If you’ve been feeling a little lost amid the ever-changing lending policies, take heart. You’re not alone. And you’re not without options. There are finance strategies to help you deal with tighter lending policies by the banks.
Despite the seemingly harsh moves by the banks recently, it’s worth remembering that mortgages are still their bread and butter.
This means they are still willing to lend to investors.
However, the banks are also under a lot of pressure from the regulators to clamp down on investment lending. So they’re obliged to put in place measures to comply with APRA’s directive to keep their banking licence.
They have to tighten their lending policies. Even raising interest rates on investor loans to rein in investor demand.
So how should you deal with the current tighter lending?
Finance Strategy #1: Weigh the merits of converting from Interest Only to Principal & Interest (P&I)
With the banks raising their rates on Interest Only loans by around 0.35%, it may be worth switching to Principal & Interest as we’ve suggested in our recent article on the counterintuitive strategies to consider now.
Schulze points out that there’s no right or wrong move. However, you need to consider a couple of things before switching.
“If you switch to P&I, you’d be paying principal on your loan, which will reduce the long term tax benefits associated with that investment property,” says Schulze.
There’s also the issue of cash flow. Because your repayments are higher, your cash flow may suffer, which could result in financial difficulty down the line.
“If you end up converting your investment loan to P&I, your higher repayments will bite into your cash flow each week. This will reduce your ability to pay down your bad debts which will not give you a good long-term outcome,” says Schulze.
So when should you consider switching to P&I repayments?
Before switching to P&I, consider taking the following steps.
Calculate and compare the repayments on the higher rate on the Interest Only loan against the lower rate on Principal & Interest.
If the difference is relatively small and you’re comfortable doing that, then you may want to go P&I according to Schulze.
“The benefit of converting to P&I right now is that you’re going to get a lower interest rate,” says Schulze.
Look at your current level of non-tax deductible debts.
If you have a high level of bad debts that are non-tax deductible, Schulze recommends that you focus on paying them down as a first priority.
This means that you keep your investor loan on Interest Only. That’s unless the P&I repayment is only slightly above the Interest Only repayment, in which case, it might make sense to switch P&I.
“I’ll only recommend P&I to investors who have a low level of bad debts such as personal loans or mortgages on their owner occupied home,” she says.
“I would never have previously recommended P&I to anyone that has any level of bad debt because they should be focusing on that and then tackle the Interest Only loan once that’s done.
“But now, things have changed. Some investors may have a really strong cash flow and have a small mortgage on their home. It’s starting to make sense because you’re saving 30-40 basis points on the interest rate.”
Finance Strategy #2: Beware of using redraw to reduce your loan
One reader wrote in to ask whether it’s smart to pay extra to the investment loan using the redraw facility.
In Schulze’s view, this is not a good idea.
“It’s not advisable to put redraw on the Interest Only loan because it’s going to impact the tax deductibility of the loan if you redraw money out of it,” says Schulze.
“I would never recommend that you use redraw in an investment loan. That’s because if you redraw money out and use it for other things than investment, then the loan won’t be 100% tax deductible anymore. If you get audited, you’ll be in trouble.”
In this case, it may be worth exploring a P&I structure if you want to lower your loan.
Finance Strategy #3: Embrace a lower LVR
Another hot button issue is whether you should lower your overall loan to value ratio when borrowing.
Schulze explains that this move doesn’t make sense for some investors.
“It doesn’t make sense to lower your LVR drastically from a leverage perspective,” she says. “One of the great benefits of investing in property is the ability to leverage. You should maximise it as much as you can.”
However, Schulze concedes that from a finance point of view, a lower loan to value ratio will make it easier for you to secure a loan and even get a better mortgage rate.
“You’ll be more attractive to the banks if you have a lower LVR and you will be able to attract a more competitive interest rate as well,” she explains.
But how low should you go?
From an investment perspective, a higher LVR is still a smart strategy according to Schulze.
