1. Using a single lender to fund your portfolio
Many investors have all their finance through one lender because it’s less paper work, they have a relationship with them and even loyalty. But unfortunately in 99% of cases the more loyalty you have by giving the lender your business the more disadvantaged you become.
Borrowing Capacity is reduced – You’re considered a higher risk
The way Lenders see it, the more you borrow, the higher their total risk exposure, so they will reduce the total leverage that you have. For example, you may be able to borrow 95% against the property portfolio value up to $350,000, 90% up to $750,000, 85% up to $1million, 80% up to $1.5 million and so forth.
Borrowing Capacity is reduced – your serviceability is penalised
Your borrowing capacity is also reduced because when a Lender assesses your borrowing capacity it applies an inflated interest rate to take account of interest rates rising. This inflated interest rate is around 3% above the normal interest rate.
For example, if you want to borrow a further $350,000 and you already have loans of say $500,000 with that lender at an interest rate of say 8% then the lender will access your ability to service the loan by adding the $350,000 & $500,000 together and then apply the inflated interest rate of 11% (being 8% + 3%). This means you are assessed on a total interest repayment of $93,500 pa.
Alternatively if you went to another lender they would usually apply the inflated interest rate (11%) to the amount that you actually want to borrow, in this case being $350,000 and use the actual amount (8%) that you are paying on your existing loan of $500,000. So the total interest that you have to service for assessment purposes is $350,000 x 11% plus $500,000 x 8% = $78,500. So your serviceability is in fact better off by $15,000 (being $93,500 - $78,500). This is a whopping $1,250 per month.
Lenders can bypass your entities to take possession of the properties you offer them as security, but not necessarily have the same power over properties from different lenders depending on how you structure it. Having everything with one lender could potentially destroy your whole portfolio if something goes wrong.
2. Cross-collateralising securities
This refers to providing a lender with security over more than one property.
This can cause enormous problems when the properties increase in value and you want to release some of that newly created equity. The lender has your assets tied up so if you want to go to another lender that is offering a better deal, the current lender may not partially discharge their mortgage to allow you to refinance the property or may require you to refinance the entire portfolio which can be very expensive and time consuming. It also gives the lender an upper hand when trying to negotiate if they feel that you are unlikely to take your business elsewhere. This is common when the loans are long term fixed interest loans and the exit costs are usually very high.
If you are having financial problems and you wish to sell part of the portfolio to solve it, the lender may call in their loans which means selling all the properties in a manner which may be detrimental to you. You may try and refinance the total portfolio but it would be harder to do given your unfavourable financial position. If the portfolio was with different lenders you are more likely to sell some of the properties to improve your position in a manner which is more beneficial to your needs and not to the needs of the lender.
3. Mixing properties with different risk profiles
A typical cross-collateralising property is using residential property as security to purchase a commercial property. Lenders can easily recall loans for commercial (including retail and industrial) properties if the value of the commercial property drops significantly. If you don’t have enough equity to cover it, you could end up losing the residential property used as security for the commercial property. This exposes your residential property portfolio to the more volatile commercial property market.
4. Mixing properties with different leverage profiles
Mixing properties with different leverage capacity could greatly reduce your total leverage capacity.
As a general rule, the higher the lenders perceived risk for a property, the less leverage the lender is willing to offer.
The following are typical examples of different leverage profiles:
Residential – 90%
Vacant land – 70%
Commercial – 60%
Rural – 50%
5. Fixing interest rates
‘To fix or not to fix that is the question’…Unfortunately too many people don’t understand the implications of making the wrong choice. Fixed interest loans are great for investors that want certainty about their cash flow or want to lock in a favourable interest rate during a rising interest market.
If you intend to sell, refinance or want to retain the freedom to do so, then fixed interest loans may not be a good idea because the break costs may be significant. This may adversely effect your situation down the track. Lenders love them because it sures-up the borrower for a set period and reducers the likelihood of borrowers refinancing during this period.
Do your research and understand the full costs associated with breaking the loan early if you chose to fix now or the fixed interest rate profile of the lender if you decide to fix in the future and select a lender that best fits your strategy.
