One of the most important pillars of property investing is your ability to get finance. After all, most Australian property investors use finance (either through a bank or non-bank lender) to help them purchase a property.
Property finance is a fantastic ‘leverage’ tool – whereby investors borrow money to grow their wealth over a certain period of time. Because of this wealth-multiplying effect, property finance is often called ‘good debt’ (as opposed to bad debt like credit cards and personal loans which generally do not grow wealth).
However, in order to get finance from a bank or other lender, you will need to be deemed ‘creditworthy.’ This means you must have a reputation of being ‘financially sensible’… and have a good track record of paying back your borrowings in the past.
If you’ve consistently demonstrated financial responsibility, most lenders will be prepared to lend to you. However, without a strong history of credit (and corresponding financial responsibility), you might find it difficult to obtain finance.
It’s often said that it’s “easy to borrow money when you don’t need it”.
When you apply for any sort of credit—whether that’s a home loan or something as simple as a new mobile phone—the lender will assess your credit history.
Most commonly, this is done by looking at your ‘credit score’. A credit score is effectively your report card when it comes to your relationship with credit in the past.
If you’ve demonstrated financial responsibility (ie. You’ve made repayments on time, or earlier) you’ll have a higher credit score. As such, you’ll be deemed ‘creditworthy’ and a provider will be far more likely to lend to you.
If you’ve made financial mistakes in the past, missed some repayments, and/or defaulted on payments, you may have a poor credit history. Applicants with a poor credit history may be refused a mortgage application or may only be able to secure lending with higher interest rates to compensate for the added risk.
Good vs. bad credit score
What’s the difference between a good and bad credit score?
First of all, every time you apply for credit (loan, credit card, finance, etc.), it is noted on your credit file. If you continually pay back these loans and meet your ongoing repayments, your credit score improves. This is known as ‘having good credit’.
If you miss payments (which is known as ‘defaulting’), apply for too many loans/credit, or even worse, file for bankruptcy, your credit score declines. This is known as ‘having bad credit’.
When you apply for a home loan for an investment property, a lender will assess your personal financial situation in terms of income and expenses and any assets and liabilities. Additionally, they will also look at your history of repayments (and other things) through your credit score.
As mentioned, a good credit score means most banks will probably be happy to lend to you at competitive interest rates.
A low score doesn’t mean you won’t be able to get a loan, instead you will have to look to smaller or private lenders (which may likely come at a higher interest rate).
When looking to invest in property, low interest rates are crucial because of the leverage you receive. If your repayments are far higher than the rental income on the property, your investment return may not be as strong.
Other factors like the type of debt are also important. If you have multiple credit cards that are effectively just paying each other off and growing every month, this might be considered bad debt by a reporting agency.
On the flip side, having loans on investment properties is considered to be good debt as they are investments in appreciating assets.
Other factors affecting credit scores
There have been some key changes to credit reporting in Australia in recent years which has changed the way credit scores are calculated.
Australia now operates under what is known as Comprehensive Credit Reporting (CCR).
In the past, credit scores were calculated based only on the number of negative events. If you did something negative, it was difficult to make back that lost ground.
That’s all changed, so now a missed payment isn’t going to be the end of the world and it can be made up through other measures.
In the past, your credit score would drop for things such as late payments, defaults, making too many applications for credit, or major issues such as bankruptcies.
Now with the positive credit reporting system, people are also able to improve their credit score by making payments on time, or even earlier.
How to get your creditworthiness in the best shape as possible to apply for your first or next investment property
There are a number of steps you can take to get your creditworthiness in great shape before applying for a loan.
Check your credit score
The first thing to do is to check your credit score. Every Australian is entitled to one free check of their credit score each year and you can do this through the likes of Equifax.
If there are any errors, make sure they are fixed prior to applying for a loan.
Pay bills early
With the amount of data that credit agencies have these days, it’s easy to see someone’s history with their loan or bill payments.
If possible, you should pay your bills as soon as you receive them, to help build your credit score in a positive fashion. If you wait to make a payment on the day a bill is due, by the time payments clear, they are often technically late.
Get a credit history
Ironically, having no debt is actually a bad thing when it comes to applying for credit. If you’re young and have no track record, it might be worth getting a simple credit card just to build up a credit history. Just be sure to pay it off quickly.
One of the biggest red flags lenders look for are multiple loan applications. Every time you apply for credit, it’s noted on your credit file and other lenders can see it.
If you’ve been rejected by a number of lenders in quick succession, that’s a red flag and it will be very hard to get a loan.
To avoid this, speak to a mortgage broker, and go through the steps of getting pre-approved for finance. This will not only give you a clear idea of how much you can borrow, but it will also make sure your credit file is looking good and it will give you a very high probability of being approved for a loan when the time comes.
Please note, the numbers and assumptions listed in this article are for educational purposes only. Individuals should seek specific advice pertaining to their unique situation and the real estate market before making any decisions.
Trilogy Funding Two is a corporate credit representative (Representative Number 506131) of BLSSA Pty Ltd, ACN 117 651 760 (Australian Credit Licence 391237)