When it comes to obtaining finance, choosing the right lender is just as important as choosing the right loan. Rob Williams reveals tips on how to pick the right lender to borrow from.
A sound strategy and a clear plan are essential to a successful outcome when it comes to property investment. The big ticket items such as the type of property, location, method of gearing (positive, neutral or negative), ownership structure, how frequently to purchase, the number of total purchases and initial loan to value ratio are all examples of the strategic decisions that need to be made when embarking on the property investment journey.
One aspect of property investment that doesn’t seem to get a lot of attention when it comes to developing a strategy is choosing a lender. Yet this is crucial to developing a strategy that will enable you to grow your portfolio.
How to choose the right lender
The first questions most people ask when it comes to choosing a lender and a loan are ‘what’s the interest rate?’ and ‘will I meet the serviceability criteria?’ Choosing a lender based on either criteria alone can, potentially, be a serious strategic mistake.
An investor will have a much better chance of avoiding – or at least delaying – hitting the serviceability wall if they enlist a strategy whereby they have a greater number of finance options available to them as their property portfolio grows. Serviceability becomes more of an issue as a property portfolio grows and having too many loans with one lender will become a significant roadblock that can be extremely difficult, time consuming, stressful and expensive to overcome. There are two reasons for this. Firstly, banks have internal policies restricting the amount of exposure they are willing to risk with an individual borrower. Secondly, banks apply a ‘loaded’ assessment rate to all loans you have with them, effectively reducing the applicant’s serviceability.
From a strategic point of view, it would, arguably, be better to try to obtain finance from the lender with the harshest service model, even if it means reducing some credit card limits and retiring some consumer debt. That way, there are more options for the next deal. Borrowing from the lender with the least restrictive service models first can mean you paint yourself into a corner over time by leaving you with only the most restrictive banks from which to choose. In effect, this can be a roadblock to further growth and a mistake many investors make, not realising they have done so until they seek finance for a great opportunity they have found, only to have the application declined.
How do banks assess serviceability?
The service models used to determine a borrower’s eligibility vary greatly among lenders. It’s important to have an understanding of the mechanisms behind the various service models in order to be able to work them to your advantage. Property investment is a game. A game with rules. And the only way to be successful at any game is to learn the rules and work out how to use them to your advantage.
Living expense scales, for example, used by banks to estimate individual or family living expenses vary between lenders. When someone tells you that XYZ Bank has the best service model, it is worth clarifying for whom they have the best service model. One bank may have a very conservative living expense scale for singles while having a more generous one for married couples.
Individual circumstances can make it difficult to compare service models between banks. To add to the confusion, some of the major banks will assess loan applications using a loan structure that isn’t the same as the loan product being applied for.
A loan application with CBA might be for an interest-only loan, however, they may assess serviceability based on a principal & interest loan to be repaid in full over 25 years. Once again, this may not make a huge difference early in an investor’s property buying career, but over time, as serviceability becomes more of an issue due to the number of loans being serviced, it will become a major factor in a loan application being approved or declined.
Watch those credit card limits
I’m a big fan of the judicious use of credit cards. They smooth out cash flow peaks and troughs and some offer great award schemes. I use mine for personal and investment expenses and have accumulated enough award points to fly me, return business class, to New York. Credit cards can be a very useful tool when used appropriately.
The renovation projects I undertake require a decent sized credit limit to fund the purchase of high-value items such as air conditioners ($2,000), stoves ($800) and floor coverings ($2,500). That credit limit is a double-edged sword, though. Each multiple of $5,000 credit limit I have costs me around $25,000 in borrowing power.
Even if your credit card is paid in full at the end of each month and you’ve never paid a cent in interest on it, that card will impede your borrowing capacity significantly if it has a high credit limit. The banks are only interested in the credit limit, not your repayment pattern, unless, of course, you’ve ever been in default. Then they become very interested.
This is another example of an issue that flies under the radar in the early stages of an individual’s investment journey. While there is a serviceability buffer from PAYG and rental income alone, issues like credit card limits factor into the equation behind the scenes, and go unnoticed.
If you’re applying for a $300,000 loan and are assessed as being able to service that loan, even with a $10,000 credit card limit, you won’t become aware of the impact the card limit has on your serviceability. When applying for the next loan, however, it may be declined simply because serviceability is borderline and the credit card limit is the major factor in not getting it over the line.
TIP: If you’re discussing serviceability with a bank or broker and not quite meeting the criteria of the service model, then it’s worth asking what difference a reduction in credit card limits will make. The result can be surprising.
Cross-collaterisation will impact your borrowing power
An interesting situation arises when multiple loans are held with the same lender and it relates to the way in which banks apply an assessment rate in assessing loan serviceability. For example, if the bank’s current variable rate is, say 5.85%, a new loan application may be assessed using an assessment rate of anywhere between 7% and 9%.
This can be problematic when applying for a loan with a bank with which other loans are also held. This is because they will apply this assessment rate to all loans held with them in assessing serviceability for the new loan.
In an ironic twist, though, banks don’t apply their own assessment rate to loans held with other banks. If a bank won’t approve a loan and you hold one or more loans with that bank, then it could be as a result of the application of the assessment rate to those loans.
One way to avoid this situation is to keep to a minimum the number of loans with any single bank. For example, having two loans with Bank A, three loans with Bank B and another with Bank C may mean that a loan which may not meet the service model of Bank A, due to the loans already with Bank A, could be approved by Bank B or Bank C.
Your next move
Knowing the rules of the game and the mechanisms behind the loan serviceability ‘black box’ should make it easier to get loan applications over the line with banks that have harsh serviceability models, whether dealing direct with the bank or dealing with a good mortgage strategist or broker.
From a strategic viewpoint, it’s far better to make the necessary changes and put in the extra effort to get a loan approved with a strict service model bank so that less restrictive banks remain available as options as the portfolio grows and serviceability diminishes. Choosing a lender is a little like a game of chess in that you have to think many moves ahead, rather than just signing up with the first lender who will approve a loan application. By the time problems with the strategy become evident, it is often too difficult, too expensive or simply not possible to correct them.
A good mortgage strategist is always up to date with the various banks’ service models and lending criteria, which can be an invaluable asset when it comes to formulating and executing a sound strategy to move forward with a property accumulation plan. Any broker can get you a loan, but savvy investors understand the need to work in partnership with a broker who plans many moves in advance.
Rob Williams is a runner up of the Inaugural Your Investment Property Investor of the Year Awards. He’s a passionate investor who currently holds and manages a property portfolio worth more than $2.3m
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