However, with APRA leaning on heavily on the banks, the ultra-high LVR loans are becoming scarce.
“Even at 90% LVR, you have very limited choices and you’re getting an expensive interest rate at that level,” says Schulze.
As such she believes the sweet spot is 80% LVR and under.
“If you can keep it at 80% LVR, that’s the ideal mark,” says Schulze. “If you have to borrow at 90% LVR, you still can. However, you’ll have fewer options as more lenders are going to move away from this space in the coming months.”
Schulze also points out that a high LVR loan such as 90% now requires a principal and interest repayment.
So not only that you’re paying a higher interest rate, you’re also getting slammed with an even higher repayment as you pay the principal component as well.
“I think 80% LVR is ideal. However, if it means getting into the market now at 90% LVR vs having to wait 2 years to get to 80% LVR, then there’s a merit to getting in now at 90%.
But you need to make sure you’re buying good quality assets that will go up in value,” advises Schulze.
Finance strategy #4: Consider non-banks as an alternative
As the major banks grapple with heavy lending regulations from APRA, it could be worth looking at the non-banks as an option.
Non-banks are non authorised deposit-taking institutions or non-ADIs) and therefore, they are not covered by the recent APRA rules directed to the big banks (authorised deposit-taking institutions or ADIs).
The RBA website explains that non-banks (Non-ADIs) are not prudently regulated by APRA, but they are required to meet disclosure, licensing and conduct requirements that ASIC administers in respect of all financial companies.
Schulze explains that they’re worth considering if you’re unable to get any more loans from the banks.
“We’ve got non-ADIs in our panel. Generally, we find that they’re more flexible. As such, they’re more attractive for investors where the servicing is tight and we need to go a bit outside the box.
“I’d say there’s been a very big uptake for non-bank lenders because of all these changes. I think investors need to be open minded when it comes to lenders.”
Finance Strategy #5: Choose your broker wisely
With all these changes happening in the mortgage market, it’s important to work with someone who is experienced, knowledgeable and independent.
“Make sure you have the right mortgage broker working for you,” advises Schulze. “It’s impossible to stay across all lending. You also need to make sure you work with a really good mortgage broker with a broad panel of lenders.”
Schulze’s Top Insider Tips
- Always maximise your borrowing capacity.
- Keep a clean credit file. Don’t do too many inquiries.
- As an investor, look at properties with good rental return. You need to have a good cash flow coming from the property because servicing is now harder.
- Beware of brokers that are owned by a bank because their panel is limited.
What to expect over the near and medium term
Unfortunately, there’s more pain ahead for investors as lending becomes even tighter.
Schulze expects more banks to tighten their policies by lowering their LVR requirements and raising rates on investor loans.
“The recent move by AMP to cut the LVR to 50% on their investment loans is just the beginning,” says Schulze.
“I think more lenders will follow suit. I think we’re going to see a lot of lenders moving to meet APRA’s regulations or guidelines.”
APRA has specifically ordered a target on how much the banks can grow their investment books and have laid out specific targets on Interest Only and P&I.
“Effectively banks are moving all their levers right now to achieve their set targets. As a result, we’re going to see lenders making adjustments depending on how far away or close they are to their targets. If they don’t meet their targets, they’ll lose their banking license.”
Schulze explains that the recent move by AMP to reduce their LVR to 50% means that they aren’t close to their target or that they’re over their target. This means that they’re purposely sending investors away – and the way they’re doing that is by setting the LVR at 50%.
“We saw AMP do that before when they said they’re not lending to investors anymore. They haven’t gone that far at the moment. I think there’s a lot more changes to come.”
You need to talk to your broker regularly to keep up with these changes. Don’t delay making any decisions on buying or refinancing because the advice that brokers give today probably won’t be relevant in a week. Things are really moving so quickly. If we quote a customer today, and not submit the application quickly, we may not get the same deal later. There’s no way we can guarantee that the policy today is the policy tomorrow.”