and other ongoing costs. Any children you have, or dependents, will also fall into this category. Note that your 'living expenses' will be likely based on an amount that the lender considers appropriate for your type of household - just because you are particularly frugal does not necessarily mean that this will benefit the numbers on this occasion.

After you have both of these worked out - the remainder of your money is what is then looked at to determine whether you can afford to make repayments on a loan.

According to Build.com.au “When you’re looking for approval for a loan, your total monthly debt expenses are expressed as a proportion of your gross monthly income. This is known as the ‘debt service ratio’ - and it should be set at a maximum of between 30 and 35% of your gross income.”

Future rate rises are also calculated in, and some lenders include a "buffer" that can affect buy-and-hold investors. If you come up against a serviceability wall it isn't uncommon to find that you are deemed serviceable by a different lender due to varying criteria.

Homeloanexperts' Otto Dargan notes that there are three methods for calculating serviceability. These include Net Surplus Ratio (NSR), Debt Servicing Ratio (DSR) and Surplus/Uncommitted Monthly Income (UMI). He notes that these are used by the bulk of Australian lenders and banks.

Serviceability can be complicated when considering all of the different factors that the banks are required to consider to ensure you can repay your loan. Luckily, they can be fairly transparent about this process.

For instance, you can do some fairly quick serviceability checks online. While these aren’t foolproof, you’ll have a pretty good understanding of where you’re sitting.

For instance, there is this fairly thorough Genworth calculator (note: this is an excel spreadsheet download).

Or you can try one of the others in AMP’s range.

Did you know that reducing the limits on your credit cards can help increase your serviceability? We will look at tips for how to increase your serviceability and the specific factors you should take a second look at tomorrow in our ‘how to’.