A good time to borrow money?
March 27, 2017
Written by Jason Cheetham
Well for those of you who haven’t touched base with us over the last couple of years, the lending landscape has changed tremendously over this time.
Once the prudential regulator of financial institutions, our good friends at APRA, started telling banks they were too flexible with credit and didn’t analyse every borrower’s circumstances to the extent they should, a few things have changed, to say the least.
So much has changed for some borrowers, it is difficult to fathom the extremities of how this has and will continue to affect new lending.
Let me give you a real-life example:
The client has loans totalling $1.5 million against four properties, all being investment properties and he himself is single and still living with his parents. He is a salaried employee earning $70,000 p.a. and yields $87,600 p.a. in rental income, with no other (hard) debts apart from the mortgages. So when he applies to borrow more from his bank in early 2016 to purchase the fourth investment property, it was approved and met their servicing criteria. In a nutshell, the rental yield used was 3.6% (being 80% of actual overall yield) and actual interest rates of around 4%, so there was not much of a shortfall for the applicant to service on his salary. The new loan was approved on this basis.
What the bank and then mortgage broker (which was not Catalyst by the way) failed to consider in their assessment:
- The loans have to revert to principal and interest at some stage (normally interest only periods are for a maximum of five years), which will increase actual payments significantly.
- Interest rates are at all-time lows……a more realistic longer term interest rate is around 7 to 7.5%. The bank assumed it would stay at 4% forevermore.
- The applicant wouldn’t live with his parents forever – at some stage, he would need to either rent or move into one of the properties and forgo one lot of rental income.
- The client had a credit card that had nothing owing on it for the previous 3 months, therefore it was not included as a liability. We all know credit card debt accumulates when cash flow becomes a problem.
Now if we look at how much this same applicant can expect to borrow today, with the same bank mind you, it is a very different story. I am using exactly the same numbers from a year ago and he can now borrow $1.05 M, which is actually less than he owed the bank when he successfully applied for finance last year to purchase his fourth investment property. So not only would the same bank decline finance for that purchase a year ago, they would also say you can’t afford (on paper) the current loans you already have!
Clients most affected by these APRA-forced changes are those with larger debts and multiple properties.
Banks are being more conservative with rental income and are removing any negative gearing benefits from their serviceability calculations while assuming that all debt is principal and interest and at a minimum benchmark interest rate of 7%. Add to this, banks are now using higher living expenses allowance for singles and families, and the scaling of overtime and bonus income for wage earners has reduced from 100% to 80%. It is so much harder to borrow money now than in my 23-year tenure as a mortgage broker.
So where does this leave us???
Many borrowers who were “maxed out” with their borrowing capacity over the past few years will now find they are hamstrung when it comes to borrowing more money. Even more concerning is those coming off interest only repayments to a normal principal and interest loan will NEED to commit to these higher repayments.
When interest only terms are maturing, banks are now doing a full assessment of your repayment capacity and if you can’t prove loan servicing based on new assessment policy, they will NOT ALLOW YOU TO EXTEND YOUR INTEREST ONLY PERIOD…… thus your repayments have to increase if you cannot afford the repayments on paper.
How’s that for a ridiculous situation?
Yes we will allow your lower repayments (interest only) to continue so long as we think you can afford to make higher repayments BUT if you can’t show that you can service principal and interest repayments at a rate around 7%, then we have no choice but to increase your repayments to principal and interest. The absurdity of all this will rise to be a major issue over the next few months.
On the other side of the coin, if you have good equity and low debt for your household income, you still have the ability to play in this current market and invest, upgrade, refinance or otherwise. Given there are a lot of consumers who are now completely hamstrung due to these reviewed lending policies, not to mention lower property valuations, those who can afford to do something in this current market indeed have the timing right to make smart investment decisions and prosper into the future.
For a full complimentary review of your financial situation, drop us an email or give us a call to discuss your options.
Download our Autumn 2017 Newsletter | Edition 49