Investing in Real Estate 110 (Loan Structuring Tips)

Reading Time: 9 minutes 

Wow! What a difference a day or two makes eh!

Looks like the Australian politicians were reading the latest post (here) from TheFrugalSamurai and decided (again) to change the leadership of our nation.

So for the seventh time in a decade, we now have a Prime Minister in office unelected by the people.

Our new PM ScoMo (Scott Morrison) won’t even get a chance to stay long, because the Leader of the Opposition Bill Shorten is odds on favourite to get in come the federal election next year.

Which means once Bill comes in – he’s going to be backstabbed by some other candidate from HIS party.

What a farce, I mean – there are fantasy sports games which are better run than our nation (at least you get to pick who you want in those games).

Which is why Aussies are just shaking our heads at the complete lunacy of the people we chose as representatives for our government.

Democracy right?

This is why the only person who can represent yourself is YOU!

Speaking of, I have to get back to the more important matter – that of continuing Bane-san’s question on:

How to start a property portfolio (and how to get/ structure loans for this), how to prepare for inevitable increase in interest rate.

You can read the first part to that question here, and you can even read up on the various structures to purchase in here, but to answer Bane-san’s 2nd part regarding loans, we have to understand the current lending environment.

Our two major cities in Australia – Sydney and Melbourne, experienced a property boom unlike any other from about 2012 onwards. Lack of supply, lowering interest rates and our strong economy amongst others has been nominated as catalysts for this boom.

Have a look at this chart for further detail:

To prevent things from being cooked to scorched – the industry regulators (APRA mainly) introduced significant measures to curtail prices via a number of changes to the lending environment such as:

• A 10% pa speed limit for lenders on investment credit growth.
• Lenders having to calculate mortgage serviceability on a mortgage rate of 2% above current rates or at least 7% (now around mid 7’s) whichever is the greater.
• Improved capture and increased scrutiny of borrowers actual expenses rather than using benchmark measures.
• A limit of 30% of new mortgage originations for interest-only products along with limits of new interest-only lending on an LVR above 80%.
• Reduced risk appetite for new lending at high debt to income levels (greater than 6 times).
• Restrictions on lending growth in higher risk segments of the portfolio (e.g. high LVR loans and loans for very long terms).
• Stronger verification of borrowers existing debt commitments and income.

All this has created a strong effect on the lending environment to reduce how the banks lend us money.

BUT coupled with a little thing called the Royal Commission (investigation into naughty practices from our banks) and it means our lenders, more than ever, are treading cautiously as to who they provide lending for.

That is why everyone’s borrowing capacity has been affected.

Yet, there are still some ways in which we can show our best foot forward for the lenders to ensure we can keep on borrowing.

Here’s how:

Get moonay

The most obvious way is to portray an increase in income – particularly stable income, which lenders love (which is why salaried individuals are preferred to the self-employed).

If you can demonstrate good history of increasing income (e.g. as your career progresses), then this gives lenders more comfort you will be able to afford the loan repayments.

Perhaps a side hustle or three on the cards?

Cut your spending, fool!

Do you go to the Caribbean every month? Have an expensive wine and food palate? Or maybe into fast cars? If this spending is reflected in your transaction statements – the lenders will know.

Even more so if your main personal “spending” account is with the same bank you are seeking finance from.

I know personally of a loan which was declined because the credit officer reviewed the customer’s account history, identified numerous repeat transactions at various casinos and gambling establishments – and declined the loan based on perceived gambling issues (whether the customer had a gambling issue was irrelevant).

So yes, big brother is watching.

Mind your conduct

Which is also a timely reminder to be aware of your credit record – a history of your creditworthiness.

This is especially important if you have missed a loan repayment here or forgot to pay a phone bill there.

Each time you do so, it may trigger a hit against your record.

Most lenders run complex algorithms tied to the credit record platforms when assessing your loans – a bad credit record is flagged and knocked back for further assessment, or worse, loan declined.

You can access your credit record through the various platforms here.

P and I 

Traditionally the go to loan structure for investors was repaying the interest only against the loan.

This is because the interest is tax-deductible, the loan repayments are lower (only interest) and more cash flow is freed up to purchase the next property.

However in the current climate, lenders increasingly prefer to approve principal + interest loans, i.e. loans which are amortizing (reducing) from day 1.

The equity position is therefore increasing and hence their security ratios are increasing also.

Speak to your broker or accountant whether P + I or I/O is the way for you.

Cheaper properties

You could also deliberately target cheaper properties, which traditionally have higher yields albeit in inferior locations.

Higher yields means that your overall strategy may be weighed towards positive or neutrally geared compared to negative gearing.

The higher rental income can be used for future borrowing capacity however.

You can understand the difference between negative gearing and positive gearing in my earlier post here.

Equity baby!

Ever wondered why it is that the banks only lend you money when you don’t need it? But when you actually really do, they um and ah before giving you the sad face?

Yeah – it’s typically how they work.

So a good strategy is, whenever you have excess borrowing capacity – access it strategically.

Many of the old dogs in the game have been tapping into their equity and lines of credit prior to the APRA crack-down, to try and take advantage of any lulls in the market.

They’re loading up their elephant guns, waiting for when the time is right to strike.

What’s the correct loan? 

A short note also on how to set up the correct loan.

Look at both fixed and variable interest rates and determine which one is best for you.

Having offset and/or redraw facilities also helps with cash-flow.

We should also have access to a safety net fund in case of an emergency.

A ‘buffer’, such as access savings, equity or other cash resources is vital if things go south.  Even in the worst-case scenario a buffer will buy time and allow us to refinance or restructure our portfolio.

It will even mitigate you against any rises in interest rates… rises in interest rates… interest rates…

HEY! that’s the last part of Bane-san’s question… which we will investigate next time.

Stay tuned!

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