Unlocking the equity in your home could help you purchase another. Chief executive of property advisory firm Property Mavens used her home’s equity to buy a Preston investment property. Picture: Lawrence Pinder
WE’VE all heard of the benefits of refinancing to get a better deal on your home loan, particularly a more competitive interest rate.
But what if refinancing could also help you buy an investment property?
“Borrowers may be able to refinance their existing home loan to access equity they may have built in their property, in order to buy an investment property,” Mortgage Choice chief executive Susan Mitchell said.
Refinancing with the aim of buying an investment property could allow borrowers to grow their wealth, according to Ms Mitchell, as, generally speaking, property was considered a safe asset class in Australia with decent returns over the long term.
“CoreLogic found that over the 10 years to June 2018, national dwelling values increased by over 40 per cent, a good return on investment,” she said.
But she cautioned there were a number of costs associated with refinancing, so it was important borrowers made an informed decision before jumping in.
The nuts and bolts
So, how does refinancing using equity work?
The Successful Investor managing director Michael Sloan explained that lenders would typically lend you 80 per cent of the market value of your home, less the debt you still owed against it.
“This is your usable equity as banks hold some back as security,” he said.
“So, say, for example, you have a $500,000 property and a $200,000 loan. Your usable equity will be $200,000,” he said.
As to what value investment property you could buy, Mr Sloan said a simple rule of thumb was to multiply your usable equity by four.
“But remember that one of the risks of property investing is spending too much,” he said.
“You need to buy well below the median house price ($742,000 in Melbourne, according to CoreLogic), in fact you shouldn’t be within $200,000 of it.”
Ms Mitchell said the figure depended on how much a lender determined a borrower could afford to repay.
“Available equity is important but the key factor a lender needs to consider is how much a borrower can afford,” she said.
“If a borrower does not have additional capacity to repay a proposed new loan, they may not be able to borrow, irrespective of how much equity they may hold,” she said.
Where do I sign?
And there’s the rub: having equity in your home is not a guarantee you’ll be able to access it.
“You can have a million dollars of equity but if you don’t satisfy the institution’s lending criteria, they are not going to loan you any money,” Mr Sloan said.
“The bottom line is they will take everything into consideration: for example, how many children you have, as the more you have the less you can borrow, your work situation and how much you spend on everything from your daily coffee to the tyres on your car.”
Lenders have also tightened their assessment procedures as a result of recent regulatory measures, such as The Australian Prudential Regulation Authority (APRA) imposing a 10 per cent benchmark in growth on investment lending last year.
This was introduced in a bid to curb activity in the housing market, Ms Mitchell said.
“These regulatory measures have resulted in lenders increasing their scrutiny of a borrower’s ability to service a loan,” she said.
“When deciding if an applicant can afford a mortgage, a lender will consider a borrower’s available ongoing income and from this allow for existing debt commitments and living expenses,” she said.
“Their decision will also factor in a buffer for potential increases in interest rates.”
But it’s not all doom and gloom. Ms Mitchell advised that borrowers could overcome the increased scrutiny by getting “financially fit”.
“Get out of debt, spend your money wisely and adopt a disciplined savings strategy to show lenders you can service a loan,” she said.
Air Mutual director Damien Lawler advised would-be investors to consult an independent broker who could access a range of lenders, which might have varying assessment procedures.
“Everyone is talking about the banks tightening up – which they are – but there are banks, particularly the smaller, tier-two banks, who are still lending,” he said.
And finally …
Mr Sloan said his No.1 piece of advice for would-be property investors was to play it safe and to have some funds in reserve if things go wrong.
“You should never buy (another) property if you have no extra money available to you after you settle, so you need to have a buffer. And protect what you are building with income protection and life insurance, if you have a partner,” he said.
The Australian Prudential Regulation Authority will ease its curbs on interest-only residential mortgage lending, it announced on Wednesday.
The supervisory benchmark was put in place as a temporary measure, leading to significant declines in lending to investors and putting downward pressure on boiling house prices and Australia’s record high household debt-to-income ratio.
The proportion of new interest-only lending is now significantly below the 30 per cent threshold APRA introduced in March 2017.
APRA will remove the 30 per cent limit from 1 January 2019, with plans to conduct a review into banks’ lending practices next year.
In April, APRA removed the 10 per cent investor growth “speed limit” it had imposed in 2014.
APRA said that the removal of the caps was subject to the banks providing “certain assurances” about the strength of their lending standards.
“APRA’s lending benchmarks on investor and interest-only lending were always intended to be temporary,” APRA chairman Wayne Byres said.
“Both have now served their purpose of moderating higher risk lending and supporting a gradual strengthening of lending standards across the industry over a number of years.”
In a letter to the banks, APRA said that its curbs had reinforced sound residential mortgage lending practices and “significantly improved” the banks’ lending standards.
The result, APRA says, is more resilient banks and better overall financial system stability.
Interest-only lending still ‘higher risk’
Owner-occupier interest-only lending remains a higher risk form of lending, the regulator said.
“APRA expects that ADIs will maintain prudent internal risk limits on interest-only lending.
“These internal limits should cover both the level of new interest-only lending and the type, including lending on an interest-only basis to owner-occupiers and lending on an interest-only basis at high LVRs.”
The regulator says it plans to conduct a review of banks’ risk controls on interest-only lending in 2019 and will continue to “closely monitor” conditions in the housing market.