6. No business plan
Lenders see lending money for property investing as a low risk business. So too property investors should treat investing in property as a dynamic business and not just a passive investment.
No one plans to fail…they just fail to plan..!
Like any successful business, an investor should prepare a detailed business plan detailing the strategy to grow their property portfolio, the finance that is required to achieve this and a cash flow analysis of how the debt and other costs are to be serviced. It is well worth the cost to seek professional advice and assistance in preparing the business plan from an accountant or financial advisor that is an experienced property investor and knows what the lender is looking for.
7. Preliminary valuation
Not all properties offer the same level of security in the eyes of the lender. Just because you paid a certain price for the property doesn’t mean that the lender will accept this as the security value.
It is prudent to obtain a valuation from a valuer that is on the panel of valuers used by your lender to verify the security value of the property before the sale contract becomes binding.
This was evident in the Ultimo precinct in Sydney during the late 1990’s and more recently the outer west belt, on the south east coast of Queensland (mainly due to marketeers) and more recently in the Melbourne Docklands and CBD precincts. To add salt to the wound, property marketeers were adding tens of thousands to the cost of property in 2 tier marketing or outrageous fees which inflated the contract price.
As a result the security value of the properties were discounted between 10% to 30% which meant that investors were required to provide the shortfall. If they didn’t have sufficient equity available in other properties or available funds then they weren’t able to settle and lost there deposit and were liable for any shortfall in the price that the vendor eventually sold the property for and the original contract price as well as penalty interest. For many people this amounted to hundred’s of thousands of dollars. People also lost there homes as a result of this which could have been avoided if they had paid a few hundred dollars for a valuation.
Keep in mind that generally lenders and more so mortgage insurers assess the quality of property as security in the context of a ‘fire sale’ rather than a normal market. SO if there is an abundance of supply in an unproven area then this is an indicator that the security may be compromised.
8. Regularly review your security
Giving too much security to lenders can greatly restrict your investment potential. As discussed in item 1 above.
As far as lenders are concerned there is never too much security. Have you ever heard of a lender freely giving back security because they have too much? Neither have I.
It’s interesting that people with shares on the stock market or funds under management will regularly, if not daily check the price. But when it comes to property most investors just set and forget about it until they need more money and more often than not they need it in a hurry which means they usually accept what’s on offer from their lender. The fact the lender holds security over the properties means it is often too difficult to refinance to a better deal.
A better approach would be to review the property values each year then have them revalued with the bank when ever there is a reasonable increase of around 7%. Over time the investor will be able to remove the security from their own home or from one of the investment properties.
Let’s see how it works. Say an investor has 4 properties valued at $350,000 each and debt of $350,000 each totalling $1,400,000 of which 90% of the loan is secured against the investment properties and the balance is secured against the family home. Now assume that they have risen in value by 10% per year over 5 years. This equates to about $213,000 per property giving a total of value per property of $563,000 each.
If the total debt to the bank is $1,400,000 and the new value of 3 of the properties is $1,689,000 then there is enough equity from the 3 properties to remove the security from the family home and the fourth investment property with a 20% leveraged loan meaning no mortgage insurance.
9. No Line of Credit or Redraw Facility
Focus on the positives but be prepared for the negatives..!
Unfortunately too few investors heed this advice. They may have $1 million worth of debt but they have done nothing to ensure that their cash flow is protected if times get tough. Things like loosing your job, getting divorced or having a baby may dramatically change your cash flow and ability to repay the loan. This more often then not results in incredible emotional and financial stress and the unfortunate ‘fire sale’ of properties.
What about if the investor had say $200,000 cash readily available to them, wouldn’t that change things? You can hold off until you find a new job, or get back into the work force after having the baby, buy out your partners share in the property as part of the settlement. Or, it may allow you to sell down your property portfolio to a more sustainable level in a manner that achieves the best price or to delay the sale until the market has improved.
This is easily achieved by establishing a Line Of Credit or a Redraw Facility when you take out the property loan. This can be created using the equity in your own home or by using the equity in the investment properties when they increase in value.
Because you only pay interest when you actually draw down the money and a minimal annual fee for the facility, it is a great way to give yourself peace of mind.
