In this exciting new section, our finance expert, Andrew Krauksts, answers a reader’s questions on how to get low-deposit loans and when an investor should consider taking one
Q: I’ve read that more lenders are now offering high LVR [loan-to-value-ratio] loans, but how do you get them? Which lenders are offering them, and when should I opt for this type of loan?
A: The highest borrowing that you can get with a single property as security is 95% of its value. To answer the question about high LVR loans, I am going to focus on the highest-ratio lending of 95% of the value of a property (where no other property is used as security).
Borrowing 95% of the value of a property represents a high risk for the lender and the borrower. Therefore, there are a few things to consider.
From a lender’s point of view, the risk is the minimal amount of equity (buffer) contained within such a property/loan set-up, in case something goes wrong and they have to sell the property quickly. This potentially exposes them to a significant loss if the property has declined in value, and taking into account selling costs may leave them with a residual debt and no security.
This is where Lenders Mortgage Insurance (LMI) comes into play. The premium is paid by the borrower but protects the lender in case this shortfall occurs. This insurance protects the lender but still leaves the borrower exposed.
From an investor’s point of view, there are several advantages though. Firstly, they can buy an investment property with minimal cash outlay. There is also high tax deductibility due to the high loan amount relative to property price. Another advantage is that this is one of the only occasions when the LMI fee can be added to the loan amount (within reason), again requiring a relatively small cash outlay.
Of course, one of the negative aspects of a highly geared property is that your repayments will be higher, and therefore, after rent, a sizeable repayment will quite possibly have to be made every week.
As a rule of thumb, for 95% loans you can roughly calculate an LMI fee of around 3% of the loan amount. As an example, if you are borrowing $500,000, the LMI fee may be around $15,000. This is a one-off fee, and if it is for an investment it should be tax deductible (check with your accountant).
Where many people get caught out is that lenders often only allow a maximum of 97% of the property value – that is, a 95% lend for the purchase plus an additional 2% to cover the LMI fee. In the above example, that would only cover $10,000 of a $15,000 LMI fee. Therefore, $5,000 from the above loan example still needs to come out of your cash outlay. (Many people have been caught out by this, believing that all of the LMI can be added to the loan.)
Some lenders don’t allow the addition of the LMI fee to the loan, while others will allow the entire amount to be added. Later in this article we will provide you with a breakdown of different lenders and their guidelines, to assist you in making an informed decision.
The Lenders Mortgage Insurance fee varies from lender to lender, so make sure you shop around. It can vary by thousands of dollars. A lack of research can be very costly.
Given that only a small deposit of 5% is paid, the lenders have a policy that this 5% cash deposit must come from genuine savings. This means that the money used for the deposit cannot be loaned or gifted but must have been saved over a period of at least three months. Lenders are looking for financial management and therefore will want to see your statement of the last three months’ savings as evidence of such management. Other ways genuine savings criteria can be met are if the 5% deposit is in the form of shares, or a cash term deposit that has been held for the past three months.
If the 5% deposit is from a non-refundable gift, make sure it stays in your personal savings account for at least three months, and don’t touch it. You’ll then qualify for genuine savings.
Your borrowing power
High LVR loans restrict your borrowing power. Borrowers often miss this when they calculate their borrowing power. If you want borrow up to 80% of the value of a property, lenders use their own calculators, in most instances, to work out how much they will lend you.
Every lender is different in terms of generosity, and the amounts can vary by hundreds of thousands. If you want to borrow more than 80%, most lenders adopt the LMI company’s borrowing calculator, which is usually much more conservative than the actual lender. Therefore, many people will see a marked drop in their ability to borrow funds when they are seeking finance over 80%.
This represents a catch 22. If you have little funds and need to shoot for a 95% lend, you will need a stronger income to borrow funds. In a lot of cases, though, if your deposit is low it corresponds with a lower income as well, thus making it harder to qualify for the funds you are seeking.
One way to overcome this is to use fixed rates with a lender, as this may increase your borrowing power. Speak to your broker about which lenders can assist, based on your financial situation.
So how do you get them?
There are a few things to consider when you make an application for a high LVR loan. Given that they are a high risk for the lender, they look for a squeaky clean application with a strong income to support the loan that is applied for.
Ensure that the lender application is filled in correctly and with plenty of information. For example, if you list bank account details like your savings account, include the account number. List everything – your super balance, home contents value, car, shares, etc. Your application needs to be strong, which is achieved in part through a healthy asset position.
Contrary to beliefs, it is also important to have a credit history. It goes towards your credit score with the lender. Some clients come to us feeling proud that they have never had a loan. This is bad in the eyes of the lender, as there is no credit history that they can judge you by.
Your employment situation is important, as is your residential living history. If you have been with your current employer and living at the same address for the past three years, you appear stable and, as a result, represent a lower risk.
If you don’t meet these standards, don’t be too concerned but do speak with your broker or banker first before making an application. Use their expertise to assess your financial situation and guide you. And should you be declined for a 95% loan, don’t worry – in a lot of these cases lenders would be happy to approve you at 90%. It may just mean having to save a little longer.
Do you have more than $120k in your super fund? You could use your super to buy property - Find out how