Correctly structuring your loan

 1. The importance of correctly structured loan

A poorly structured loan portfolio reduces your flexibility, increases your risk profile and can create reporting and tax nightmares. This problems include:

arrow-orange   Flexibility—a poorly structured loan portfolio reduces flexibility though cross-securitisation. This reduces your ability to freely use other lenders because your lender has control over your properties.

arrow-orange   Risk management – a poorly structure portfolio may not separate home and investment lending and may provide Lenders with too much security.

arrow-orange   Reporting – a poorly structured loan portfolio will not adequately separate tax deductible and non-deductible expenses which could mean loosing out on deductions or worse still, being caught out by the tax man for over claiming your deductions. arrow-up4.jpg


2. Avoid Cross-securitisation/collateralisation

This is where the Lender has security over more then one property.

This may not pose many problems to investors who own one investment property.

However, if you plan to build a portfolio consisting of many properties, you need to have the flexibility to source other Lenders who may have better products in a cost effectively manner but this could be hampered if all your properties are tied up with a single Lender. It may also have the effect of limiting you from achieving your maximum borrowing potential.

I’ll now show you how to avoid cross securitisation.

Step 1

Set up a Redraw or a Line Of Credit facility (“LOC”), so that you can quickly and easily access the equity in the property to pay the deposit when you find a suitable investment property. This is done by setting up a separate loan secured by the existing home.

At the same time, make sure that you arrange pre-approval for the maximum loan amount so that you know how much you have to spend when looking for the investment property.

Step 2

You can now use the LOC to pay for the 10% deposit to secure the investment property purchase.

Step 3

Now use the new investment property as stand alone security for the new investment loan. Depending on your strategy, you can obtain either an 80% or 90% loan.

What’s the benefits you ask?  

My preferred strategy is to use the 80% LVR loan scenario. The thousands saved on the mortgage insurance can go towards improving the value of the new property and with the advent of time before you know it the new property will have increased by 10% in value. Once this happens have the property revalued and repay the 10% from the LOC using funds obtained from the new property.  

Step 4

Repeat the process again by buying another property. You can either wait till you’ve refinanced the new property or use the LOC facility if there are sufficient funds available. Make sure that you leave adequate funds for a rainy day in the LOC facility.

Remember, it’s in your interest to have the finance structure and long term plan in place before you take action. Work with the mortgage broker or Lender to ensure that they are on side and as eager as you to make this work. That way their will be fewer disappointments and greater opportunities.

Step 5

As this process continues over time and by adding value to the properties before too long you will be able to revalue the investment properties and draw out the equity to repay the LOC facility against your own home.

Congratulations, you’ve now achieved loans that are secured against the respective stand alone properties only.  arrow-up4.jpg


3. Fixing a bad structure

i)  How to fix a bad loan structure

Being informed is the best weapon to making sure the Lender does what you want them to do.

A bad structure is one that has cross-securitisation and perhaps a lack of separation between debts (i.e. it’s difficult to identify what debt relates to what property).

Often unwinding a debt structure can be difficult. There is little incentive for the Lender to change your loan structure because a bad loan structure is generally good for the Lender because it provides them with better security and ties you to them. Furthermore, often there is no incentive for the staff member to help you.

Combine these two factors and you’re likely to experience some ‘push back’ when you ask to uncross-securitise you loans. Unfortunately, the only way to deal with this issue is to threaten to take you business elsewhere.  But before you threaten this, make sure that you have another Lender or Lenders and that the restructuring will be beneficial.

In this situations it is well worth employing the expertise of an experienced mortgage broker because they will bend over backwards to come up with a better deal and are more likely to use different lenders if it achieves the result you want. Also, an experienced mortgage broker is often in a great position to provide sound advice in respect to the ideal mortgage structure to achieve the desired result.

Generally, fixing a bad structure involves changing/splitting a few loans. Often professional packages will allow you to do this at no (or very little) cost.

The important thing is to structure your portfolio so that you can identify what debt relates to which property and to avoid cross-securitisation. If in doubt, then seek independent advice form a knowledgeable professional.

It may not be possible to undertake any restructures while your loan interest rate is fixed. The reason for this is that altering a loan’s structure may trigger significant break fees. Therefore, you may have to wait until your fixed rates expire before optimising your structure.

ii)  Professional Packages

One of benefits of professional packages is that many of them allow customers to apply for a number (sometimes unlimited) of separate mortgages without any extra upfront or ongoing fees.

