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In this week’s episode, Dave, Cate and Pete take you through:

  1. Assessment of variable incomes. Eight out of ten people have some form of variable income, whether that’s overtime, commissions, bonuses, sub-contracting or self-employed income. This is a key component for lender policy, as lenders have different methods of assessing and more importantly, shading, (moderating) variable income. However, there are second tier lenders who will consider 100% of your variable income, having significant impact on your purchase price, strategy and portfolio planning. Real estate agents are a perfect example, where they are typically on a modest salary and the majority of income earnt is in commission payments.
  2. Rental incomes. Much like variable incomes, lenders will usually shade rental income to 70-80% when assessing your borrowing power. This is to make allowances for rental vacancies and property maintenance. Similarly, to variable there are second tier lenders who will not shade rental income.
  3. Vanilla or rainbow deals. PAYG applicants, with no variations in income are referred to as ‘vanilla deals’ – plain, delicious and easy to get approved. However, if you have variable income, rental income, credit issues or you’re an expat living overseas, (or any other challenging aspects to your application), it pays to have a strategic mortgage broker in your corner, who is an expert in the market and can find you the most favourable lender and product offering to maximise your borrowing power.
  4. Interest only vs principle and interest. When APRA implemented caps to interest only and investment lending, the way interest only loans were assessed also changed. If you elect to have an interest only period, the lender will assess your capacity to repay the loan based on the remaining P&I term. This means that if you have chosen 5 years interest only, you will be assessed based on your ability to repay the loan over a 25 year period, rather than 30 years, having the effect of reducing your borrowing capacity. However, choosing a smaller interest only period of 1 or 2 years, rather than 5, will also increase your borrowing power.
  5. Interest only and future changes in borrowing capacity. Many investors will elect to have interest only periods, with the view to refinancing at the end of the period to secure a further interest only term. However, if your borrowing capacity changes during this time and you cannot refinance, you may be stuck with the principal and interest payments. This is something that all borrowers should consider. Ask yourself if it will be affordable for you to pay principal and interest if you can’t roll over the interest only period or refinance.
  6. Repayment type, strategy and loan to value ratios. When choosing an interest only period, it’s also important to understand how that will interact with your loan to value ratio (LVR). Most of the major lenders will not allow you to borrow higher than 90% LVR on an investment loan, while some non-majors will only allow interest only repayments if the LVR is 80% or under. Other lenders don’t allow interest only repayments on owner occupier debt. These three key factors will either limit or increase the number of lenders that you have access to:
    1. Repayment type – interest only or principal and interest
    2. Strategy – investment or owner occupier
    3. LVR
  7. Lenders mortgage insurance, hurdle or enabler? Lenders mortgage insurance (LMI) is payable on loans with an LVR above 80%. Simply, it allows you to get into the property market with savings of as little as 5%, plus stamp duty costs. For most first time buyers, unless they are getting significant support from parents, LMI is the leg up they need to get into their first property. It’s also helpful for those who have an aggressive property portfolio strategy to accumulate property quickly. For someone who has savings of $100,000, LMI can be the difference between purchasing a property of $500,000 or $1M. For those not wanting to pay LMI, and preferring to save the money for a deposit, ask yourself whether you can save at the same or higher rate than the rate at which property market is moving? There are tips and tricks to use for reducing your LMI bill, but don’t let that get in the way of making a great property decision.
  8. Core difference between banks and non-banks. For those wanting to maximise borrowing capacity, especially property owners with multiple properties in their portfolio or investors with significant debt, non-bank solutions will often provide a superior outcome. They have a certain policy niches that make non-banks more attractive (subject to the complexity of your situation). Non-banks can cater to those who have credit problems, shorter-term employed and larger non-base incomes (bonus, commission, overtime, allowances). The important thing to remember is not to get too caught up if the rate is a bit higher, if it means that it’s costing you achieving your dream home. Be conscious of the lender choices you’re making and how that’s impacting your property strategy and property plan.

