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Overcoming Serviceability Issues to Obtain Finance in the Current Market

Over the last 15 years, residential properties have gone up in value significantly, if you have been investing in properties during this period, you may find yourself in a situation where you have a lot more equity than you have available income to obtain finance.

In other words, you feel that you are being stopped by lenders who don’t see how you can service more debt, but you think you still can.

So how do we work around this problem so that lenders can lend you as much money as you feel you can handle?

I have listed quite a few typical problems here and their solutions.

1) Diversify your lenders.

If you have multiple properties with the same lender and they tell you that you can’t borrow more money due to insufficient income.

This is usually the easiest to resolve, all your need to do is to use a competent mortgage broker to start helping you to diversify your lenders, so that you can continue to obtain finance.

Many property investors don’t know that the more mortgages you have with the same lender, the less you can borrow from them. This is mainly due to some of the following reasons:

  • The first reason is because most lenders apply an interest rate penalty on your existing mortgages with them when they assess your income capacity, but they won’t apply such a penalty on mortgages that are with other lenders.  For example, you may be paying 6.5% interest for a particular mortgage, if this mortgage is with the lender you are applying for another mortgage, the lender can apply a 2% penalty on this loan and assume you are paying 8.5% for this existing mortgage, hence severely reduce your available income to service another loan.  But if this mortgage is with another lender, they will just take it as 6.5%, because it is someone else’s risk.
  • The second reason is when your total debt exposure gets bigger and bigger with the same lender, you are moving across from a retail type low risk borrower (e.g. total debt exposure less than $1m) to a business type high risk borrower (e.g. with multi-million dollar debt exposure).  Lenders tend to worry when you borrow too much money from them, so they start monitoring your total debt exposure, and the safest thing for them to do is to start reducing your total LVR from 80% gradually down to 60%.
  • The third reason applies to investors who have a mixture of different risk levels of finance with the same lender, lenders tend to reduce their total lending by gravitating towards the lower denominator.
    For example, if you have obtained finance from the same lender for some of the higher risk securities: rural properties, serviced apartments, factories, warehouses, vacant land, offices, retail stores, property development projects, businesses, etc. You may find that the same lender can give you a hard time when you try to get an 80%LVR mortgage for a normal residential property even if your income allows it, because they will have to consider the risk of your overall debt portfolio.

2) Reduce your monthly cash flow commitment.

How much more finance you can obtain is determined mainly by how much surplus cash flow lenders believe you still have, provided equity is not a problem.

A few ways you can reduce your monthly cash flow commitment:

  • Reduce your existing mortgage repayment obligation. This may include some of the following:
    • Change a higher fixed rate mortgage to a lower variable rate, with the same lender or a different lender.
    • Refinance your existing mortgage from higher interest to lower interest.
    • Pay interest only when you obtain your loans. You can always pay extra on principal whenever you see fit, but do not make it part of the obligation on your loan statement.
  • Move short term debt into longer term debt.  This may include some of the following:
    • Absorb your car loan, personal loan or any small short term debt with high monthly commitment into your property mortgage by simply doing some debt consolidation. This can greatly reduce your monthly cash flow obligation from a lender’s perspective.
    • Reduce your credit card limit. As credit card limit, regardless of whether you owe anything on it, will be assessed as if you owe the whole amount at twice the interest rate of a normal property mortgage.
  • Consider renting instead of having a home mortgage.  Obviously this is a very personal matter and it is not for most people.
    • Renting cost you about 2.5%-4.5% of the property value, a home mortgage costs you roughly twice as much. It is also cheaper to keep an investment property than a home because of tax benefit.
    • Most lenders will accept your new income arrangement as long as your intention to rent is confirmed at the time of your loan application.
  • Replace monthly debt obligation with a future exit position.  For example:
    • If you are developing properties to sell, instead of taking a normal construction loan which requires a monthly repayment, you can take on a development finance facility where you have no debt repayment obligation during the project until the project mortgage is discharged upon completion by sales or take out finance.
    • This can similarly apply to an unconditional sale of an existing property, where the ongoing mortgage commitment will be removed in the near future.
    • Sell down properties with serious negative cash flow issues and replace them with better cash flow properties. E.g. the cash flow of an old $800k investment property at 3% rent can be worse than the cash flow of five brand new $400k investment properties put together.

