::Robert Mayor & Associates Pty Ltd::

The financing of an investment property has many considerations. The good news is that competition between bank and non-bank financial institutions has resulted in very competitive interest rates available to borrowers as well as a very flexible range of products to suit the particular needs of individual borrowers.

Some of the issues that I will cover here include the amount you will need to borrow, the various loan types available, how to select a lender, the application process and some of the risks that you could face in financing your investment property both now and in the future.

Firstly, how much cash that you have available to cover your deposit and set up costs (Stamp Duty, legals etc). It is possible to borrow up to a maximum of 95% of the purchase price of an investment property, therefore, you require cash to cover the 5% deposit plus the set up costs. The only way to calculate the amount of borrowing required is to do several calculations on varying purchase prices until you find your price range which will be based on your available cash. You should be aware that where you borrow in excess of 80% of the purchase price you will incur mortgage insurance which can be very expensive. For example, when borrowing 95% of the purchase price, mortgage insurance can be as much as 2.5% of the amount borrowed. This expense must be factored into your costs. It is very important that an accurate assessment of all of the costs be made otherwise you will be wasting time looking at property that you do not have the resources to purchase.

If you have collateral security (i.e. equity in other residential property such as your own home) then this equity can be used instead of a cash deposit to assist in buying the property. Where sufficient equity exists, you may be able to purchase 100% of the purchase price of an investment property plus the set up costs. You should note, however, that where collateral security is offered in support of financing an investment property, it will in all cases require that any existing first mortgage on the collateral security will need to be refinanced as part of the deal. This is usually done as a split loan which separates the owner occupied or existing investment loan from the new borrowing. Using collateral security is very common with investment purchases. It usually overcomes the requirement for mortgage insurance and maximises the negative gearing aspect of an investment property purchase. For owner occupied purchases, however, the most suitable borrowing ratio is 80% of the purchase price with the borrower having sufficient funds to cover the deposit and related costs.

Secondly, the loan amount is determined by your serviceability or the amount of income available to service the loan. These ratios vary from lender to lender, but, basically, involve taking into consideration all of your existing monthly commitments, credit card liabilities etc plus the monthly repayment required to service the new mortgage loan. Where an investment property is purchased, the rental income from the subject property is also considered when establishing the ability to service the loan. Evidence of income and proposed rental income is always required by lenders except where a Lo-Doc loan is obtained where no documentary support of income is required. These Lo-Doc loans, however, attract an interest rate loading of between 0.5-1%.

Selecting the right loan type is very important and there are many to choose from. The considerations include whether you select a fixed or variable interest rate, whether you have a basic no frills home loan, a line of credit or one of the more sophisticated loan packages which come with a credit card, cheque book and involve direct salary crediting. It is not possible here to provide a recommendation in this regard as the loan product selected is totally dependent upon the needs and resources of the borrower. If the borrower is highly geared then a no frills style loan with a fixed interest rate may be ideal. Borrowers with surplus income may select a home loan type with salary crediting and use the available credit card and cheque book for living expenses. These loans, however, require a good deal of discipline as there are no contractual monthly repayments to be made as the interest is debited to the mortgage balance each month based on usage. If a high deal of flexibility is required in the loan then a line of credit facility may be the best option. It is, therefore, very important to consider what your future needs and risks are when considering which type of loan to select. It may also be valuable to discuss these issues with a lending professional.

As is evident in the media there are a wide variety of mortgage lenders all claiming to have the perfect product for you. Clearly it is not always the best idea to rely on your existing bank to provide you with a suitable mortgage loan. The considerations when selecting a lender include the following:

Interest Rate – the rate must be very competitive. Available interest rates from most lenders are usually found in the press and can be found on the Internet through sources such as Cannex. Particular care should be taken with non bank financial institutions that their variable interest rate quoted will only change following an official Reserve Bank rate movement.

Fees and Charges – upfront fees and ongoing monthly charges can have a significant effect in the overall interest cost of the loan. To reflect this, lenders have recently been legislated to publish comparative rates alongside the contract rate which shows the impact of fees and charges on the interest rate charged.

Product – Clearly the lender selected must have a comprehensive range of loan products to cover not only your immediate need but have suitable product alternatives should you wish to change during the term of the loan.

Service – It is important that your lender be able to respond to your needs not only when the loan is written but into the future when your circumstances may change. Having access to an account or relationship manager is an important consideration.

Having established the loan amount required, an approval must be obtained prior to making an offer to purchase a property or attending an auction. To cover each scenario it is important that you obtain a pre-approval for finance so that you can make a bid on a property which is not subject to finance. In this way you do not run the risk of missing out on a property while you are waiting a week for a finance approval. Pre-approvals are usually only conditional upon a satisfactory valuation which can then be completed within the five day cooling off period. The application process usually involves the completion of an application form with the lender or mortgage broker at which time would be addressed the issue of the most suitable loan type, the amount required to be borrowed etc. It usually takes between two and four days to receive an indicative or pre-approval for a loan.

Usually on exchange of contracts 10% of the purchase price must be paid as deposit. This can be paid in cash, or, where collateral security is being used to support the purchase a Deposit Bond can be used. Deposit Bonds are issued usually by insurance companies which substitute for the 10% cash deposit. They are only issued where an approval for the end finance is available and evidenced. The cost of deposit bonds is usually between 1 and 1.5% of the amount of the deposit. Deposit Bonds also have time limits which are priced accordingly. In most cases Deposit Bonds are acceptable to a vendor, however, you should always check as in some cases the vendors require a cash deposit only. With a standard mortgage contract settlement is usually required six weeks after exchange of contract.

The most serious risk in borrowing money is to over commit or have the potential to be over committed. Borrowers should always maintain a reasonable level of gearing and as much as possible remove the exposure to rising interest rates. If such a rise will cause financial hardship then one simple way of assessing this exposure is to calculate your monthly repayments at an interest rate 3 or 4% higher than the start rate to see the impact of such a rate increase on your cash flow. If such a rate increase would cause hardship then you should consider selecting a fixed interest rate rather than a variable interest rate.

Borrowers who become too highly geared or over committed run the risk of hardship in the event of an unforseen occurrence such as an untenanted property, employment problem, pregnancy or other contingency. In these cases the borrower may need to sell a property quickly to get out of trouble for a figure well below its market value. Borrowers should always consider a “second way out” or have a contingency plan should their circumstances change. They should always monitor their borrowing situation and certainly not leave a decision to liquidate a property to the last minute.

It is also a risk that we regularly see where borrowers make an offer on a property or attend an auction without a pre-approval. Borrowers can also tend to leave insufficient time for the pre approval process. You should allow at least one week to obtain a pre-approval prior to attending an auction or making an offer on a property.

Whilst clearly there is a lot to consider and many options in selecting a suitable mortgage loan, all of the above considerations can be raised, discussed and resolved in a meeting with your selected lender or mortgage broker. As previously highlighted all borrower's circumstances, needs and levels of discipline are different. It is very important to understand exactly what your needs and expectations are from a mortgage loan. It is only then that the correct loan product can be selected. Ideally it should contain all of the good features such as rate, flexibility, low costs etc and be tailored to meet your specific needs.