The spirit may be willing, but the banks don’t always share the enthusiasm. So, how can you get finance to invest in property as a low-income earner? Philippe Brach explains
For most borrowers, applying for an investment loan from a bank is generally a tick-the-box exercise. Provided that a given set of criteria is satisfied, they should obtain a loan.
The three main criteria every borrower needs to meet in every case are:
- Security. A lender needs to be happy with the property the applicant is buying or giving as collateral.
- Serviceability. A borrower needs to pass the servicing test, ie the borrower needs to be able to afford the loan.
- Funds to complete. This means that the borrower needs to have enough deposit or equity to settle the loan.
A borrower needs a green tick to all three of these criteria to have any chance of getting a loan. These criteria are described in more detail later on.
If you only tick two out of three or even just one out of three, you won’t get a loan. It’s that simple.
As an example, if you have substantial savings but no income, the bank will not lend you any money. Similarly, even if you’re earning a high income but haven’t saved a deposit, you won’t get a loan either. Finally, if a bank does not like the security (the property), they won’t grant you a loan even though you have a good income and sufficient savings.
How the banks assess your application
There are other important hurdles to pass, but depending on which lender you go to, these other hurdles may be overcome.
For instance, most lenders credit score applicants but some do not. Credit scoring is done by a computer that scores every applicant based on a complex algorithm made up of many variables.
The information used is mainly from the applicant’s credit file and the data provided in the application form including income, assets, liabilities and so on.
If you fail this scoring, there is usually no appeal. It is not uncommon that even the bank can’t explain why someone fails a credit score test, as too many variables are involved.
One cannot help thinking back to the famous quip “computer says no…” in the Little Britain show. If an applicant fails their credit scoring, then it is best to find a lender that will not credit score.
Lending criteria for low-income earners
For low-income earners, these three criteria are critical.
1. Security
A common practice for low-income earners is to look for the cheapest possible property that delivers a positive cash flow. This usually means looking at older properties in regional locations that usually have little capital growth prospect, or looking at fringe investments such as retirement units, student accommodation, serviced apartments, etc.
Banks tend to restrict lending to these products as they are not easily sellable if they need to repossess the property. So, sourcing an acceptable property is an important factor.
2. Serviceability
In principle, this is a logical process. A lender will look at an applicant’s income after tax and then deduct living expenses and other liabilities such as car loan instalments, personal loan repayments, rent etc.
They also allow for some credit card liability, usually between 2% and 3% of the credit limit per month. And yes, banks will always assume that you are maxed out.
On the subject of living expenses, most banks will ask the applicant to list these outgoings. They will then compare the declared expenses to their benchmark. This benchmark can vary but is usually based on the Household Expenditure Measure (HEM) produced by the Melbourne Institute of Applied Economic and Social Research.
Typically, this index would show that for a married couple with no dependants, their minimum monthly living expenses should be about $2,100 per month. Typically, the lender will use the higher of the figure declared by the applicant and the HEM.
On the good news side, when an investor applies for a loan for an investment property, the rent of the property he/she intends to buy is taken into account when calculating the applicant’s borrowing capacity. This gives a big boost to serviceability.
Given the above, it is logical to state that a low-income earner would have to eliminate as many existing liabilities as possible in order to increase servicing.
As an example, someone on $30,000 per annum, living with relatives (ie, no rent payable), with no credit cards, no car, no personal debt, technically could afford a $300,000 loan to invest in property.
This is possible if the chosen lender accepts that living at home is free, and accepts to take into account the negative gearing effect, which most lenders do.
The loan to value ratio (LVR) will also play a part in this scenario, so it’s important to target the most favourable lender based on serviceability and LVR.
3. Funds to complete
If a borrower applies for a loan that is 80% of the value of the property (LVR of 80%), then he/she will need to have 20% deposit plus enough money for stamp duty and legals.
This can be a high hurdle. More and more, I come across applicants who receive a ‘gift’ from their parents for the deposit and this is fine if the LVR remains below 80%. Above this LVR, mortgage insurance is payable and obtaining a loan becomes more difficult.
For example, over 80% LVR (some lenders have a higher threshold) an applicant needs to demonstrate ‘genuine savings’, ie show the lender that they have managed to save 5% of the purchase price.
In my above example, the borrower may obtain a $300,000 loan on his low income, but he will also need to have about $100,000 in savings to pay for the 20% deposit plus stamp duty and legals.
If this borrower applied for a 90% loan, the banks’ guidelines are dictated by the mortgage insurer and are also harsher. It may decline the loan as the profile does not show a strong enough overall financial situation.
Top tips for borrowing to invest as a low-income earner
To have the best chance of obtaining a loan on a low income, you may want to consider the following tips:
- Have a stable job and regular income
- Be employed by a company rather than being self-employed
- Have a stable address, ideally live with parents rent-free
- Show that you are financially responsible by making regular desposits in a savings account
- Reduce liabilities to a minimum (credit card, car loans, personal loans, etc..)
- Pay bills on time to avoid a bad credit rating
- Do not overdraw your credit card if you have one
- If you have any defaults on your credit file, pay them immediately
- Invest jointly with someone you know and trust
- Lower your LVR, ie put down a bigger deposit
Common sense is the key
Aside from the technicalities of obtaining a loan, there are some common sense elements to take into account:
1. Buying an investment property is not just about the loan, it is about holding costs and cash flow. It is important for any investor who obtained a loan close to his/her borrowing capacity to really have a good grip on numbers and stress test cash flow by running ‘what if’ scenarios, especially looking at the effect of interest rate rises. This is particularly important for low-income earners who have less capacity to cope with adverse fluctuations.
2. Having a ‘buffer’ in place is a fundamental risk management tool. Putting all savings towards a property acquisition leaves the investor with no backup. For high-earning investors, it is less of an issue as they should be able to rebuild their savings quickly, but for a low-income earner, there is much less wiggle room.
3. Low-earning investors can have vastly different profiles. For instance, consider the following:
- A young single tradesman starting his career and living with parents
- A divorced person with two kids on a part-time job with a large deposit from the divorce settlement
These two profiles have different priorities. Profile A is looking at building some wealth and has little financial obligations. Profile B has to plan to make sure that there is enough income to satisfy the growing needs of the children and although there is a large savings available, is it the best strategy to use most of it to buy a property? Remember that a property is a great tool to create wealth, but an investor will only access the capital gains when he/she sells the property.
In conclusion, there is no impediment for a low-income earner to obtain a loan for an investment property. It is a matter of navigating the lending scene by using a savvy broker who can select the most appropriate lender for the circumstances. Obviously, not every low-income earner will qualify, but it is far from being an automatic decline, so if you are a low-income earner, give it a go!
Philippe Brach is a successful property investor and founder and CEO of Multifocus Properties & Finance
