Borrowing hurdles: and how to get over them

First published 30/08/2010

If you’re finding it increasingly difficult to get financing for your next investment property, read on as our experts reveal practical tips on how to get across the line.

The recent credit crunch has forced all lenders to re-evaluate their lending policies.

During the past 18 months, there has been a big shift in policies as lenders, or more importantly mortgage insurers, try to limit their perceived risk. Suddenly, many investors are considered by lenders as being too rent-reliant or too heavily geared.

While one could argue that this is one of the objectives of investors, it has created a few issues, says Michelle Coleman of WHO Finance. “Of course you are rent-reliant and one of the basic lending strategies is to borrow as much as you can against an investment property to maximise your gearing benefits. However, the reality is, the lending environment has gone back to the old-style of lending. You now have to prove to the lender why you deserve the money and that you are not a risk.”

Harsh reality

Some of the key changes in lending that are having a significant impact on investors’ ability to build a property portfolio as quickly as previously include:

1. Cash out

This is one of the hardest changes that affect investors and this is where the biggest move has been recorded according to Lee Dittmer of WHO Finance.

“Lenders want to make sure that they are going to receive interest payments on the money they advance,” she says. “They are reluctant to hand over money to have it sit in a line of credit or in an offset account where technically they are not earning money. So anyone who is trying to realise equity to cover buffers or to plan for the future are the hardest hit.”

For example, if you have a $500,000 property with a current mortgage of $200,000 we know that you have at least $200,000 equity available to you. If you tried to refinance that property to release the $200,000, Dittmer adds that there are some lenders who will only give you $10,000 over and above your existing mortgage balance or others who will give you a maximum of 20% of the property value (ie, $100,000 above the existing mortgage), which obviously has an impact on future strategies.

You also now need evidence of reason for cash out and you face stricter enforcement, says Bill Zheng, CEO of Investors Direct. “Nowadays, you can’t just draw the cash out of your refinance facility to do anything you want; you must have a good reason and they want to see evidence,” he explains. “It is

getting very hard to leave a very large line of credit unused when you first obtain the finance facility; many investors used to set them up ready for future purchases when they can extract equity out of their line of credit.”

2. Low doc

Low-doc borrowers are limited to maximum borrowing of 60% LVR (loan to value ratio) without BAS (business activity statement). “You can’t just simply declare how much income you have as a low-doc borrower. Lenders will use the BAS statement to estimate your real income,” says Zheng.

As a low-doc borrower, most lenders want to see your BAS statements, so attempting to get ‘cash out’ as a low-doc borrower is going to be very difficult. Zheng points out that there are also now limited purchasing entities for low doc, which means that it is almost impossible to use a trust for 80% LVR loans.

“Most lenders prefer not to take on trust structures; some even make it hard for company borrowers. There are fewer lenders that are willing to lend to company borrowers, particularly in the low-doc arena,” says Zheng.

When taking construction finance, Zheng warns that you are likely to face reduction of the number of dwellings per title. “Some lenders will still allow four dwellings per title for full doc, but most of the low-doc lenders will not do more than two,” he says.

3. LVRs

Most banks now cap the borrowing at 90% with only a few going to 95%, according to Coleman. “This can really affect some investors who utilise the leverage factor to the utmost,” she says.

Previously, a 95% LVR with any applicable lenders mortgage insurance (LMI) capitalised onto the loan was offered by pretty much all lenders. Although it is still available with some lenders, the criteria have become much more stringent, according to Ivan Karamatic, Loan Market Group national manager for operations and risk.

“In some cases, the investor needs to have been a customer of the lender for at least six months for the bank to consider an LVR greater than 90%. In most other cases, 90% is the maximum, with some allowing for LMI to be capitalised onto the loan,” he says. There has also been a reduction in LVRs to top-end properties as most lenders want to reduce their exposure to expensive properties.