Don’t have equity but you do have a 20% deposit? Rather then try and save mortgage insurance by borrowing 80%, an investor may be better off providing a 10% deposit with a 90% loan and pay the remaining 10% into the loan which has a redraw facility. That way the investor can draw on the 10% whenever they need to whilst also saving interest on the loan. This provides a financial contingency plan for a minimal cost because the benefits of this safety net far outweigh the costs involved especially when you consider that mortgage insurance is a tax deduction.
10. Shop around & mortgage brokers
Why do many investors spend more time shopping around to save 2c a litre on petrol or $200 on a plasma TV but won’t take the time to properly investigate the best mortgage product for their needs which could save them tens of thousands of dollars?
As a property investor, you need to have someone representing your interests and to provide you with the best options. An experienced mortgage broker who actively invests in property are in a much better position to provide a rang of suitable mortgage options, as most of them have access to a huge range of lenders.
A mortgage broker works for the investor and not the lender and most lenders pay the similar remuneration. So it is in the interest of the mortgage broker to do the right thing by the investor to encourage more business and referrals.
You should also review your financial situation every year to see if there are better loan products and deals available. Your mortgage broker is more likely to actively seek a better deal for you because he gets an up front fee from the lender as well as maintains the income stream he receives from the loan for as long as you remain his client.
11. Shopping for convenience—not expertise
Most successful property investors have a successful team around them which includes an experienced lender or mortgage broker that has expertise in the property investing industry. They need to be able to do more than just show you how to fill out a form. They should contribute to your long term strategy and provide expert advice so that you obtain the best suited products and advise to help achieve your goals.
Look for someone that specialises in property investment loans and has a successful client base because this is a marvellous source of experience and knowledge which they can utilise when advising you.
12. Selling for the wrong reason
All too often investors sell for the wrong reason because they failed to obtain the right advise from an experienced expert.
Which one of the following phrases which all of us have heard at one time or another is the successful property investor…
a) ‘if only I hadn’t have sold, what would it be worth now?’ or
b) ‘never, ever sell…’
Yep, b) is the right answer. So there must be some truth in the sayings.
Let’s have a look at the most common reasons people sell and how the right loan can help avoid selling
To get access to the equity
You can obtain up to 90% of the equity by simply setting up a line Of Credit facility with the lender. Yes you will pay interest on the money that you draw down but you will not be liable for any tax and you will still be earning capital growth on the property. On the other hand if the property was sold there would be selling costs, agents fees, capital gains tax, legal costs etc. which are more likely to outweigh the interest costs and capital gains of not selling the property.
To buy another property
So long as you can service the loan payments then you don’t need to sell the property in order to buy another property. Just borrow 90% against the new property and use the current property to raise the 10% deposit through a line of credit or draw down facility. If you are using the same lender then you need only provide collateral security to the lender over both properties.
Down turn in the Market
Inexperienced investors are easily spooked into selling because they fear what will happen if the property market ‘crashes’. I often say to my clients ‘ if interest rates haven’t gone up and the rent hasn’t gone down then all things being equal wouldn’t your the cash flow from the property be the same?’ The obvious answer is yes. So why sell?
Even more importantly, why would you sell in a falling market when you will obviously receive a lower price then if you held on till it was a rising market in which case you’ll won’t want to sell because of the growth in the equity.
The fundamental rule is that losses are only realised when you actually sell along with all the future capital gains that the property will earn.
Interest rate rise
13. Borrowing less to avoid mortgage insurance
Mortgage insurance is basically a tax deductible cost of doing business.
It is for the benefit of protecting the lender and not the borrower. It applies when a lender loans more than 80% of the value of the property. The higher the loan to value ratio (‘LVR’) then the higher is the insurance premium.
If you take into account the principal of leveraging then the money that you would have otherwise put into the deposit could be used to purchase another property which may earn you tens of thousands of dollars in capital growth over many years. So to save a few thousand dollars in the short term could actually cost you hundreds of thousands of dollars in the long term.
If you have limited funds available to buy more properties it may be better that you borrow 90% LVR and pay the mortgage insurance. You can include it in the loan so that you repay over the life of the loan which can assist your cash flow.
