Each lender has a standard variable which it will apply to its variable rate home loan products. You may assume that this is the rate your lender will use when calculating how much you can borrow, however it’s not the case. Rather, they use an altered rate that is higher than their variable rate. This accounts for the possibility of future interest rate increases and is known as the assessment rate.
As mentioned, each lender has a standard variable rate. It uses the cash rate of the Reserve Bank of Australia (RBA) to calculate this rate. When assessing your home loan application, your lender will add between 2% and 3% onto their standard variable rate. Your lender then uses this rate to work out your ability to make repayments. The assessment rate covers both you and your lender in the event that the RBA’s cash rate increases. An increased cash rate leads to a higher standard variable rate, which means you pay more interest per month. Of course, you will pay less interest per month if the cash rate falls and your lender lowers their interest rate. This extra couple of percent also provides the lender with a buffer. It ensures they can cover the costs of providing the loan, while making a profit on it as well. As such, you can think of the assessment rate as a way to protect your financial future. Your lender checks to ensure you can make your repayments, even if certain circumstances change. Lenders don’t advertise their assessment rates, which means you can’t be aware of them before you lodge your home loan application. However, you can estimate the rate if you add 2% or 3% on top of the lender’s standard variable rate.
The assessment rate assumes you pay more interest than you will on your home loan. If your income doesn’t cover this extra interest, your application may fail. The Australian Prudential Regulatory Authority (APRA) played a large role in the increased use of assessment rates. In 2014, APRA asked that all lenders apply a minimum of 2% as a buffer to the standard variable rates. Furthermore, they stated that the minimum assessment rate must be 7%. This means any home loan application you make will be assessed under the assumption that you will pay at least 7% interest on the loan. This can cause serious issues for those who have debts. For example, investors who already have other home loans may find it very difficult to get subsequent applications approved. In fact, some lenders apply an even higher assessment rate to home loans for investors. The good news is not all lenders use assessment rates. APRA’s mandate only affected banks and Authorised Deposit-Taking Institutions (ADIs). As such, there are several smaller lenders who don’t use assessment rates. Instead, they use their standard variable rates when working out your borrowing strength. As a result, you may have a better chance of getting your home loan application approved with a smaller lender.
Assessment rates could ruin an otherwise strong home loan application, but they exist to help ensure you’re able to afford the loan down the track. For more information, you can email us at email@example.com and: