Did you know that many lenders don’t use the current interest rate when assessing a borrower’s capacity to make payments.
Instead, they use what is called an assessment rate, which can impact on a borrower’s ability to get a loan and the amount that can be borrowed.
Before deciding to lend money to someone, say, for the purchase of investment property, the lender will carefully evaluate the borrower’s ability to make the necessary interest payments.
The size of these payments, as we all know, is determined by the loan size and its particular interest rate.
But lenders don’t use the current interest rate when assessing a borrower’s capacity to make payments.
Instead, they use what is called an assessment rate which is typically between 1 per cent and 2.5 percent higher than the interest rate on the loan.
Why do lenders use this inflated interest rate?
They do it to allow for any future movements in the interest rate or, more specifically, to ensure you can still afford the loan if interest rates increase.
Each lender will set their own assessment rate so the rates will vary from lender to lender.
Plus, one lender may have different assessment rates for each of their loan products.
Sometimes, for instance, a fixed rate loan will have a lower assessment rate than a variable loan because the interest is locked in for a set period of time.
An assessment rate can also vary depending on whether it is for a new or existing loan.
Clearly, assessment rates can impact on a borrower’s ability to get a loan and the amount that can be borrowed.
It’s worth noticing, however, that lenders have a whole series of internal lending policies that will determine whether a loan is approved or not, or how much can be borrowed.
For instance, it may hinge on what percentage of rental income the lender will accept towards servicing, or policies regarding credit cards.
Assessment rates, which aren’t typically publicised, are one of the reasons why online calculators can be extremely misleading.
If users input into an online calculator the current interest rate when assessing their borrowing capacity, they may later be disappointed when their capacity to borrow is much less than expected.
It’s worth remembering that online calculators are a sales tool and should only be used to determine a ballpark figure.
Since different lenders have different assessment rates and will offer different amounts, it clearly pays for borrowers to contact an experienced, qualified finance broker who can guide them towards the lender that is most suited to their needs and situation.
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