Loan serviceability is a lender's test of whether your income covers living expenses, existing commitments and the proposed home loan repayments. Borrowing capacity is the loan amount that passes that test under the lender's rules.
Start with accepted income, subtract assessed expenses and commitments, then calculate the loan supported by the remaining repayment budget. Compare that amount with your deposit and the property's value before setting a purchase budget.
What Loan Serviceability Means
A serviceability assessment measures the cash available for repayments after the lender applies its income and expense rules. Each lender uses its own formula, so the same application can produce different borrowing figures.
A positive monthly surplus is one part of approval. The lender also checks the property and the borrower's credit profile.
What Goes Into the Assessment
The calculation needs verified income and spending, every existing credit commitment and the proposed loan's terms. Gather payslips or business records, account statements and current debt statements before running it.
- Accepted income after the lender's discounts and tax calculation.
- Living expenses tested against the lender's household benchmark.
- Existing loan repayments, credit card limits and student loan obligations.
- The proposed loan amount, term and repayment type.
- The assessment interest rate, including the buffer and any minimum assessment rate.
The Australian Prudential Regulation Authority (APRA) requires banks to apply a serviceability buffer of at least 3 percentage points above the loan rate. APS 220 Credit Risk Management sets this requirement.
A 6% product rate therefore produces a 9% assessment rate before any higher lender floor. The borrower pays the contracted rate, while the lender uses the assessment rate to test repayment capacity.
How to Calculate Borrowing Capacity Step by Step
Calculate borrowing capacity by finding the monthly repayment budget, then converting it into a loan amount at the assessment rate. Use the same repayment frequency throughout.
- Calculate accepted income. Apply the lender's treatment of casual earnings, overtime and income during probation, then deduct assessed tax. Shading means counting only part of an income source. Keep the accepted amount separate from the amount shown on a payslip.
- Load existing liabilities at their assessment values. Record loan repayments and card limits even when a card balance is zero. Record the Higher Education Loan Program (HELP) balance and its assessed repayment. Avoid deducting HELP twice if it is already removed from the net income figure.
- Apply living expenses. Use the higher of declared spending and the lender's applicable benchmark, then add expenses outside that benchmark. APRA's APG 223 Residential Mortgage Lending explains this approach.
- Test the proposed loan at the buffered rate over the assessment term. Subtract expenses and existing commitments from accepted net income. Allow for any minimum surplus the lender requires before converting the remainder into a loan amount.
- Compare the supported loan with the deposit. Reserve buying costs first, then calculate the property price and loan-to-value ratio (LVR). Reduce the budget if the deposit or security rules require a smaller loan.
Worked Example
This hypothetical household has two adults, no dependants and a proposed owner-occupied principal-and-interest loan over 30 years. The figures illustrate the method and are not a lender quote.
| Input | Assumption | Monthly Assessment |
|---|---|---|
| Base income | Verified income after ordinary income tax | $7,200 |
| Overtime | $1,000 after-tax equivalent, with 80% accepted for this example | $800 |
| Living expenses | $3,200 declared, $3,500 illustrative household benchmark | $3,500 |
| Car loan | Assessed monthly repayment | $500 |
| Credit card | $10,000 limit assessed at an assumed 3% per month | $300 |
| HELP | $10,000 balance with an assumed monthly obligation, not deducted above | $200 |
The income figures already allow for ordinary income tax. A real lender calculates tax under its own calculator rules after treating each income source. The benchmark and card assessment percentage above are example assumptions.
Accepted monthly income is $7,200 + $800 = $8,000. Existing commitments total $500 + $300 + $200 = $1,000. The monthly repayment budget is $8,000 minus $3,500 minus $1,000 = $3,500.
Assume a 6% product rate plus a 3 percentage point buffer. The assessment floor is 9% and the required extra surplus is $0. At 9% over 360 monthly repayments, $3,500 supports approximately $434,986. Round down to a $434,000 loan.
The calculation is loan amount = monthly repayment budget times [1 minus (1 + monthly rate) raised to minus repayment count], divided by monthly rate. Here, monthly rate is 0.09 divided by 12 and repayment count is 360.
