Gone is the rhetoric, and as finance industry regulators move to prevent the type of questionable sub-prime lending practices that brought America to its knees during the 2008 GFC, it seems Australian property investors are in for a rude awakening.
With its proverbial hands tied for close to two years now, the Reserve Bank recently began (rather overtly) pleading for assistance to tighten monetary policy, in a bid to rein in certain sectors of our housing markets (i.e. Sydney).
Now it seems the cavalry has finally arrived in the form of the Australian Prudential and Regulatory Authority (APRA).
After looming threateningly for the last 12 months, APRA has turned its eagle eye on Aussie credit providers and their practices, with regard to investment related lending in particular.
The regulator made its move in the wake of home loan data for the year ending March 2015, which indicated a 20.9 per cent rise in loans attributable to investor activity – more than double the 10 per cent speed limit identified by APRA at the beginning of the year.
Now, property investors are at risk of being blindsided by loan rejections from banks that are under increasing pressure to put the brakes on hyped up investment activity in certain property sub-sectors, as a result of ongoing access to ‘cheap’ debt.
In the wake of this unprecedented macro-prudential policy implementation, APRA chairman Wayne Byres was quick to quell concerns around the health of our financial services industry.
At a recent Customer Owned Banking Association event reported by The Australian, Byres assured his audience that, “Australian ADIs (authorised deposit-taking institutions) are thankfully well away from the types of subprime lending that have caused so many problems elsewhere (for example, lending with loan-to-value ratios in excess of 100 per cent, at teaser rates, to borrowers with no real capacity to repay).
“Nevertheless, our overall conclusion from this hypothetical borrower exercise was that there were clearly examples of practice that were less than prudent.”
Byres warned that lenders aggressively chasing investor business could “expect to find APRA increasingly at their doorstep.”
Banks fall in line
Having gained APRA’s unswerving attention, all the majors have started withdrawing the discount offers we were seeing a lot of up until recently, for investment related funding.
Some commentators believe that in trying to appease APRA and their request to keep investor loan growth to less than 10 per cent per annum, available lender capital will be slashed by at least a third within the weeks to come.
This means a lot of potentially disappointed property investors whose applications now won’t make it across the line.
Along with the abolition of ‘special pricing’ on interest rates for investors, offers like the Commonwealth Bank’s $1000 Investment Home Loan Rebate was scrapped in May, while the ANZ promised to grow its portfolio in a ‘balanced way’ and make immediate changes to the way it manages investor loans.
Meanwhile, BankWest has started applying a maximum LVR of 80% for investment loans.
While this might seem like ‘no big thing’ at first glance, when you consider they were dishing out LVR’s of 98% to property investors just a couple of months ago, it’s clear the banks are not prepared to aggravate APRA any further.
What it means for property investors
Interest rates minus the perks of discounts and rebates means increased holding costs for investors in the first instance, with higher monthly repayments.
Beyond this, we anticipate that tighter serviceability models, where banks are less generous when assessing things like rental income levels and negative gearing benefits, will mean a reduction in the number of investor loan approvals.
Real estate with higher price tags will now be evaluated for rental income based on 60%, rather than the traditional 80% in some states and ‘cash out’ facility requests are being met with an increasing amount of questions and conditions.
In this new APRA world order, lenders want a viable reason for your cash out request and I hate to be the bearer of bad news, but responding with a ‘buffer’ or to ‘service negatively geared properties’ is unlikely to be met with bank approval.
Typically, lenders are restricting cash out to:
- New property investment acquisitions, with the proviso that the security must meet their servicing model requirements. Depending on the LVR, a Contract of Sale for the new property must also be provided before the lender will release funds.
- Renovations where again, depending on the LVR, builder’s quotes might be requested before ‘cash out’ approval is granted.
Obviously, these new restrictions could create cashflow obstacles for those looking to grow their portfolio by leveraging existing equity, or obtain a new loan product.
And for those who think this is just a knee jerk reaction to a few fast paced property markets, you might need to reconsider your perspective.
With interest rates anticipated to go nowhere but south for the remainder of 2015, it’s likely that this is the new normal you’d be well advised to embrace and learn how to work with, in order to continue growing a wealth producing investment portfolio.
A for instance…
Let’s say a client comes to us with $1 million worth of existing property debt. In April, we could have guided them to a lender that would calculate ‘Other Financial Institution’ or OFI debt at the actual interest rate and repayment.
With a 4.5% interest rate applied, this means their existing loan expense would be $45,000 per annum (interest only).
Now though, all OFI lending is assessed at the ‘stress level’ rate of 7.25%, with both principal and interest accounted for. This means the investor’s OFI debt exposure on a $1 million loan portfolio could equate to $82,000.
In other words, an additional $37,000 will be deducted from the applicant’s servicing calculations.
When you work backwards, that equates to interest repayments worth $822,000 of additional lending…or $822,000 that the investor can now longer afford, according to the bank.
Suck it up buttercup!
Given we seem to be stuck with this tough new regulator regime, property investors must acclimatize to a much colder lending climate than we’ve been afforded so far in our low interest rate environment.
So here are some tips to prepare for a frostier financial services sector…
- Seek expert advice from a properly qualified mortgage broker who understands the specifics of property investment, and can assess your current and future borrowing capacity and optimise your finance structure.
- Talk to your buyer’s agent and consider making a few adjustments to your current strategy. If you want to purchase multiple properties over the coming years for instance, you may need to look for more neutrally or positively geared opportunities to help with servicing and borrow as required to reach your target.
- Get creative! Think about different ways you can improve your serviceability if it might come under extra scrutiny. You can potentially manufacture equity and improve cashflow through strategies like:
- renovations,
- rental allowances that make your property more attractive and could mean charging a higher rent (such as allowing pets)
- the addition of a granny flat.
Now is the ideal time to review your financial portfolio, particularly if you plan on securing capital for things like OTP investments in this changing lending environment.
Why not connect with the Trilogy team for an evaluation of your current finance structure? We have the necessary expertise and industry knowledge to optimise your cashflow and borrowing position, in any type of market.
About the Author
Since 2008, David Thomas has built a business aimed at servicing the needs of property investors, owner occupiers and small business owners. David is recognised as one of the top 10 independent mortgage brokerages in the country, David and his team have settled almost billions of dollars worth of residential and investment loans over the last decade.
Known for his straightforward, relatable style, David believes by educating people about property funding; they fare better in the market. By sharing his expertise openly, some of the people he educates will likely become his clients. It's a win-win approach.
David Thomas is a credit representative (Representative Number 506153) of BLSSA Pty Ltd, ACN 117 651 760 (Australian Credit Licence 391237).