No finance, no investment. It’s that simple. So how do you get the bank to say yes to your mortgage application each time you ask?
Do you sometimes worry whether the bank will accept your loan application? I can hear you say yes, while simultaneously nodding your head. I do too. I think everyone has felt this way at some point in their investing career. No matter how solid you think your application is, there’s always that niggling doubt that the bank might refuse to give you money.
This is even more nerve-wracking if you’ve already put an offer on a property. The good news is that there are a lot of things you can do to influence the outcome in your favour. How, you might ask? Well, it all starts with the letter C.
Giving the banks what they want when the banks evaluate your application, they apply three main criteria you need to meet in order to get the green light. As long as you keep meeting these magic three C’s, you’ll be able to get the loan you want every time. These are:
• Collateral
• Capacity
• Character
Collateral
Lenders want to feel safe when lending you money, explains Pia Vogel, joint managing director at HomeSource. “It’s important to show them that you have already established a strong asset base.” Your asset base can be in the form of another property, cars, boats, bikes, shares; anything with value that demonstrates you have the ability to acquire assets as well as having funds to call upon in the event that things don’t go according to plan. Make sure to go through all relevant assets with your broker.
Capacity
Servicing is another element the lender focuses on when deciding if they want to continue saying yes to your loan application. The banks want to know if you have the capacity to pay back the loan you’re borrowing. “The banks want more than just a snapshot of our current financial position,” says Vogel. “The proofs you need to show include a stable source of income and employment history.”
Vogel points out that a sudden and large pay rise may not help you get that new loan. Therefore, you have to be realistic about the size of loan you’re seeking and consequently the type or size of house you want to buy. If you’re self-employed or a contractor, you will most likely need two years’ worth of full financials.
These include:
• the balance sheet and profit and loss statement prepared by your accountant
• your income tax return
• notice of assessment
Alternatively, if these are not available, you can show them:
• six to 12 months’ worth of bank statements
• six to 12 months’ worth of trading account statements
These enable the bank to calculate how much income you could derive from your business. “Remember that the more information you can provide, the better,” says Vogel. “This means that as soon as you know you’re thinking about a new home/mortgage or a move, start planning and getting your paperwork in order.”
To further fortify your application, you need to understand how the banks assess your application in relation to your existing debts, according to Garry Harvey, property investment coach and a prolific investor. “The bank needs to be comfortable that you have enough income to not only service the new money you are asking for but your existing loans as well,” he explains.
Harvey points out that most lenders will test your capacity to borrow money on a sensitised interest rate that’s higher than the actual rate, and on a principal and interest repayment basis, for the new money you are requesting. “Some lenders will also apply the same test to existing debts you have, even though you aren’t paying the higher interest rate and, in some cases, you may only be making interest-only repayments.” If that’s the case, then your ability to access more funds and continue expanding your portfolio will be hugely impacted.
To overcome this hurdle, Harvey recommends that you are selective with the lenders you use and look at doing business with. “Only deal with the lenders that will assess your existing debts on the actual interest rate that you are paying and actual repayments you are making,” he advises.
If you’re serious about expanding your portfolio, you need to keep your mortgage commitments to a minimum to maximise your borrowing capacity. This means you need to think seriously about keeping all of your loans on an interest-only repayment basis. You can still reduce your debt by making additional repayments into the loan and have access to it in the future, so you get the best of both worlds.
Harvey adds that in order to continue borrowing you will also need to keep building your savings or have your existing properties appreciating in value so that you can use the equity as your contribution to the purchase.
Character
This is where any past bad debts, missed payments and so on can come back to haunt you. “Most of us have a credit history, and all lenders have access to this file because when applying for a loan you give them authority to assess your credit history,” says Vogel. “If you have a bad debt or loan they will know about it.”
The best way to handle a previous bad credit record is to disclose it up front and explain to the bank what happened and why, or what you’ve done to change that behaviour so it won’t happen again. Better yet, get a copy of your credit record before you sit down with your mortgage broker to see if there are any mistakes or defaults that you were unaware of. You can get it for free from www.mycreditfile.com.au.
How to avoid refinancing each time you buy
Most investors would look at refinancing their existing property to access equity to use as a deposit for their next purchase. But there are a few ways to avoid having to do this, according to our experts. Here are some suggestions.
Borrow the maximum amount
To avoid refinancing every time, Harvey advises that you should borrow up to your preferred limit and park the excess funds to your redraw or offset account. “You can then use this as your contribution towards the next purchase and obtain an additional loan with the same or different funder for the property being bought,” he says.
If serviceability allows, you may choose to borrow more than 80%. Many investors will often go to 90–95% loan-to-value ratio (LVR). Beware, though, that higher gearing usually comes at a cost, either in the form of lenders mortgage insurance (LMI) or higher interest rates. If your income is good, you can get a tax benefit from both financing costs and interest repayments on your investment properties.
Consider offering more than one security, but only as a last resort
Harvey says that another option is to offer your current property as well as the new property as security to the lender you are already with. “Depending on the LVR, the bank may be able to fund the full purchase price plus costs,” he says.
