Author – Jonathan Millar, WBP Property Group
In this article, we’ll talk about how to best increase your lending capacity and get every cent possible from the banks. How much you can borrow will depend on your deposit, your spending habits, your equity in current property and your credit history, but there are actions you can take to give your application the best chance of success.
In a nutshell:
- Protect your credit file
- Reduce your credit card limits
- Prove stability
- Choose different lenders for each loan to avoid cross collateralisation
- Apply to different lenders in the right order
- Use the right ownership structure
- Choose the right property to get the best LVR (Loan to Value Ratio)
- About Lender’s Mortgage Insurance
1. Protect your credit file
Before being knocked back for a loan of some description, most people haven’t taken any notice of their credit history. But it’s a very important factor when requesting finance and once tainted, it’s difficult to rectify.
a. To protect your credit history, ensure all bills are paid on time. Don’t give any business/organisation any excuse to put a mark against your name. If there’s a payment in dispute, make the payment first and then fight it. It’s not worth the damage to your credit history.
b. Ensure all loan repayments are made on time. This is important to lenders and they will check your history.
c. Don’t apply for numerous loans in a short period of time and particularly don’t apply for loans for other people. Each application for a loan will be noted on your credit file and this will ring alarm bells if there a large number of applications in a short period. This is where having a good mortgage broker can assist. An experienced mortgage broker will ascertain your requirements and will apply to the most suitable lenders meaning less applications.
d. Get a copy of your credit report from www.mycreditfile.com.au. Look into any inconsistencies and ensure you understand all items listed. If there are any negative entries, have explanations prepared and keep good records and copies of receipts.
2. Reduce your credit card limits
Banks are continually sending letters offering a higher limit on your credit card and it can be easy to accept, but you need to set your own limit and decline further offers. When a lender is considering your position they take into consideration the limit of each of your cards as your lending commitment, regardless of how much is actually currently charged to each card. It is important to keep a buffer of available funds, but don’t accept more than you need. Also, cancel any unnecessary credit cards and pay down remaining card balances.
3. Prove stability – don’t keep changing jobs – or have a good reason why
Lenders will look at your work history and take into consideration your stability of employment. If there is a number of job changes in your immediate history, have prepared some good explanations as to why. Lenders will prefer to steer away from applicants who regularly change jobs.
Also, lenders will be reluctant to lend to an applicant who has recently taken on a new position and who is likely to still be within a probationary period. If at all possible, avoid changing jobs until after the loan has been processed. If the applicant is a business owner, the banks will be looking for a minimum of two years of successful operation. In addition, assessors will hesitate if an applicant has changed addresses too often without good reason.
4. Choose different lenders for each loan to avoid cross collateralisation
When applying for a second loan with a bank, they will want to use your existing property as collateral. This is called cross collateralisation. Cross collateralisation is where more than one property is used to secure a loan. However, this should be avoided if at all possible. The lender will tell you of the convenience of having your loans together, but it’s not worth the risk of losing both properties if the situation takes a turn for the worst.
It is also more difficult to release equity from a well performing property if cross collateralised with another ‘not so well’ performing property. Before releasing equity to purchase another property the lender may require that both properties be valued to ensure their position. If one property has lost value, then the equity of the second property will be eaten up by the loss of the first, leaving no equity for further purchases. If both properties were held separately, then the equity of the well performing property could be used for a further purchase.
You may choose to sell a property in order to purchase a preferred property. However, there is the possibility that the bank could demand that any profits from the sale of the first property be used to reduce the limit of the second loan. They do not have to agree to discharge a mortgage when the property involved secures another mortgage.
5. Apply to different lenders in the right order
Some lenders are more flexible than others when it comes to the required lending criteria. Some lenders are more investor friendly. This is why it’s important to approach the banks in the right order. Apply to the most rigid lenders first, while your lending capacity is good, and leave the more flexible lenders for when you are more committed. The order in which you select your lender can have a considerable impact on the amount of finance you will be able to secure. Start with the bank that is less ‘investor friendly’.
This is where a good mortgage broker can be helpful. They are experienced with the lending criteria of a great number of lenders and can steer your application in the right direction.
6. Use the right ownership structure
It’s important to think seriously about setting up the correct ownership structure before setting out to find the right property. Before getting started, it’s best to engage the professionals to ascertain the best ownership structure to meet your needs and therefore whose names will be on the loan documents and title. When the right property comes along, you can sign the contract immediately and not waste time sorting out what name will go onto the contract.