4. Credit records

A small and unknown default on a person’s credit file (usually telcos) may be enough to hold you back, says Karamatic. “Many lenders are ok with these if they’re paid and a satisfactory explanation is held; on the other hand, if the LVR is higher and LMI is applicable, it is quite possible that the LMI provider will refuse to insure the loan,” he says.

5. Rental income assessment

Many lenders have tightened their credit scoring and the percentage of rental income they will allow to be used for the assessment of serviceability, says Karamatic. “There is certainly limited information around this but any good mortgage broker can tell you that loans that were being approved earlier last year are not getting approved now. Much of the ‘tightened’ criteria stems from not only the banks, but also from the LMI providers (mainly Genworth and QBE),” he says.

6. Approval times

Some lenders are now taking three weeks to actually commence looking at a file. There are others who are able to provide an indicative approval in a matter of days. The lender who is taking a long time can change dramatically from week to week.

“In general, all lenders are asking for more information and can come back several times during the application process and request more information,” says Coleman. “Applications are taking longer to process than they used to, so be prepared for longer delays and make sure you leave enough time to get the refinance done and arrange longer finance clauses when purchasing. We recommend you allow 21 business days,” she says.

7. Limited lender options

Most non-bank lenders are not lending money or have stopped operating.

In a nutshell, it is now much more difficult to obtain finance above a 90% LVR than it used to be. Investors now need to wait longer before being able to invest because they need to contribute more savings or equity than previously necessary. This means it will take longer to repay debt, build up savings or wait for an existing property to grow in value.

“Lending policies have become stricter, especially when borrowing more than 80% as it needs mortgage insurers’ approval. In effect, investors cannot access as much finance as previously, which also puts pressure on their ability to invest in their preferred area of the market or their preferred types of property,” says Karamatic. 

How to get around these obstacles

While the above challenges are significant, they are not insurmountable. Here are some ways to tackle these hurdles:

1. Paint the best picture you can

“Put forward the best possible picture you can when you submit your loan application as the lender takes a snapshot of your current financial position,” says David Johnston, director of Property Planning Australia. Some examples of this includes ensuring all your loan repayments are up to date, you are paying off your credit card in full each month, or remaining in stable employment.

2. Fully disclose your situation

Don’t hide anything. If lenders feel there is any non-disclosure, they are likely to reject the application with no second chance.

Johnston says if you do not fully disclose your situation, it is likely the lender will later pick up information you have not included, which will make it all the more difficult for the credit assessor to trust you. “The better your broker understands you, the more meaningful the advice and direction that they can give you,” he says.

3. Choose the right lender

Different lenders have different policies and servicing criteria and unless you know the policies, it is tough as a borrower to go to the ‘right’ lender. Ensure you understand their lending policy and submit your loan application with the lender that is likely to be able to give you what you want. That is where having the right team of experts such as mortgage brokers around you helps.

4. Choose the right broker

The right broker will take the time to maximise the likelihood of approval and ensure you are placed with the most appropriate lender, says Johnston. “The right broker will be fastidious with the detail to ensure that he or she makes the bank’s serviceability calculator sing and dance for you within their policy requirements. Grill your broker to ensure that they have dotted every ‘i’ and crossed every ‘t’ before submitting your loan application. He or she who asks the most questions will build the greatest knowledge. You will also keep your broker or banker accountable to what they are doing for you. If they seem to not want to answer questions, they are probably taking short cuts in other areas.” Zheng adds that it’s important to select a mortgage broker with good volume. “Low-volume brokers are treated very badly by the lenders at the moment. Be accurate and direct with your brokers. Any mistakes in a loan application will trigger negative consequences with the lenders,” he says.

5. Reduce debt more rapidly

No rocket science here: tighten the belt and pay off your existing debt more rapidly to build up your equity sooner.