“If you choose this option you will still have the choice to either cross-collateralise the properties or keep them separate from each other. It may mean the loan structure is slightly different, depending on your preference.” Cross-collateralisation has become a dirty word in property investing, so approach this with caution.
Some investors are happy using it, but beware of the risks and downsides, according to Andrew Crossley of Crossley Property Advisors. “Cross-collateralising your loans will expose you to the one lender more than you really need to,” he says. “Lenders are not really your friends. They are in the business to make money, and the less you have to deal with them for each purchase, the easier you can invest and the quicker you can act on an opportunity. You would have more control of what you want to do.”
Lenders mortgage insurance: avoid it or embrace it?
LMI is easily one of the most misunderstood concepts in the mortgage world. While you, as a borrower, pay big dollars for it, it’s actually the lenders who are protected in the event that you default on your loan. LMI is charged if you take out a loan that is more than 80% of the value of the property. If you don’t meet the required 20% deposit, then you could opt to pay less deposit and increase the size of your loan.
The downsides of taking LMI
The cost is hefty
LMI is only a one-off premium, but the cost is fairly high. “LMI serves a purpose but at a cost,” says Crossley. “The cost can range, and can end up being in the tens of thousands. If you have not done your research, this can unnecessarily eat into your capital and/or capital gain.
Bear in mind as well that it can eat into your cash flow, as you not only pay this insurance but you also end up paying interest on this insurance amount if you borrow it on top of the loan or within the loan.” Consider the typical breakdown of LMI thresholds shown in the table below.
Using this breakdown, you can see that the cost of an LMI premium on a $300k property at 83% LVR is around $1,230. If you borrow more, say $500k, this will be $2,650. The higher your LVR goes, the higher your premium becomes.
Taking the same example:
$300k loan @ 95% LVR = $6,420
$500k @ 95% LVR = $14,300
LMI attracts higher mortgage repayments
When you’re taking a bigger loan, your corresponding repayments will be higher as well. This will have a significant impact on your cash flow. Vogel recommends that you only consider doing this if you feel you can afford it. “If you’ve signed a major contract with huge guaranteed revenues, or your job is safe and secure and you have sufficient funds to meet the required payments, maybe you can consider it,” she says. “But be cautious. Make sure you’ve planned and forecast the repayments and your ability to repay. Only take LMI if you think you can afford the repayments.”
LMI can trigger credit scoring
Crossley warns that applying for a loan with LMI could prompt credit scoring by some lenders. “Credit scoring is an automated way that some lenders and certainly the mortgage insurers use as an assessment on you as a borrower,” he explains. “If you have too much exposure to low-doc loans or LMI-insured loans, your score can end up being lower, which could inhibit you borrowing more money.”
LMI reduces equity on the property
Using LMI increases the LVR on the investment property and reduces the amount of equity you have access to.
LMI restricts the areas you can invest in
There are postcode restrictions in terms of where the property to be used as collateral can be located. Postcodes can be a deciding factor as to whether a lender will lend in a particular area.
How to use LMI safely
Plan for contingencies and ensure you have enough buffers
If you decide to use LMI, make sure you stress test your cash flow with the higher repayments. Meeting your monthly mortgage repayments should become your priority, so put in place solid measures to make this happen. This could mean freeing up some cash to stash in the emergency fund if necessary.
“When we started HomeSource, we gave up our corporate jobs. At that time we had a huge mortgage with very high monthly repayments. We knew with a start-up business the danger was we might default. So we decided to sell the house and lift that risk off our shoulders,” says Vogel.
View LMI as a tool, and use it if it will help you achieve your investing goals
LMI gives you that additional leverage that enables you to stretch your cash. It can help in growing your portfolio at a faster rate because you don’t need to wait until you save up enough deposit to be able to invest. “Using LMI is a personal choice with no right or wrong answer; as long as you understand the benefit and how it applies to you, you can make an informed decision,” says Vogel.
“Using LMI is safe, but you must always be up to date and aware of your asset and liability position, particularly in a flat or declining market. As an investor, you always need to take responsibility for the level of debt you take on and be absolutely sure you can manage it. “My personal approach was to use LMI a lot when I was in expansion mode and rely on it less and less as my investing objectives were met.
I think as the amount of debt you have increases, it would be prudent to slowly deleverage so you are better placed to cope with market movements.”
Conclusion
We’re all guilty of vilifying the banks, but we can’t escape the fact that they do control the purse strings. If they don’t release the funds, we won’t be able to buy the property we want. Despite seeming tyrannical, the banks are only after one thing: to make money. And the only way for them to do this is to ensure that the borrower will be able to repay their debts.
Knowing the lender’s criteria, keeping a squeaky-clean credit record, and presenting your application well will go a long way towards securing finance that will help you build your portfolio. This is why it’s important to work with a qualified mortgage broker who knows lenders’ criteria, and can help you put together a surefire application.
