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A loan application can feel like a report card on your personal financial progress. While it might be a little unnerving, it can also be a healthy dose of tough love.

A poor credit history, lack of capital or inability to service a repayment schedule has nowhere to hide. Yet, signing up to a debilitating loan, or to a mortgage on which you ultimately default, is a painful experience that can last years.

The criteria for obtaining a mortgage has become a lot tougher over the past year, following exposure at the banking royal commission of poor lending practices by major banks.

Currently, Australians spend an average of 41.2% of household income on servicing a mortgage. That’s far beyond the accepted norm of 30%. Banks are now trying claw back this average by placing tighter restrictions on loan applicants and limiting loan sizes.

Before applying for a mortgage, consideration should be given to how much you can afford. A great way to make this calculation is to use a loan calculator, which features on most bank websites.

In making that rough calculation, you should assume you will not pay an interest rate lower than 7 per cent. If you feel especially diligent, you can conduct a stress test by seeing what you can afford when the interest rate is two points higher.

Lenders still apply the same basic assessment despite the current changes in market sentiment. It is known as the 5Cs: Credit history, Capital, Collateral, Capacity, and Character.

Any broker or bank loan officer will investigate your credit history.

If you do not have a credit history, then it is important to build one before applying for a loan, as this will demonstrate your responsibility with using and repaying borrowed money.

In the lead-up to applying for a mortgage, resist any urge to change employment as this will affect a lender’s assessment of your capacity to meet a repayment schedule.

Lenders want to see a regular income and be reassured the income that underpins the repayments is as secure as possible.

Lenders are currently resisting offering mortgages that require more than 30-35% of a gross household income to service. So, make sure you have the paperwork to demonstrate your income and outgoings that meets this criteria for a three-month period.

If the sums add up, this will be ample proof of your Capacity to repay your desired loan.

Lavish purchases, such as a car, will undermine your efforts. If a personal loan is used for such a purchase, it will count against your capacity to service a mortgage. If cash was paid, then it could have been included in a deposit, which can influence the size of the loan to be offered.

Any Collateral, such as a unit or land, will also be an important contributor to obtaining a loan.

The final C – Character – is a softer, more personal judgment on whether, despite all the information presented, you are a good risk.

When looking to get a mortgage, focus on the Five Cs

Credit history – demonstrate you always repay your debts on time
Capital – show you have worked hard to accumulate savings
Collateral – offer property or asset as proof of personal wealth
Capacity – gather records of income and outgoings for a recent three-month period
Character – you are honest and can be trusted across the term of the mortgage

This article is of a general nature. Readers should seek professional advice.

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