How to steer clear of a mortgage dead end
As a property investor, it is important you are always able to borrow money from lenders so you can build your portfolio.
The GFC forced some big changes in the finance world: most obviously the way investors and lenders decide which ventures are safe bets and which aren’t worth the risk. All of a sudden, everyone is leaning towards the conservative side when dealing with financial products and this is making waves in the property investment world. Not wanting to follow in Europe’s footsteps, the Australian government decided to clamp down on money being lent to those who may not be equipped to service the loans. Enter responsible lending legislation, in effect since January 2011, which has seen lenders’ policies tightened across the board. Now that it is harder to secure loans, you need to be vigilant in order to make sure you don’t run out of borrowing power. As a property investor looking to continuously expand your portfolio, you don’t want to find yourself at a mortgage dead end.
Preparing yourself to borrow
Even though they must adhere to the same laws, all lenders have different policies; most importantly, they have different serviceability calculators. You will be able to borrow more from some than others. To avoid getting a bad credit rating and make sure you can borrow as much as you need, you should make yourself as eligible as possible. In general, the banks have their own assessment criteria for maximum lending capacity and it is up to you to increase your own capacity by taking the right measures. To put yourself in the best borrowing position:
– Reduce your credit card limits. Even if you don’t use them up, high limits can stunt your borrowing power by four to one.
– Eliminate any credit card debt and personal loans. Refinance these into your home loan if necessary.
– Get a better rate on your existing property loans; longer term and interest-only.
– Live at home rent free and invest.
– Increase your personal income, through a second job or otherwise.
– If in a relationship, apply for loans when you have two full-time incomes.
– Put six-monthly increases on any rents for existing investment properties.
Structuring your loans
Home loans are likely to be the biggest investments you make in your life by a long way, so it is important that you call the shots and don’t allow terms to be dictated by an opportunistic lender. You will want to set the loan up with as much flexibility as possible, to increase tax effectiveness, allow you to make extra or reduced repayments as opportunity dictates and make it possible to change your loan structure to accommodate changes in circumstances.
Avoid fixed rates Fixed rate home loans are generally as inflexible as you can get. If you must fix, however, ensure the rate offered is well below 7%, which is the long-term average for lenders according to RBA statistics.
Get the LVR right To ensure you keep your investment options intact, you don’t want to over-borrow. Many believe keeping your LVRs around 80% is ideal, but some argue that using the lender’s money, instead of your own, is a good strategy.
Regular valuations in good times If your LVR is at 80% and you are able to draw up to that amount from the property’s value, you should look at revaluing every couple of years. You can then increase the credit limit to 80% of the new value, which locks in equity, even if the market suffers a drop.
Spread your lender exposure By having different loans with different lenders, you can stop a lender wielding total power over all your properties. It may be easier to have multiple loans with the same bank, but you should beware of what are known as ‘all monies mortgages’. If all your mortgages are with the one lender, you may be exposed to a clause that allows the lender to make a call on any or all of your assets if something goes wrong with payments on just one of the assets. Using multiple lenders means they can only get their hands on the securities they are lending against, not those belonging to other lenders. If you are confident that you don’t need this protection, multiple loans with the same lender can be beneficial. A smart ‘middle ground’ strategy may be to use one lender for your family home and another for all your investment properties.
Use common debt reducers Sometimes it is worth asking a lender to consider common debt reducers, which may increase your borrowing power.
Choose interest-only repayments Most interest-only loans these days allow you to make principal payments when you like. Therefore, setting up an interest-only loan gives you the ability to pick and choose. However, you don’t want to get too relaxed, as the loan will revert to principal and interest after a set period.
Interest-only with offset
If you buy a property and are planning on turning it into an investment property in the future, an interest-only loan structure with a linked offset account can be extremely beneficial. By paying the difference between the interest-only and a principal and interest loan into the offset account each month, you would accumulate enough funds to ensure you don’t pay any extra interest. When the property becomes an investment, you will still have the original loan amount, but the interest charged becomes fully tax deductible.
If you had made principal repayments, the loan balance would be less and so the amount of interest you could claim would be reduced. You could then use the money in the offset account as a deposit on your next property purchase.
The cross-collateralisation trap
If you want to buy your next investment property without using your own funds, you might be tempted to employ cross-collateralisation; when more than one property is used to secure a loan. Your bank will then use the properties already in your portfolio as collateral for the new loan. This may benefit you initially, because you don’t have to use your own cash, but problems can arise down the track, because you have handed extra control over to the lender. Other potential problems with cross-collateralisation include:
– If you release one property, the bank may decide to revalue all the other properties within the portfolio. This can result in a significant cost to you.
– Your lender may deny you the most ideal loan products for future investments. For example, you might want to set up an interest only loan, but find the lender will only offer you a principal and interest structure.
– You are likely to pay higher fees to establish loans and also to move all your properties to another lender.
– You may not be able to access equity delivered by one of your properties, because the others may have dropped in value and cancelled out any equity in the overall portfolio.
Essentially, once you cross-collateralise, the bank takes the reigns of your portfolio and you need to run most of your investment decisions by them first. By ensuring all your loans are on a stand-alone basis, you can revalue properties and access equity as you wish, without your lender spoiling the party.