The secrets to releasing equity that I am going to share with you will apply whether you have one property which you live in or whether you already own multiple properties. It doesn’t matter whether you are PAYG or self employed, full-doc or low-doc. While the details may change for each category, the principles remain the same throughout.
Accessing equity is about applying specific principles to your financial position just as successful property investing revolves around repeating successful strategies over and over again.
Lender diversity is the key
One of the first things to do is to split up the portfolio into separate facilities with separate lenders. For some investors this will be hard to come to grips with. The number one reason that investors end up with a portfolio financed with only one lender is convenience. I was going to say laziness but perhaps that’s too harsh.
There is no doubt that it is very convenient to have a personal banker ‘on call’ to approve any new purchases and there is also the attraction of a lower than normal rate if the portfolio is big enough. That’s the myth.
The facts are that your personal banker is not allocated to you alone. He or she is a personal banker to hundreds of bank clients and all too often they change jobs regularly. Just when you get used to one, they are promoted (if they are good at their job) or transferred to another area (if they aren’t suited to it).
The other issue is that these days banks don’t see large portfolios on their books as a good thing. Think about this. Larger loans attract greater risk for the bank so naturally, they keep an eye on them. At the first sign of danger, who will they look at first? The worst part is that the bank will always have control over your ability to increase your financial position. I don’t know about you, but I don’t think the bank has the right to tell me if I can be rich or not!
The simple answer to this inherent problem is to have multiple lenders looking after your portfolio. Yes, this means you have to take responsibility for the management and review of the portfolio but it does give you more safety, more flexibility and more control. Understandably, this is not as easy today as it has been in the past; however, diversity is extremely important to your ability to keep moving forward.
So many times I see investors who think they are stuck simply because their lender told them so. Usually it’s the lender who is unable to assist, not the client who wants their help.
Benefits of having multiple lenders
Ease of refinancing
Diversity gives you the ability to refinance a single property without notifying every lender that you have done so. Remember we want equity. Equity will enable you to buy again or hold on during tough times. I am not advocating withholding information from a lender here. That would be wrong on so many levels. What I am saying is that the lender you want to get finance from is the only one, at that point in time, who needs to know about this particular transaction. Naturally, when you next deal with another lender, at another time, your current details will be required for that loan application. The existing lenders do not need to know about your new loan until you approach them for another loan down the track.
Ability to borrow more
Another advantage of using separate lenders is that each lender has their own method of calculating your maximum borrowing amount. These calculators are reviewed regularly and get updated when interest rates change as well as when other factors alter, either in the economy or the risk profile within the lender itself. Let’s say that a certain lender has reviewed its loan book and sees that it has an inordinate amount of loans in the 90–95% LVR range. The review process lists this as a risk to profitability.
To help minimise this new risk the lender can alter the setting within the calculator to make those deals which are in the 90–95% LVR range service harder to get. This results in loans that are of better quality for the lender if approved, as well as a reduction, of course, in the percentage of loans within that group that are ‘riskier’. If that scenario affects you, then you can see it’s easier to move one loan to another lender than it is if your whole portfolio is under the control of a single bank. I’ll discuss servicing calculators further on when we look at borrowing power.
Ability to borrow using other ownership structures
You may well have a mix of several different ownership entities such as companies, trusts and individuals within your property portfolio. By having separate lenders you can also benefit in this position as well. For example, while all lenders will happily accept individual and joint ownership on a security offered for a loan, not every one of them will accept companies and trusts. Some banks will accept family trusts but not unit trusts while others will accept a unit trust but not a hybrid version.
While your property portfolio might not have evolved into using trusts and corporate trustees, you can see very quickly that if your existing lender is one that doesn’t accept these ownership entities you will be limited by their credit guidelines. Besides, why should a bank decide what entity you should purchase your property in? After all, a trust structure is for your protection, isn’t it?
A good rule to follow is to keep personal debt separate from investment debt. This is extremely important as you move from the income stage of finance to the asset stage. Your accountant will also thank you at tax time.
Tapping into your equity
Now that we have identified the necessity of splitting up the portfolio, we have to be able to access the equity. How do we do that?
Step 1. Maximise your borrowing power
This is where it’s important to know how lenders view your debt. All lenders use a specific servicing calculator to work out if you can manage the debt you want and the debt you already have based on a certain formula. Part of their methodology is to over-compensate for your existing debts. For example, if you have interest-only repayments on your loans these will be calculated as principal & interest. The term may also be reduced, from say 30 years to 25 years, further decreasing your ability to borrow. Maybe the fixed rate loan you have will be the rate they calculate your repayments on, regardless of when it will be maturing.
Remember, lenders are compensating for risk, for their benefit, not to help you to borrow as much as possible. Knowing which lenders are flexible and generous in each area of your financial position is critical.
