One of the most common problems for property investors these days is accessing the equity that has accumulated in a property. I hear regularly from people that have had issues with their existing Bank when they have tried to increase their loans. This is a pressing issue for investors who rely on the equity to maintain their cash flow.
There is no question that we are entering a new phase in property investing and the key elements for successful borrowing have altered dramatically due to circumstances abroad and locally.
I think it’s wise to consider why we are in this position in the first place and to do this we need look at two issues separately.
The first issue revolves around the recent Global Financial Crisis and the measures the Banks have taken to deal with finance since this event. The ongoing implications and fall out are still being felt today and undoubtedly will be with us for some time to come. While the average investor may not be aware of how the GFC occurred or what is still being played out behind closed doors, its obvious that the restrictions in available funding for Banks have placed great pressure on their ability to meet the demands for local borrowing.
While it’s true that our Banks are certainly in better shape than others around the globe, this in itself is no guarantee that funding will be always readily available.
By tightening up how they lend money and adopting a decidedly risk adverse policy, the Banks have begun building up the quality of their loan book with safe, secure, low LVR loans. Evidence of this change of policy can be found everywhere. Look at your lender and see if they offer a lower rate to those borrowers that only need loans with LVR’s of 75% or below. This appetite for low LVR is driven by the need to sell quality Mortgages to raise funds for further lending.
The second issue we have to consider is the latest Government initiative to protect consumers, the National Consumer Credit Code Act, launched in January 2011. The basic principle behind this legislation is simply to ensure that borrowers understand what they are being offered and that they have a choice of products available for their particular circumstances. Aside from a list of checks the lender must make, the Act makes it necessary for anyone participating in credit activities to make reasonable enquiries into a borrower’s financial position. Simply put, the Lender or a Broker must verify the borrower’s ability to repay the loan without undue hardship.
On the face of it this is not so hard because it is quite easy to verify someones income by reference to payslips, tax returns etc. The hidden consequence of this legislation is that it makes it very difficult to get a Low Doc loan. For example, if you need a Low Doc loan because you can’t provide the sort of verification required to meet Full Doc requirements, how will a Lender be able to give you a loan and still meet the basic core principle of the NCCP?
As you can see, these changes have particular significance for Investors who rely on Low Doc loans.
The onset in 2011 has therefore seen all the major lenders change their policies to reflect this new legislation. Low Doc loans in particular have been hardest hit.
Most Lenders who offer Low Doc loans now require 12 months BAS as well as trading statements to show deposit amounts appropriate to the income declaration. In some situations an Accountants Declaration will also be required for confirmation.
While most self employed borrowers could provide these new requirements, they do not always show the real picture. In the past Low Doc loans have given self employed borrowers the ability to declare their actual income without the burden of having to have the Tax Returns completely up to date. This has now changed with none of the majors willing to provide asset lending for residential investors as a general rule.
Here is a tip. Check with your Accountant if they have provided these sorts of Declarations for other clients and whether they would be prepared to supply you with one.
Right now the key to borrowing easily is to be classified as one of the “good quality borrowers” who are the target of every Lender.
What makes up a good quality borrower you ask? Let’s go through the main points;
- You have been employed continuously for a minimum of 2 years
- You lodge your tax return every year
- You have surplus income
- You save regularly
- You are repaying all your loans on time
- You own a home and have a mortgage
- You have a clean credit history
Now compare the list above to the requirements for borrowing say 5 years ago
- You are alive
Completely different isn’t it?
Ok, I admit there is a little more to it than that, but I’m sure you see my point.
One thing you may notice is that income features prominently and this applies to both PAYG and Self Employed.
Maximising your income position is a must these days. If you can work overtime do it. If you can show more income in your tax returns do it. The argument I hear about maximising income is that the tax will be higher. Well, that’s true but is it necessarily a bad thing? The more you borrow the more money you have to use. Surely the core element of every investment is to make money isn’t it? I don’t know anyone who has retired early because they saved tax.
Clearly, for Full Doc borrowers releasing equity is easier, there are still hoops to jump through but nothing as severe as those that apply for Low Doc applicants.
Ok, if you can’t borrow what’s the alternative?
