Bank Servicing Tests

Why You Might Not Get a Mortgage, Even If You Can Afford It


Ed McKnight

Economist, property investor and host of the Property Academy Podcast

You could look at the current low interest rates, plug your numbers into a mortgage calculator, and think “I can afford that”.

Similarly, you might consider an investment property that requires a top-up of $50 a week and say “that’s do-able”.

But, even if you can afford the mortgage repayments, you may not be approved by your bank.

Why is that?

When a bank assesses your mortgage application they will ‘stress test’ your application using several fictional calculations. These are known as ‘servicing test rates’.

These test rates differ by bank and are not heavily publicised. However, these calculations will generally be applied:

  • The interest rate will be tested at 7%
  • Any rent received will be scaled down by 25% (that’s the equivalent of not having a tenant for 3 months of the year)
  • Any boarder or flatmate income will be scaled down by 50% (that’s the equivalent of not having a flatmate for 6 months of the year)
  • Your repayments will be tested on a principal and interest loan for the remainder of the term.

The last point is particularly important for property investors.

Generally, property investors will use an interest-only mortgage to decrease their expenses and maintain an acceptable cashflow for their properties.

Typically an interest-only loan will only be granted for 5 years, and after this term your mortgage will revert to a standard 25-year principal and interest home loan.

Throughout these ‘stress test’ calculations, the bank will make sure that you have the income right now to cover these principal and interest payments over a 25-year term, at the higher interest rate, with 75% of the rental income you may end up having.

This can be significant.

Let’s say you secure a $500,000 interest-only loan at 3.5% interest and use it to buy a property that earns $500 a week in rent.

With 3-weeks standard vacancy, you’ll receive $24,500 in rent and pay $17,500 in interest.

However, your mortgage application will be assessed on the basis that you receive only $19,500 in rent ($5,000 less than what will likely happen), making total annual repayments of $42,408.

The likelihood of you ever getting into this scenario is small. However, in many ways it’s good that the banks go to this level of scrutiny as it minimises the number of people who might default on their mortgage, and strengthens the financial system.

So what can you do if you aren’t able to get a mortgage because of these servicing test rates?

First of all, you can get your spending in order and decrease your debt. This will decrease the potential repayments you would need to make to your lenders and give you more available cash in the bank’s eyes.

If you have consumer debt, such as a Q Card or hire purchase, even if these are interest free, they’ll be incorporated into the calculations as an expense every week.

Likewise, any credit card debt or revolving credit will be calculated at the full amount.

That is, if your Amex has a limit of $80k, even if you are no way near that limit, the bank will test whether you would be able to afford your mortgage if you maxed out your credit card and made the minimum repayments each month.

Where possible, you should try to eliminate unnecessary debt that may have an undue influence on your ability to get a mortgage.

If you have other properties, you could extend the loan terms temporarily, reducing your repayments and weekly expenses, with the intent of resuming your more regular payments later.

Of course, if in doubt the best course of action is to use a good mortgage broker who can look at your application and give you advice about the best way to structure it so your loan has the highest chance of being approved.


Ed McKnight

Ed McKnight is the host of the Property Academy Podcast – NZ's #1 business podcast. He is an economist, having studied at the University of Auckland and the University of Waikato. He's a frequent writer for Informed Investor Magazine and has contributed to NewsHub, Stuff, OneRoof and Property Investor Magazine.