You also need to be aware that some lenders will penalise you for having certain types of debt such as credit cards, store cards, personal loans, family loans, etc. For example, I frequently see clients who have high credit card limits with no debt. These cards will rarely be used, if at all. Now I know that in the past lenders would say that if the credit card was cleared on a monthly basis then the limit didn’t count towards your commitments. Unfortunately, this is no longer the case and most lenders will factor in your full credit card limit, regardless of the current debt.
This tightening up of credit policy is being felt in all facets of lending. Simply cancelling or at least reducing the limit should allow an increase in your borrowing power. Remember, we want to reduce your commitment level for existing facilities so we can increase your potential borrowing. It’s always possible to revisit your credit cards later on anyway. Personal loans can also be consolidated to improve your borrowing power. I know that there are people out there advocating not consolidating your personal debt. I understand the rationale behind that. I want to keep in mind though that we want to increase our borrowing power. We want to borrow more. More equity equals more choice.
Personal loans invariably have a higher repayment per month than the equivalent mortgage loan. Loan calculators are designed to calculate the cost of your commitments against your income to determine whether you can service the proposed debt. This is not calculating the benefits of one type of loan over the other. To borrow more you have to reduce your monthly commitments. Simple as that.
Step 2. Maximise your income position
If you are self-employed, declare as much income as possible. I can hear the accountants and tax agents groaning already. However, your income is what allows you to borrow, not your tax deductions.
Lenders look for income and the bottom line is more important to your ability to convince a lender you can service your debts that the tax deductions. The benefits of borrowing more money may outweigh any extra tax payments if you can purchase another property or even be able to refinance away from high interest lenders. Income is critical.
Let’s not forget that rent is income too. How long is it since your rental properties have been reviewed: could they be increased? Maybe you could have six-month leases put in place next time instead of the usual 12 months. Rental properties are in short supply but there are plenty of tenants about. Perhaps this one small change could allow you to borrow more equity. If your managing agent doesn’t want to review the rent, try another agent.
Rent is also important when lenders calculate your borrowing power. Some lenders only allow 70% of its value while others will allow over 80%. It’s worthwhile investigating a lender that has a generous allowance for rent if you’re trying to extract the most equity from a property. The trade-off is likely to be a higher interest rate. However, we are concerned with getting out equity so it may be worth it in the short term.
Now comes the hard part. What should you take into consideration so that the lender will say yes!
Well, we definitely have to make sure there is equity in the first place. We need to have a reliable valuation to provide us with some certainty that equity will be available. Unfortunately, the days of getting your own favourable valuations then reassigning them to a lender are long gone. In nearly every case, lenders will demand their own valuations to verify the security.
Also, there is no doubt that some valuers are coming in below the market at present, reflecting the uncertainty about future values. It is still a good idea to meet the valuer on site, not to twist their arm, but to be available to answer any questions that may arise. Of course, pointing out the benefits of the property makes good sense too. Be realistic in your assessment, it will save some heartache later on. You should be aware that some lenders will allow valuations to be done upfront, at your expense obviously, which will help to decide your strategy. Lenders are entitled to be cautious and knowing this can be your best asset.
Given the turmoil in the finance market, and the constant changing of regulations and guidelines from the lenders, I recommend using a professional in the finance area to help you make the most efficient decisions and allow you to build your property investment safely and quickly.
A YIP reader recently wrote in and asked for advice about accessing equity. “I currently own two properties: my principal place of residence (PPOR) valued at $370,000 and the other valued at $200,000 renting for $150/wk. In total, we only owe the bank $105,000 as we have already fully paid off the second property. We’re planning to sell our PPOR and buy another house, where we’re expecting to pay around $550,000. I’m currently earning $75,000 a year and have no other debts. What is the maximum that I can borrow by accessing equity on these properties? Is it better to use the proceeds of selling the PPOR as a deposit for the next purchase or to use it to build a bigger house on the second property?”
“Naturally, I will have to make some allowances based on certain assumptions about your financial position as it has been presented.
The good news is you should be able to borrow almost $550,000 based on your income position. The rental yield could be reviewed if this hasn’t been done yet. Selling your home will release funds for the new purchase, minimising your borrowings. With the existing debt paid off by the sale, you will have around $265,000 to put towards the next home.
The only real benefit to selling the home is that you won’t pay CGT. If selling it was to release equity then you might be surprised to learn that you can borrow that equity. That way you can keep the property and take advantage of the natural growth in the property market.
One option would be to keep the existing home and turn it into a rental property, improving your income position by the rental income. This could allow borrowings up around $650,000, which easily covers the new purchase.
Remember though, that the borrowing for your new PPOR may not be tax deductible and you will be borrowing a higher amount so the repayments are going to be a lot more than if you sell. But this option allows you to have three properties potentially increasing in value, improving your overall wealth position, rather than merely two.
Lastly, your idea of building a bigger house on the investment property is certainly an option. I would investigate the equity growth achieved in that suburb over the last two property cycles, and the potential increase in rental yield by building a bigger house before I committed to that course of action. It could be that a simple renovation may achieve the same rental yields.”