Resources

Show notes

  • Variable incomes 
  • 8 out of 10 people have some form of variable income 
  • Overtime, commissions, bonuses, sub-contracting, self-employed.  
  • Not all variable income is equal.  
  • Most lenders will take a shading off the variable income.  
  • They could factor in 50%, none of it (subject to how long you’ve been earning that income for) 
  • Rental incomes can be thrown into this bracket as well. Most lenders will factor in 70-80% of this. Make allowances for a property not being tenanted for a period of time, maintenance, agent fees etc.  
  • But there are second tier lenders who will consider 100% of your variable income and 100% of your rental income.  
  • This is where the devil’s in the detail and it can make a real difference in end purchase price, strategy and portfolio planning.  
  • Real estate agents – could be on a very small salary and majority of income is in commissions. So, there will be lenders you could target to maximise the borrowing capacity. 
  • Expats 
  • LVR – could be as low as 60-80% for some expats. Some don’t consider expats at all, currency being paid in, country you’re working in. It’s a whole other kettle of fish.  
  • You really need someone who knows their stuff, it’s not the same as taking a PAYG vanilla Australian worker.  
  • Interest only vs principle and interest 
  • When APRA started making changes to cap interest only loans and cap investment lending, which no longer applies, they also changed how interest only loans could be assessed.  
  • If you elect to have an interest only period, the lender will assess you on your ability to make repayments on the remaining P&I term. Previously, they would assess your capacity to repay over the whole term. 
  • Having an interest only period will reduce your borrowing capacity – you may need to look to take a shorter interest only period of 1 or 2 years than if you went for 5 years.  
  • If your borrowing capacity changes, you may not have the ability to roll it over and you could be stuck with P&I, and that’s the type of thing that you need to think about as the borrower.  
  • It’s affordable for me to be paying interest only today, but will it be affordable for me to pay P&I if I can’t roll it over or refinance? 
  • What was Pete’s attitude to interest only lending? 
  • Interest only is what we went for, helped cash flow and allowed us to buy multiple properties.  
  • In the last month I’ve been refinancing, I’m 60 and now is the time to pay down some debt. 
  • The other reason is that you can depend on the market to increase what the proeprty is worth, compared to what we paid.  
  • But after this boom, I think the property market is going to flatten out. So, to increase equity margin, people will most likely have to do that via debt reduction. 
  • For interest only loans most of the majors allow you to go to 90% LVR on investment loans only. 
  • Some of the non-majors eg Citibank will only allow interest only repayments up to 80% LVR. 
  • Some lenders don’t allow interest only repayments on owner occupied debt. 
  • Repayment type, strategy investment or owner occ, and lvr – those three factors will either limit or increase the number of lenders you have access to.  
  • There would definitely be a correlation between age and how often you move lenders. As you get older, you have more properties, more kids, more responsibilities, it becomes a hassle to move.  
  • LMI – the enabler of first time buyers 
  • There are many countries whose economy and banking system isn’t stable enough to offer LVR above 80%.  
  • LMI allows you to get into the proeprty market with savings as little as 5% with stamp duty costs.  
  • For most people, unless they’re getting significant support from parents, it’s necessary for first time buyers and those who want to build a property portfolio aggressively.  
  • For eg. with $100,000 as savings + cash for stamp duty and fees, at 80% LVR, the client can purchase a property worth $500,000.  
  • $100k plus stamp duty and fees at 90% LVR, the client can purchase a property of $1 mil with the addition of LMI cost being capitalized on the loan amount thereby increasing the effective LVR. 
  • The bigger the loan amount, the bigger the LMI payment and also relating to loan to value ratio 
  • For example every dollar in lending above 90% LVR incurs about 40c in the $ in LMI premium 
  • In comparison every dollar you increase lending between 85% and 90% LVR incurs about 11c in the $ in LMI premium 
  • Tips and tricks on how you can reduce this, but don’t let that get in the way of making a great property decision. 
  • Core difference between banks and non-banks 
  • Wanting to maximise borrowing capacity and purchase price, especially multi property owners or investors with significant existing property and debt, then non-bank solutions will often provide a superior outcome.  
  • They have a certain policy niche that makes them more attractive (subject to complexity of your situation.  
  • Non-banks can cater to those who have credit problems, shorter-term employed, larger non-base incomes (EG more bonus, commission, overtime, allowance based) 
  • Don’t get too caught up if the rate is a bit higher, if it means that it’s costing you achieving the home that you want to buy and hold for the mid too long term. Just make sure you’re conscious of the lender choices you’re making and how that’s impacting your property strategy and property plan. 

Gold Nuggets

David Johnston – The Property Planner’s Golden nugget: For all this talk on borrowing capacity, you want to make sure that you understand what we call your money goals. How much surplus cash flow do you want after you settle on the next purchase and how much savings do you want available after the purchase. You need to understand your living expenses to get to those numbers and these should be the barometers for the purchase price.

Peter Koulizos – The Property Professor’s Golden nugget: If you listen to our episode last week, remember that Dave said your interest rate could be increased as well. But all you have to do is wait for your debt to equity ratio to increase, then you can go to the bank to refinance and you should get that lower interest rate.

Cate Bakos – The Property Buyer’s Golden nugget: if and when you’re refinancing or getting a new LVR, you’ll most likely trigger a valuation. If you’re doing this for your investment property, be clear to tell your agent and tenant that it’s because you’re refinancing. They may be fearful that you’re going to sell.

Market update

  • The price of iron ore has dropped by 30% since the end of July and property growth in Perth wanes . Looking at the daily CoreLogic index, Perth is the only city exhibiting negative growth this month. Although we don’t place as much trust in the daily index, Perth has shown, (over 2021) to have the least growth of all capital cities, at 11%. The declining price of iron ore hasn’t helped Perth as far as the economy and property market is concerned. It looks as if the Perth property market is flattening out.
  • Latest unemployment data for July. ABS unemployment data has shown the unemployment rate drop to 4.6% from 4.9% in June, which is the lowest rate since 2008, (post the GFC). However, in the wake of lockdowns, the participation rate has fallen by 1.3 points over the year, which indicates that people leaving the job search yet not being picked up in unemployment statistics. This could be due to retirees hitting the go button or casual workers holding off on finding employment to take the opportunity to upskill. The effective unemployment rate could be actually 6%.

  • The lay of the land post lockdown. As vendors put their plans to sell on hold, post-lockdown campaigns are going to bank up. It’s likely that auction campaigns could be reduced to run for only two weeks, to accommodate for the back log and desire to sell prior to Christmas. This could be a good opportunity for purchasers to take advantage of. It is critical to be prepared and ready, have your finance approved so you can pivot quickly leading into the spring market.

 

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