Interest Coverage Ratio: How to Calculate It and What It Means for Your Home Loan
If you’re an Australian expatriate living overseas or a foreign buyer looking to purchase property in Australia, you’ll need to understand your financial health before you apply for a mortgage. One important metric to consider is your interest coverage ratio (ICR).
The ICR is a measure of how easily you can afford to pay your mortgage interest payments. A high ICR means that you have a good ability to repay your mortgage interest payments. A low ICR means that you may have difficulty making your payments, which could make it difficult to get a mortgage.
In this article, we’ll explain how to calculate your ICR and what it means for your mortgage. We’ll also provide some tips for improving your ICR if it’s on the low side.
What is the Interest Coverage Ratio?
The interest coverage ratio (ICR) is a financial ratio that measures a borrower’s ability to repay their loan payments. It is calculated by dividing the borrower’s earnings before interest and taxes (EBIT) by their interest expense.
As mentioned earlier, a high ICR means that a borrower is more likely to be able to repay their loan, while a low ICR means that they are more likely to default. Lenders typically look for an ICR of at least 1.5, but a higher ICR is always better.
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How to Calculate the Interest Coverage Ratio
The formula for calculating the interest coverage ratio is:
ICR = EBIT / Interest Expense
- EBIT = Earnings before interest and taxes
- Interest Expense = The amount of interest that the borrower pays on their loan each year
For example, if a borrower’s EBIT is $100,000 and their interest expense is $25,000, then their ICR would be 4.
What Does the Interest Coverage Ratio Mean for Your Home Loan?
A high ICR means that you are more likely to be able to repay your home loan. This is because you have enough income to cover your interest payments and still have money left over to cover your other expenses.
A low ICR, on the other hand, means that you may have difficulty repaying your home loan. This is because your income may not be enough to cover your interest payments and other expenses.
If you have a low ICR, you may have to pay a higher interest rate on your home loan. This is because lenders are taking on more risk by lending to you.
How Does it Affect Australian Expats and Foreign Buyers?
The interest coverage ratio (ICR) is an important metric for Australian expats and foreign buyers who are considering purchasing property in Australia. A high ICR means that you have a good ability to repay your mortgage interest payments, which could make it easier to get a mortgage.
Lenders will look at your ICR when they’re considering whether to approve your mortgage application. If your ICR is too low, you may have difficulty getting approved for a mortgage.
There are a few things that can affect your ICR as an Australian expat or foreign buyer. One is your income. If you have a high income, you’ll be able to afford to make higher mortgage payments, which will give you a higher ICR.
Another factor that can affect your ICR is your expenses. If you have a lot of debt or other expenses, this will reduce your ICR.
The type of mortgage you choose can also affect your ICR. Some mortgages, such as interest-only mortgages, have lower monthly payments than principal-and-interest mortgages. This can lower your ICR, making it more difficult to get approved for a mortgage.
How to Improve Your Interest Coverage Ratio
There are a few things you can do to improve your interest coverage ratio:
- Increase your income: This could mean getting a raise at work, starting a side hustle or getting a second job.
- Reduce your expenses: This could mean cutting back on unnecessary spending, eating out less, or cancelling unused subscriptions.
- Pay down your debt: This will free up more of your income to go towards your home loan payments.
If you can improve your interest coverage ratio, you’ll be in a better position to get a home loan and you’ll be more likely to be able to repay it.
Ask Our Expert Mortgage Brokers
The ICR is an important metric to consider if you’re an Australian expatriate living overseas or a foreign investor looking to purchase property in Australia. A high ICR means that you have a good ability to repay your mortgage interest payments, which could make it easier to get a mortgage.
If your ICR is on the low side, there are a few things you can do to improve it. By following the tips in this article, you can increase your chances of getting approved for a mortgage and securing the home of your dreams.
Still have questions regarding your ICR? Our expert mortgage brokers are here to help!
Contact us today to discuss your situation and receive personalised advice on improving your ICR and increasing your chances of securing the home of your dreams. Don’t let a low ICR hinder your mortgage prospects – reach out to our knowledgeable team and take the necessary steps towards your property ownership goals.
Get a free Australian mortgage assessment today.
Frequently asked questions
A good interest coverage ratio is typically 1.5 or higher. However, a higher ICR is always better.
If your ICR is too low, you may have difficulty getting approved for a mortgage. Lenders may be concerned that you won’t be able to afford to make your payments, so they may be less likely to approve your application.
There are a few things you can do to improve your ICR. One is to increase your EBIT. This could mean increasing your sales, reducing your costs, or both.
Another way to improve your ICR is to reduce your total interest expense. This could mean refinancing your mortgage at a lower interest rate or paying down some of your debt.
There are a number of government-backed programs in Australia that can help you with your mortgage. A few of these include:
- NHFA First Home Guarantee: This program allows first home buyers to purchase a property with a deposit of as little as 5%. The government guarantees the remaining 95% of the loan, which can make it easier to get approved for a mortgage.
- NHFA HomeBuilder Grant: This grant provides eligible first home buyers with a $25,000 payment towards the purchase of a new home. The grant can be used to help with the purchase price, stamp duty, or other costs associated with buying a home.
- APRA Lender Mortgage Insurance (LMI): This insurance program is offered by lenders to cover their losses if a borrower defaults on their mortgage. LMI can be purchased by borrowers with a deposit of less than 20%, which can help to make their mortgage more affordable.
These are just a few of the government-backed mortgage programs that are available to Australian expatriates living overseas and foreign buyers. If you’re interested in learning more about these programs, you can contact a mortgage broker or visit the website of the National Housing Finance and Investment Corporation (NHFIC).