A few weeks ago, after attending a property seminar, one of our clients contacted us and asked us to assess his borrowing capacity for an additional investment loan.
By way of background, we had procured loans for this client of $1.6M in February this year.
Nothing had changed in the client’s circumstance except for an eventual increase in rental income (with the proposed purchase of the new property). The client’s current LVR was well under 70% and with the new acquisition, that LVR would increase to 75%.
Pessimistically, I expected the client’s borrowing capacity not to have increased at all. While I was right, the results surprised me.
With a slight increase in revenue, the client’s borrowing capacity from the same major Australian bank had reduced from $1.6M to $1.3M. That’s a decrease of $300,000 in less than 6 months. Indeed, the best the client could achieve now from any bank is $1.35M.
So, if the client’s circumstances have improved what’s changed in the past six months? The answer is the banks’ appetite and their more conservative approach to borrowers. In no particular order here are the changes that we reckon have affected borrowers:
- Decreased reliance on rental income: In the good old days (last year) most banks would stress test your rental income at around 100%. That is, 100% of your rental income was applied to your ability to service your loan. Now, that has reduced to between 70-80% depending on the lender. So immediately, there is a discount applied to your income when used to calculate your ability to service your loan.
- Decreased reliance on irregular income: There was a time when you could include your bonus in your servicing calculations. While some banks still allow you to, they may discount the number by 20-50%. While others refuse to accept your bonus in there servicing calculations at all.
- Increased focus on real expenses. When a client tells us that they have combined income of around $300k (before tax), we used to think that getting approval for a $1M loan would be easy. Until you visit the client. Before we enter the house, we may walk past a new Range Rover and a Porsche. The Range Rover may have two private school stickers on the bumper and a European ski resort sticker in the rear window. Immediately, we surmise there is around $150-$200k in expenses (that’s after tax folks), that’s before ringing the doorbell. More and more banks are utilising real expense numbers (particularly, fixed expenses like car leases, school fees etc). In days gone by, they may have applied a poverty index annual expense of $20k. Those days are gone.
- Stress testing of income: While we may quote you a real interest rate under 4% and you may think you can afford that – and you are probably right – the banks use a different rate (sometimes referred to as the plug rate). This rate stress tests you should interest rates rise. At the moment that plug rate is around 7.5-8.0% (depending on the lender).
- Valuations: I’ve written before about bank valuations and their complete disassociation with reality. In summary, the banks pay an external valuer to provide a valuation assessment. The valuer will have insurance to protect themselves should they get values wrong. Say a valuer is insured for valuing properties up to $1.5M. Your house was last purchased two years ago for $1.8M. If the bank uses this valuer, chances are your house will be valued at $1.495M. This is to allow the valuer to have insurance cover should things go wrong. It’s also a way that banks add another layer of stress testing. They assume – particularly at the top of the property cycle (whenever that is) – that eventually the value of your property will drop.
These are just some of the steps taken by banks to ensure that they don’t get themselves into trouble. You, as a borrower, may be miffed at these heavy handed tactics. Think of it this way. The banks have had a limit placed on them by the regulator to only grow their home loans by 1.1 times. Meanwhile, there’s an overwhelming demand from home buyers and investors that can’t be met. So what do you do if you’re a lender? You change your criteria so that you only lend to the lowest risk clients. It’s economics 101: supply and demand.
So before you go to that auction or put a bid on a home or investment property, give us a call and we’ll let you know if and how much you can borrow. That’s better than losing your deposit. Init?