3) Improve your income and its representation to the lenders.

All things being equal, the more income the lenders believe you have consistently over an acceptable period of time (e.g. 1 or 2 years), the more money they are likely to lend you.

Here are a few ways you can improve on your income representation, some are more obvious than the other:

  • Lenders give higher weighting to full-time, permanent employment income over part-time, casual or contracting income, simply because it is easier to observe a consistent pattern.
    • Some lenders are more difficult than others when it comes to recognizing income evidence. You can have more difficult lenders asking for the last two years of tax return and tax assessment notice, to easier lenders that only require an employer letter and two pay slips.
    • Many investors who have left full-time permanent employment the last few years may have found themselves sitting on some very high interest rate low-doc loans unable to refinance to a lower interest rate mortgage. For example, a 2% higher interest rate on a $3million mortgage can mean $60k in saving a year; it is almost worth them going back to full-time permanent employment for a while simply to get their finances sorted out first.
    • If you are self-employed or running a business with employees, you can pay yourself a permanent wage high enough to benefit from property tax deduction with no real extra cost to you, but make your income can look so much more attractive to lenders.
  • Improve your rental income and its representation.
    • You need to ensure that you are getting the best market rent for your investment properties.
    • You can offer your tenants incentives to pay you a higher monthly rent, such incentives can be a rent free period at the beginning of each year, or some freebies or additional services you can throw in every now and then.
    • Lenders accept rental income from rental statement, rental agreement, and even rental appraisal. So if you don’t like the rent you are getting, there is nothing to stop you from presenting to the lender the rental appraisal from your next managing agent.
    • Add additional income streams that are recognized by lenders.
    • Most lenders would accept family allowance income or other family distribution.
    • Any fixed income that has been around for 2 or more years and are likely to continue into the future, such as income generated from shares and fixed income asset.
    • Superannuation pension income for investors over age of 55.
    • Structure yourself with an additional business income. This applies to property investors who are consistently making profit from property transactions, you can set yourself up over a period of 1-2 years to demonstrate the profitability of your property business, most lenders will accept such consistent profit as part of your income.
    • Additional income from a 3rd party, such as other family members like parents and children, etc. This can work when your own income is not sufficient to service the debt, an additional borrower/guarantor with extra income may be used to help service the loan.

4) Select lenders in the right sequence to maximise your income serviceability.

Every lender is different when it comes to assessing how much you can borrow. Let’s take a look at their differences:

  • Some lenders would consider negative gearing benefit in their debt servicing calculation, others don’t.
  • Some lenders will take a deeper discount on rental income when you have a large property portfolio or have regional properties, others don’t.
  • Some lenders will add an interest rate penalty to all mortgages you have, regardless who is the lender; others will only add the interest rate penalty to their own mortgages.
  • Some lenders will assume automatically that you are paying principal on your loan even when you are paying interest only, others will accept what is on your loan statement.
  • Some lenders will make the servicing criteria much harder to pass when you try to borrow more than 80%, others don’t.
  • Some lenders require BAS statement and bank account statement for self-employed borrowers, others don’t.
  • Some lenders are more desperate for business and more willing to make the deal work, others will only do the minimum.
  • Some lenders are willing to work with the borrowers on the valuation, others won’t be bothered.
  • Some lenders accept a wide range of properties and borrowers, others have a much narrower selection.

While the above looks very complicated, it is not too bad in the current lending environment as there are not as many lenders to choose from.  If you have no more than 20 properties or $10m worth of mortgage, it is not difficult to line up the lenders in the right sequence to maximize your borrowing capacity.

A couple of simple rules to follow are:

  • Try not to mix properties with different risk level with the same lender.  E.g. standard residential properties will not be with the same lender which provides you business overdraft or development finance.
  • Use the lenders with the easiest debt servicing criteria later, this will ensure that you don’t waste any of your borrowing capacity.

Summary

Over the years in helping property investors to obtain finance, I have found that the basic lending principles have not changed much, but lending criteria and borrower’s situations are always changing.  Hence it is a good idea to observe the rules and be flexible at the same time when it comes to obtaining finance, and always assume that ‘it can be done’.

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