6. Select the right investment property

Dittmer says it’s important to make sure that the property you are buying is attractive to the lender – median price range, good location and with strong rental potential. “You also need to have a positive asset position and be able to prove to the lender that you have got adequate cashflow,” she says.

Insurers don’t like anything outside the box so Dittmer advises to ensure that:

Getting around these tighter lending criteria may be a matter of reducing the amount you borrow, so no mortgage insurance is involved. This way, there are fewer hoops to jump through when lending is limited to 80% or less. 

7. Review or increase rents

Be proactive in asking for rent increases to help your servicing capacity, advises Zheng. “Remember that your rental increase won’t make a lot of difference to your rental manager’s income, hence there is not enough incentive for them to do so, but it can help you with better cash flow and easier finance,” he says.

Explore ways of increasing income (second job or additional part-time job). Having an extra income through a second or additional job will help you boost your borrowing capacity. Make sure it is a permanent part-time position to be recognised by lenders.

8. If you’re self-employed, pay yourself a wage

Instead of just getting a distribution from the business, pay yourself a salary. This way you can demonstrate better income when borrowing. You will also enjoy the negative gearing benefit, and you don’t necessarily pay extra tax with this arrangement. “Look after your income and present it well. This may require some people to change from contracting work to full-time permanent, or pay yourself a regular wage from your business,” says Zheng.

9. Use correct wording when applying for cash outs

If you’re refinancing to release equity, you need to ensure that correct wording is used when explaining what you are going to be doing with those funds. Dittmer advises to ensure the following documents are prepared carefully:

“A lot of the documents that they are asking for may seem ridiculous, but if you want their money, then you will have to comply with their requests. Make sure that you supply everything at the same time. The worse situation for an assessor is the need to keep picking up an application to add other information or to change figures,” Dittmer says. 

10. Get an accountant to review alternative structures

Complicated structures will have to give leeway to finance. Borrowing entities such as trusts are tough to get around, particularly for a low-doc borrower. You need to decide on what your biggest priority is: the tax benefits/asset protection of using companies and/or trusts or purchasing another property and increasing your portfolio.

11. Sub-divide first to allow more dwellings to be constructed

This is needed when you can’t get finance on multiple dwellings on one title.

12. Be quick and responsive

Lending criteria change weekly, sometimes daily. What is acceptable today may not be acceptable the next day.

13. Be patient

“Don’t rush. Don’t compromise on quality with the aim of building quantity! More properties do not necessarily mean greater wealth. Understand what you are trying to achieve and then focus on the best way to get there. Knowing your end goal and planning for how you will achieve it will certainly help you stay on the right path,” advises Johnston.

Where you can go when the banks say no

Your next move depends on how or why your application was declined. If it was because you didn’t meet their lending policies, then you approach a new lender says Coleman. “Keep in mind though, that every time you apply for a new loan a credit check is done. Too many credit checks are going to alert a new lender that you are shopping around. Why would they give you the money when no-one else will?”

There are other options rather than just the major lenders. Some of the non-bank lenders are not quite as rigid as the banks and it doesn’t necessarily mean you are paying a premium on the interest rate. While there are not a lot of them around, they are coming in and out of the market. Your brokers will be more aware of who they are and what they can do.

If you were declined due to an adverse credit report, this is when things will get stickier – but not necessarily a no says Coleman. “There are lenders who specialise in this non-conforming market and while they may be able to help you, bear in mind that they charge a premium on fees and interest rates,” she says.

Consider using a mortgage broker to handle your loan application, if one bank rejects your application, a good broker will continue to try the next lender. By using a good broker, they do the research for you and should know the lenders’ policies to avoid going to different lenders.

Ensure your structure holding the property makes it simple to get finance. It is not easy to get finance for properties held in trust.

Sometimes being rejected may not be such a bad thing, says Johnston.”If a bank rejects your application, maybe you are stretching yourself further than you should. Always ensure you have undertaken your own risk analysis and fully understand and be comfortable with the risks that you are taking.”