Some banks will not lend to certain structures (some complex trusts) so it’s important you know which structure you will use before applying for finance. Tell your broker how the structure will be set up so they can find the most suitable lenders. The ownership structure will affect the following:
- Asset protection
- Taxes – Land Tax, Income Tax and Capital Gains Tax
- Depreciation
- After death arrangements
- Which loans are available
The main ownership structures are individual ownership, joint ownership, ownership through a trust (Discretionary, Hybrid or Unit) or via a Self Managed Super Fund. It’s imperative to source professional advice according to your personal situation but here is a brief overview. Some banks will not lend to certain structures (some complex trusts) so it’s important you know which structure you will use before applying for finance.
i. Individual ownership has the benefit of taxes, depreciation and tax losses being assigned to you only for the purpose of saving income tax. However, there are numerous pitfalls; no asset protection, the possibility of meeting land tax thresholds if more than one property, and inability to distribute income to a lower income spouse, just to name a few.
ii. If purchasing in joint ownership, it must be considered whether to use the Joint Tenants structure or Tenants in Common. Joint Tenants is usually where the property is purchased together with a spouse or de facto and if one passes away, their half of the property automatically passes to the remaining spouse. With Tenants in Common, the property can be owned in different proportions eg. 90/10 or 60/40. If one partner passes away their share is not automatically transferred to the remaining partner, instead their share is distributed as per their will. This can have serious implications when investing in property. Again there are no benefits of asset protection with this structure.
iii. Trusts are becoming more and more popular for property ownership because of the asset protection advantage and the ability to distribute funds and minimise tax. A trust separates the property from the rest of your assets. Trusts can be complex and professional advice is needed here.
iv. Self Managed Super Funds are a booming industry. Purchasing in SMSF offers good asset protection and relatively low tax rates during both the accumulation and pension phases. Also, a SMSF can have up to four members, so you can combine resources with your spouse or partner, which is also beneficial when investing in property. However, be aware that the laws are continually changing and the set up and ongoing costs incurred for professional services to maintain can be considerable.
7. Choose the right property to get the best LVR
Often there can be a good property deal to be had, but whether finance will be readily available needs to be addressed. There are more and more types of properties that banks are either refusing to lend against or will only offer a relatively low Loan to Valuation Ratio (LVR) e.g. studio apartments or serviced apartments. It pays to know which they are before becoming too heavily invested in your property search. It’s important to check with your lender before spending time on due diligence for a property that might be difficult to borrow for.
8. About Lender’s Mortgage Insurance
If you don’t have the necessary deposit, Lenders Mortgage Insurance can help you get started in your property investing journey. With Lenders Mortgage Insurance, lenders allow you to borrow a higher percentage of the property’s purchase price. LMI can be paid upfront or capitalised into the loan.
If the property is required to be sold as a result of the failure to pay back the funds in accordance with the terms of the loan, the net proceeds of the sale may not always cover the balance outstanding on the loan. If this is the case, the lender is entitled to make a claim against the Mortgage Insurer for the reimbursement of the amount outstanding. Where a claim is paid to a lender, the mortgage insurer will usually then take steps to recover the funds from you the borrower, or any guarantor.
Lenders Mortgage Insurance should not be mistaken for Mortgage Protection Insurance. Mortgage Protection Insurance covers your mortgage payments in the event of death, unemployment, sickness or disability. Lenders Mortgage Insurance protects your bank against a loss should you default on your home loan.
While LMI can help you to lend more money, keep in mind that LMI is neither portable nor refundable. This means that if you wish to refinance with another lender you will be required to pay the LMI a second time unless you have the required minimum deposit.
In conclusion, increasing your lending capacity and getting access to the maximum finance available is all about being prepared and putting forward a well presented loan application. Ensuring you have a clean credit file, minimal credit card limits, a stable employment history and the ownership structure all set up are all important factors.
A good finance broker can point you in the right direction to apply for the right loans in the right order. They can assist you to prepare the required documents, shining the best light on your application. The next step is to ensure you are looking for a property that the banks are prepared to lend against.
Following the above will put you in good stead for a positive outcome to borrow the maximum amount possible.
Jonathan Millar
Executive Director
WBP Property Group (Qld)