CBA, the nation’s largest mortgage lender, is axing residential and commercial loans for self managed super funds amid growing concerns about regulatory problems, property market weakness and stricter capital adequacy rules squeezing returns.
The bank is set to announce it is pulling SMSF lending product, SuperGear, in a bid to “become a simpler, better bank and streamline our product range”, from October 12.
But the moves will shock mortgage brokers and financial advisers and make nervous property investors more jittery about the outlook amid falling prices, rising costs and oversupply, particularly for apartments in the inner suburbs of Melbourne, Sydney and Brisbane.
It is also being done during a period of increased regulatory scrutiny of leveraged superannuation assets, potential reputational risks to lenders and advisers from “high risk” single investment SMSF schemes, and lenders’ capital adequacy requirements.
“CBA has decided to withdraw its SMSF lending product that allows SMSF trusts to purchase both residentially and commercially secured properties,” a spokesman said.
“This is part of our strategy to become a simpler, better bank. We are streamlining our product portfolio and have decided to discontinue SuperGear.”
Support existing accounts
The bank said it will be writing to customers who hold a SuperGear loan outlining the changes.
It will continue to support existing loan accounts.
“We are seeing the writing on the wall for leveraged SMSFs,” said Sally Tindall, director of research for RateCity, which monitors rates for financial service products. “This calls into question the viability of the leveraged SMSF sector.”
Regulators fear problems arising from SMSF investors leveraging their superannuation to invest in a single residential property because of the lack of diversification and increasing dangers of loss in a falling property market where it is difficult to find tenants. Systemic risk is low because the loans are non-recourse, which means they are secured by the property.
The Australian Taxation Office and Australian Securities and Investments Commission are targeting the use of SMSFs to invest in property after a review revealed 90 per cent failed to comply with “best interests” tests and other legal obligations.
It warned the strategy of gearing through an SMSF to invest in property, which is heavily promoted by property seminars and “property one-stop shops”, is risky.
The one-stop shops typically involve real restate agents, developers, mortgage brokers, accountants and financial advisers.
A key finding of the David Murray-led financial system inquiry in 2014 was that leverage should be banned in superannuation funds to mitigate the risk of financial instability. The government rejected his advice and Mr Murray said that was a mistake.
Mr Murray, who was recently appointed chairman of AMP, the nation’s largest financial conglomerate, is expected to launch an internal review of its SMSF lending practices.
Banks are also believed to be quitting the sector because of increased capital adequacy requirements by the Australian Prudential Regulation Authority are squeezing profits.
The greater complexity associated with SMSF loans and relatively small size of the market are also disincentives, according to analysts.
“As banks are looking to streamline and reduce costs, these are the types of products that get reduced,” he said.
There are fears that legal restrictions – or caps – on how much an SMSF investor can contribute to their plans could cause a credit crunch for many borrowers and force fire sales of their properties, which becomes more likely as property capital values and yields slump.
This scenario could arise if the expense of renovating a property, or supplementing rental income, exceeded annual caps.
Lenders are also lowering their lending book risks by increasing scrutiny of borrowers’ income and expenditure in assessing their capacity to repay.
Other major lenders are also tightening their SMSF lending policies in addition to increasing rates on loans and other property-related credit.
Nearly $700 billion is held in SMSF funds by more than 1 million investors. During the past four years the number of members investing in property has increased from about 3.6 per cent to 6.9 per cent of SMSF fund assets.
Tighter regulations and slowing credit growth are forcing financial institutions, including Westpac and Suncorp, to increase their variable interest rates. These increases come when the drought and a weakening property market are reducing the prospects of continuing growth in key sectors of the economy.
As a result, the Reserve Bank has been reluctant to increase the official interest rates from the present historically low levels to more normal levels. With rates rising offshore and continuing political uncertainty, the cost of overseas short-term funding for our major banks has increased even though the official cash rate hasn’t changed.
The increased costs arising from the regulatory charges and the ongoing banking Royal Commission have also helped trigger the variable interest rate increases. Borrowers now face the unusual situation of rising interest rates when property prices are falling.
The prospect of major changes to the taxation of property investors isn’t helping investor confidence. But for those contemplating new borrowings the tightened regulations are limiting the amount that can be borrowed as well as lengthening the time needed for loan approval.
Both factors have been restricting the ability of potential purchasers to acquire properties and for vendors to achieve good prices. Given the importance of property construction to continuing strength in the economy, the Reserve Bank is unlikely to add to developers’ problems by increasing the official interest rate.
If anything, the Reserve Bank will face pressure to reduce the official rate to help the banks and property sector. The increase in interest rates for borrowers has been relatively small and can be financed in some cases by reducing repayments of principal. Borrowers who’ve taken advantage of lower rates to reduce their outstanding loans can make this choice.
One major bank has already responded to the slowdown in credit growth by informing existing clients about the possibility of reducing their minimum monthly repayments. However, taking advantage of this option increases the risks of being adversely affected by any future rate rises.
Indeed, the current interest rate increases are a warning that further increases are possible. Continuing to repay capital as quickly as possible is a way to reduce risks and build wealth even with investment loans where the interest payments are tax deductible.
Not paying off an investment loan makes excellent sense when there’s also an owner-occupied home loan in existence. In this case, paying off the home loan first reduces non-deductible interest outlays. When the only loan is an investment loan, paying off the principal still makes sense, especially when property prices are falling. Owning an investment property with little or no debt allows the owner to take a long-term view and sit out downturns in values or periods of vacancy.