Assume $150,000 cash and $30,000 reserved for all buying costs. The remaining $120,000 deposit plus the $434,000 loan gives a $554,000 purchase budget. At a matching lender valuation, LVR is approximately 78.3%.
Check the result by calculating the repayment on $434,000 at 9% over 30 years. It is approximately $3,492 monthly, within the $3,500 budget. A lower valuation or higher assessed expense reduces the result.
Check Security Before You Quote a Number
Estimate LVR early and screen the credit file before presenting a borrowing figure. LVR compares the loan with the lender's property valuation, which can differ from the purchase price.
Crossing an LVR threshold can change the rate and trigger lenders mortgage insurance (LMI). LMI protects the lender. Some borrowers qualify for an exemption or guarantee, so a higher LVR does not always mean an insurance charge.
Allow for any financed LMI in the total loan and rerun serviceability. Moneysmart's home-buying guide explains deposit and buying-cost considerations.
Check the credit report for undisclosed facilities, repayment problems and errors before choosing lenders. One lender's public serviceability calculator gives an estimate under that lender's assumptions. It cannot establish a universal borrowing limit or approval.
Why Lenders Reach Different Answers
Lenders reach different answers because they accept different income amounts and apply different assessment settings. Compare the inputs as well as the final loan figure.
Consider a hypothetical applicant with two years of consistent overtime. One lender might accept all that overtime, while another shades it. These are illustrative policy differences, not named lenders' published rules.
HELP treatment needs a separate distinction. The repayment depends on income, so an income below the compulsory repayment threshold differs from a small outstanding balance. A balance alone does not set the monthly obligation.
APRA permits limited exceptions where HELP debt will be repaid soon, with repayment within 12 months as its example. A lender applying that exception can exclude repayments while another includes the full assessed obligation.
APRA's HELP guidance response distinguishes this serviceability treatment from debt-to-income reporting. Do not assume that excluding HELP from one calculation excludes it from both.
Rate settings also change the answer. Cash rate movements can flow through to product rates and therefore assessment rates. Borrowing capacity is a snapshot of the lender's inputs and policy, not a permanent allowance.
Ratios Lenders Use Beside Serviceability
Lenders use ratios to test different parts of a file alongside the repayment calculation. Passing one measure does not establish that every other measure passes.
The net servicing ratio expresses assessed income relative to the commitments included in the lender's calculation. The lender's formula and pass level determine what its result means.
The debt-to-income ratio compares debt with gross income. It is a separate debt-load test, with APRA limits applying to banks' high-DTI lending.
A common debt reducer is a policy treatment for shared debt. Where accepted, it can reduce the commitment attributed to one borrower and improve the serviceability result.
Improve Capacity Before Lodging
Improve capacity by changing the inputs that constrain the actual file, then rerun the lender's assessment. Start with unused card limits because the assessed commitment can remain even when the balance is zero.
Debt consolidation can lower monthly commitments, but compare fees and total interest over the replacement term. A lower monthly payment can cost more over a longer loan.
A longer term can reduce assessed repayments where the lender accepts it. Changing repayment type helps only if the lender's assessment improves. Interest-only payments do not guarantee extra capacity because assessment can use principal-and-interest repayments over the remaining term.
Keep a separate worksheet for each lender. Record accepted income and tax, expense assumptions, every liability, the assessment rate and term, required surplus and the resulting loan amount. Save the policy basis beside any exception.
Compare the worksheet with the eventual approved amount. If the numbers differ, identify the changed input before using that lender's estimate on the next file.
What Serviceability Does Not Measure
Serviceability measures assessed repayment capacity. A credit score describes credit risk, while LVR measures the loan against the security value. A borrower can pass one test and fail another.
The wider home loan eligibility checks also cover matters beyond affordability. Keep those checks separate when explaining why an application succeeds or fails.
Stamp duty and other purchase costs still need funding outside the borrowing estimate. Reserve that money before calculating the deposit, then choose repayments that also fit the household's own budget.