Think about it. If you are stuck because finance is unobtainable it’s usually as a result of heavily negative geared properties. Most investors recognise the need to move ahead and the itch has to be scratched at some time. A negative geared property portfolio requires income to support it. When your income in insufficient to do that the Lender won’t support you. You simply need to decide whether you want to stop and do nothing or move forward. Brutal I know.
Selling releases equity which can reduce debt and place you in a more favourable position for finance. You may well be able to replace the property with another one which has a better rental return. Perhaps, a change in strategy is required and more emphasis should be placed on buying and selling than long term hold and equity release?
Here is a tip. Review your strategy and consider other options if you are heavily negative geared.
Clearly the Bank won’t release equity if the valuation is too low.
Valuations can be a problem so it’s wise to know what to expect. The Banks will most likely apply lower valuations so be aware of their conservative approach. You can certainly dispute the valuation but be prepared to back up your figures with comparative sales from the most recent 3 month period. When I see “comparable sales” produced which bear no relation to the property in question other than the postcode is it’s fairly certain the valuation is probably right. For the record, a comparative sale a property similar in land size, number of bedrooms, bathrooms, car spaces etc. It should also be a sale as well, not a property for sale. For those with ”unique” properties that deserve a higher valuation because they are different to those around the area I suggest you take what you can get. The comparative rule holds sway right now and without it’s not worth the bother.
Lenders also constantly review their risk positions regarding suburbs and property types. If they see they have a high exposure to a certain area they will bring the LVR down in that particular suburb. Other Lenders who don’t have the same exposure will continue to lend at normal LVR levels. Naturally this can create confusion, especially when you are not involved in finance on a daily basis. This especially applies to Mortgage Insurers.
There will also be instances where certain types of property go out of favour. For example, in the past, Student Accommodation and Serviced Apartments were fine up to 80%. Nowadays, the common LVR is around 60% and you may have a tough time convincing your lender to advance more funds against it at any level.
From a valuers perspective they have already looked into what sales they can find to support their valuation so you will have to produce something special to overturn their value. However, Valuers are human and can make mistakes so if you feel unjustly done by don’t hesitate to provide the evidence.
The bottom line is that the Lender will defer to the valuer, or their in-house valuation model, to set your properties value and LVR. Remember that valuations go in cycles. What you lose on the swings you will make up on the roundabouts. Property investing has been about long term gains and if that is still your strategy take some solace in the view that eventually things will get easier.
Another tip for you. The valuation will most likely be below what you want. Do some research to get an idea of where yours fits in the market and confirm it with comparable sales.
Ok, we have established there is equity to get from our property. What now? Well, the Bank will ask for proof of what you are going to do with the money and the answer is not as clear cut as you may think.
Accessing equity from a property without explanation is called “Cash Out” and all Lenders have cash out policies. This is where it gets tricky. There are limitations to the amount of cash out, the respective LVR level involved, the reason for the cash out and whether or not Mortgage Insurance is involved. Some will only require a Statutory Declaration as to the purpose while at the other end of the spectrum you will be required to show evidence of the declared purpose.
Naturally it’s impossible to cover all of them here but the good news is that any professional finance consultant will be able to steer you through the maze.
It’s easy to prove that you are buying a car or taking a holiday but for investors this is a difficult question. You see, if your answer is that it is a deposit for another purchase, the Lender may hold onto the funds until you have bought. They may also ask how you will purchase the next property and then factor in that finance amount to the equation, whether it is with them or not. This is fine if you can show enough income to support the purchase as well as the equity release. If not it creates another issue.
If you answer that the money is for supporting the negatively geared property portfolio then what you are effectively saying to the Bank is that you can’t afford the properties in the first place. Remember, all borrowing is based around income now, not equity. If you can’t meet the repayments with your available income then you can’t afford to borrow more.
Can you see the difficulties now?
Here is another tip. Consult a professional in finance to help understand the different conditions for cash out.
Well, there you have it. Accessing equity in a difficult financial might seem daunting but it’s not impossible. Don’t despair, all is not lost. When it is all said and done, investing in property is about understanding the finance equations and moving with the market. We are entering a new chapter in property finance yet the Golden Rule remains.
Give the Bank what it wants and you get the money.