These packages are perfect from a loan structuring perspective because they allow the customer to set up the optimal structure for each property. However, if you cannot benefit from professional packages for what ever reason then you should weigh up the costs and benefits of restructuring your loans with various lenders to achieve the optimal structure.

iii) Minimising Mortgage Insurance

The cost of mortgage insurance is dependent on the loan amount and the loan-to-value ratio (LVR). The higher the LVR and the larger the loan amount, the more costly mortgage insurance can be. However, this cost can be minimised by structuring individual loans so that they do not exceed 80% LVR. A good way to do this is to use a LOC or redraw facility against your home and/or other properties to fund the 20% deposit making sure that the LVR for these properties do not exceed 80%. As soon the new property increases in value by 10% have it revalued and draw the equity from it to repay the 10% used from the other properties. Now the new property has stand alone security with no mortgage insurance being paid and an LVR of 90% of the purchase price.  

If you don’t have sufficient equity in other properties then you’ll have to bite the bullet and pay it. You can include in the cost of the loan and repay it over the life of the loan which will assist your cash flow. It’s important to note that the cost of mortgage insurance can vary greatly between Lenders so if it’s worth shopping around.

Another point to keep in the back of your mind is that the mortgage insurers may offer you a partial refund of mortgage insurance if your LVR reduces to 80% or less within 12 to 18 months. All you need to do is reset the loan term and ask your Lender to apply for a mortgage insurance refund. arrow-up4.jpg


4. Other Issues about Loan structure

i) Excess Security

There is no benefit in offering lenders any more security than they need. That is why it’s important to review your loan to value ratio on a regular basis to determine if the bank still requires all the security they hold.

The rule of thumb is to aim to maintain an LVR as close to 80% as possible. If the LVR reduces significantly, then consider requesting the Lender to release a property as security.

ii) Interest Only versus Principal and Interest

Most variable interest only products allow unlimited extra repayments on a regular basis. Its’ a common misconception that repayments on an ‘interest-only’ loan are limited to interest only. This is generally not true. Therefore a borrower can elect interest only and repay either interest only or principal and interest.

Any principal repayments made during an interest-only term are generally classified as extra repayment. In most cases the extra repayments can be redrawn at any time, the borrower can always redraw the loan back up to its original limit.

iii) Borrowing Capacity

Borrowing capacities can vary greatly amongst Lenders. Therefore, it’s advantageous to have a flexible loan structure to allow you to draw the required deposit from your existing lender using LOC or Redraw facility and use another Lender to finance the remaining amount of the property.

iv) Different Lenders

Some people recommend investors use a number of different Lenders. One of the main reasons being that if you have all your lending with one Lender and something goes wrong then the Lender is in a powerful position as it holds all the mortgages over your properties which minimises your ability to restructure yourself out of the problem.

However, one benefit of consolidating your loans with one Lender is that you may be able to negotiate better deals if you have a significant loan portfolio. Generally, interest rate discounts level out at around $500,000 to $750,000. Therefore perhaps consider moving to another Lender when your borrowings reach this level.

Another tip is to use a different Lender for your home and investment borrowings.

v) Interest Only Offset

Consider the future use of your properties. A good way to increase your level of borrowing is to have an interest only mortgage with an offset account for home property. In this case you repay interest only which means that you have more funds available to repay another loan. However, while you’re living in the property you continue adding monies into the offset account. The critical point is that you’re never actually ‘repaying’ the loan and you have funds available to buy more investment properties but the interest you pay is the same as though you had a principal and interest loan.

vi) It’s all about the future

If you’re a more serious investor and plan to build a significant property portfolio, then thinking about your loan structure from the beginning may save you a lot of heartache and unnecessary expense down the track. It’s like taking a trip across Australia without a road map showing you how to get there and sufficient provisions to enable you to make the journey.

Seek the advice of experienced and qualified experts who own and specialise in investment properties. Having a good mortgage broker is the first step to building a successful property portfolio.

Always, have your pre-approved finance which is subject to valuation only before you actively start looking to purchase properties. A conditional loan approval usually lasts for 3 months before having to renew it.