Be aware that some Lenders will refund a portion of the mortgage insurance premium if done within the first 12 or 18 months. So if you could add say 10% to the value of the property and have it revalued by the bank, you can then claim a refund of the mortgage insurance. Be sure to raise this feature with the Lender as they do not readily volunteer this information.
14. Buying ‘off the plan’
There are many benefits of buying off the plan including making significant capital gains before you need to settle on the property. But the major risk is things may change over time in your own ability to obtain finance to settle on the property when it is complete. Also, if the value of the property actually goes down then how will you afford to make up the shortfall in the deposit which is required.
Make sure that you seek the advice from an experienced mortgage broker to assess all the risks and that you have a plan to deal with them all. If you can’t then don’t do it.
Using Deposit Bonds or Bank Guarantees are great if used correctly but make sure that you are able to qualify for a loan at higher then current interest rates. Many investors who purchased off the plan when interest rates were 6.1% were unable to qualify for the same loan amount when the property had completed 4 years later and interest rates had risen to 8%.
15. Finance clause in purchase contract
It is prudent and good business practice to include a finance clause when you sign a contract of sale. This will enable you to get out of the contract if for some unforseen reason you have a problem with the conditional loan approval becoming unconditional.
Investors often accept conditional loans as sufficient when they sign contracts of sale which is very dangerous because often these are conditional upon valuation, income verification, credit reference check etc. So there are many things which may go wrong and it could cost you your deposit.
If the vendor resists this clause then make sure that you have a loan approval which is conditional only on the valuation and have the valuer complete a valuation prior to or during the cooling off period.
If you are buying at an auction, it is unlikely that you’ll be able to get a conditional contract or do a valuation for each auction that you attend. But it would be prudent to make sure that you do your home work and get the advice from your experienced lender or broker.
16. Don’t allow enough time it to arrange finance
A normal finance application usually takes between 5 and 7 weeks given that everything is normal. As soon as there is a complication then it could add weeks to the time frame. I had a rather complex finance deal which took up to 3 months to get the funds and it was through a major bank using a very experienced mortgage broker. On the other hand I had a bigger deal take only 7 days using the same mortgage broker but a smaller lender.
So it is so very important to have your finance organised and conditional upon valuation before you start to seriously look for a property.
Experienced investors know exactly how much they can borrow and have the funds ready to go as soon as they find the property. That way they can act quickly and have the confidence to favourable settlement terms to win the deal.
17. See the lender after they’ve found the property
This is one of the biggest and most common mistakes made by inexperienced investors. By the time they see the mortgage broker they’re on the back foot desperately trying to get finance before the contract settles which often means going to the lender that is most likely to meet the time line.
Instead the investor should be meeting with the mortgage broker well in advance of finding a property to develop a relationship of understanding and to work on a finance strategy that will achieve the investor’s goals. There would be sufficient time to select the most suitable loan products for the investors needs.
18. Excessive credit reference inquiries by Lenders
When ever a Lender assesses your application it makes reference to a data base which lists all the dealings and any problems you have had regarding credit. This is your credit rating and is referred to as CRA (Credit Reference Association). The CRA doesn’t list whether you actually obtained the loan but rather that you have made an application for the loan. Every time your CRA gets checked, it may be interpreted by other Lending institutions that you are ‘shopping the deal around’ or ‘you have a credit problem’. Here are a few suggestions to help minimise this:
Do not allow the Lender to do a credit reference check unless they have provided you with an irrevocable letter of offer and you have accepted it.
Your credit rating should only be checked once you accept the offer.
Pre-empt the financier by advising that your CRA is regularly checked due to the fact that you are always ‘doing deals’.
It’s in your best interest to ensure that there is nothing on your CRA that will hinder your ability to secure finance. So get a copy and review it. If there is a problem then investigate it and substantiate the reason. Then bring it to the attention of the Lender and include supporting documents in your proposal folder.
There are new laws coming into play which will effect how the CRA will be used in the future and with the Privacy Laws that have been put into place to limit the time period that information can be listed on the CRA, a borrower can now get
away from a poor credit history.