When investors are searching for an investment property the last thing that most think about is ‘will the property qualify for finance’. They are too caught up in the property itself than to think about if the property is an acceptable risk to the Lender, or for that matter the mortgage insurer.
Mortgage insurance is something most of us have heard of but know little about. For borrowings above 80% Loan to Value Ratio (‘LVR’) the lender is required to have mortgage insurance. The higher the LVR so too the higher will be the mortgage insurance premium. The mortgage insurance does not protect the borrower, it only protects the Lender in the event that things go sour.
Lenders and particularly the mortgage insurers are risk adverse. A property is considered risky if the number crunchers sitting behind their desk feel:
the market value for that property may decrease over time
the loan amount may not be recovered in the event of a mortgagee sale
In fact in many circumstances it is the mortgage insurers who are responsible for loans being refused even after the Lender has provided conditional approval. So not inly do you need to satisfy the lender but you need to make sure that the property will satisfy the requirements of the mortgage insurer.
Let’s now look at what property characteristics and features the Lenders and mortgage insurers consider as risky.
1. Quality of the property
The security of the loan is the value of the property. If the property is in a poor state or has a potential to rapidly deteriorate (such as white ant infestation), then the lender will unlikely loan the money or at best at a lower LVR.
The property valuation report prepared by the valuer specifically comments on the condition of the property and any significant issues that may effect it.
So if the property is a renovators dream then you will need to make sure that you are only paying for land value as the valuer is unlikely to place much value on the house. This is a bigger risk with apartments where land value represents a lower portion of the total value.
2. Property size
Properties that are below 40 square meters in size are consider more difficult to sell in the short term. Even though they may show a good yield as an investment they are consider risky as they traditionally have a weaker capital growth than larger properties. Much of this has to do with minimal appeal to owner occupiers. But this is slowly changing as the affordability of larger dwellings decreases and the appeal of small units increases.
3. Change in Zoning or Classification
A change in the zoning or classification of property by a government authority can reduce the value of the property.
Adverse Zoning – a property may be situated in an area that allows for high density apartment developments up to 6 storeys to be constructed. But local council may change the zoning to low density residential which allows only a single dwelling to be erected. Or the Department of Main Roads may have listed the property as part of a series of properties for future road expansion.
Adverse Classification – a property may have redevelopment potential but a heritage order may be placed on the property which prevents any redevelopment to maximise the properties potential. Or a low rental protection order on a block of apartments or boarding house to prevent the redevelopment and subsequent increase in rent for the properties.
4. Intended usage of the property
This may affect the potential resale value of the property.
For example serviced apartments which can not be leased out to long term tenants or owner occupied. This means that the potential selling market is limited and effected by the commercial agreement in place for the property.
5. Market segment events
This is when particular events in the property market have a negative impact on the potential resale value.
An example of this is when the Lender or mortgage insurer believes that there is an oversupply of properties being built in an area. The Docklands and CBD in Melbourne and until recent years Ultimo and Surry Hills in Sydney are considered high risk areas by mortgage insurers who refuse to provide insurance for apartments in these areas.