Your Serviceability = Your Opportunity - Use it wisely

Over the past two years, things have changed in a big way in the mortgage world.

In 2014, APRA undertook a review of mortgage lending practices and they found significant gaps in processes between lenders. They found flaws in the way borrowers were assessed and since 2014 radical change has swept through the home lending profession.

As every month goes by, my inbox is hit with new changes. Each change on its own is nothing to be too concerned about. But when they are all combined over the past two years, there is a strong trend downwards in what you can now borrow.

While this may be a lot of the time, a good thing, it does change the game.

When I look at what's changed, it's hard to put a number on it because every bank has fallen. But if I was going to guess, I would say that it is now at least 20%, maybe up to 30% under what you could have borrowed all things being the same in 2014.

You might be sitting there thinking why is this important? I don't need to borrow that much.

The truth is that it a big sign of what is to come.

Lower credit growth = lower growth.

Now before I begin, this is not just one lender but a total market shift. It has hit some lenders more than others due to how relaxed their policy was prior to the review.

Some lenders with "looser" policies have had to increase their hurdles dramatically and those with stricter rules have maintained their position and actually strengthened.

As the past few years flew by, I was taking note and constantly having to rebuild what best practice was in my mind.

I decided that it was time I took out some further research for myself because over the past three months in particular the pace picked up.

The quick summary of the below, is that there is a new reality on the way - borrowing as much as you want from banks is out and wisely using your limited serviceability is in.

Where have we come from?

In the past, borrowing money from banks for property was typically quite easy. Banks love property. As long as you were working, you could basically borrow an amount that was usually over what you were comfortable with.

It was common that you could borrow over 7 times your income for a home. For example, if you earned $200,000 as a couple, you could borrow $1,400,000.

If that same couple wanted to buy an investment, it would be even more. It may have been as high as 9 times their salary depending on their home rental situation.

I think you will agree that we all have or know of a story where a bank said you could borrow $1,000,000 and you nearly had a heart attack.

Generalising here, but that was the view that society had of the bank. Banks would lend you more than what you would need and the only real challenge was getting the deposit.

Furthermore in some cases, you wouldn't need very little deposit as 97% mortgages were quite common.

But that was the past I believe. Now I think there is a clear shift the other way and while it still clear you can borrow a lot of money in most cases, servicing has tightened considerably over the past two years.

If you are a homebuyer, don't worry too much. Banks love you and you can probably still borrow 5-6 times your combined income.

For investors however, change is here and depending what bank you choose, the amount you can borrow will vary widely.

Due to the changes that I will talk about below, I believe now more than ever, you have to pick a bank that will like your situation from an income and servicing point of view.

The best rate was a number one factor in most peoples decision when picking the right bank. But now income servicing could be number one if you are looking to invest in more than one property.

If you are an Investor, make sure you pick the right bank

Now before I move on, I want to make an additional warning. At the moment a lot of people are considering fixing longer term and for five years. A lot of my clients did this just after Donald Trump got in. The five year rate started to move up and most my clients locked in at what just luckily happened to be the bottom of the market.

Even though rates have moved up, there are a couple of good deals and if you are thinking about it, before you lock in on long term fixed rates be careful.

If you lock in, you tie yourself to a bank and you need to make sure that they will support everything you want to do in the coming years.

Is this a good thing?

Personally, yes. I am all for Banks and Brokers needing to protect people. People and investors will do what they want and are allowed to do. While we live in a country filled with freedom, sometimes someone needs to stop people taking out financial debt or investing too much.

No one wants to hear stories of people losing everything because they were made redundant. No one wants to struggle every month because the bank said they could borrow an extra $200,000 that they couldn't afford.

So yes, I believe tighter standards is a good thing and overall we need to protect the future of Australians.

One hand Borrowing more, One hand Borrowing less

As I have said above, things are getting tough. An interesting point to note is that now more than ever people are forced to borrow more.

In Sydney and Melbourne, prices have doubled. Homebuyers are now having to borrow $100,000s more.

The house that was only $900,000 a few years ago is now $1,500,000. The $600,000 one is now $1,000,000.

So while they are finding it harder to borrow on one hand, on the other they are having to borrow much more than a few years ago.

The Changes

To give you an idea of some of the changes that have happened since December 2014

  1. 10% Investor loan book growth limit - Banks now have a 10% limit on growing their investor loan book. Some banks have already been told off by APRA and stopped Investor Lending not once but twice. This is a big shift from banks being always open to business from everyone. Banks saying no to business, I didn't think I would see that day.
  2. Investment Vs Owner Occupied - It seems normal now but two years ago, there was just one loan interest rate. There was no difference in interest rate for a home loan or investment loan. Now investor loans can be 0.2-0.5% higher and that's growing.
  3. Interest Only Vs Principle & Interest - Like above, banks did charge the same rate for Interest Only or P+I. After APRA telling the banks off, now they charge more for Interest Only. It can sometimes be a small amount like 0.1% but can be as high as 0.30%. Like Investment loans, the gap is getting bigger. I do not believe that this will be the end of it however, bank servicing calculator are making it harder for interest only loans now and you can borrow more as principal and interest. Expect this gap to widen.
  4. Increase to Living Expenses - Living expenses typically used the Household Expenditure Measure (HEM) or the Henderson Poverty Index (HPI) in loan calculators as a minimum. These are on the way out, and they have increased dramatically to now be based on applicant income and where they live as a minimum. Lenders are now redoing all their calculators and more scrutiny will happen here on actual expenses. New calculators will be broken down and itemised for every item that you spend. One rough figure is not good enough.
  5. Haircut to bonus or overtime income - If you earn additional income, it was once included at 100%. Now it may only be 80%, sometimes even less. Any income that is not PAYG is cut down now.
  6. Removal of long term interest only - Some banks used to allow you to go 15 years interest only. This option is all but forgotten about and five years is standard practice now. Some banks will do longer but it is getting rarer by the day.
  7. Existing debt is sensitised, not actual repayment - This is a big change. Servicing calculators used to use the actual repayment of mortgages you had elsewhere. So for example, if it was interest only and on a low rate or fixed, the bank would use that figure. Now regardless of what your repayment is, about 7% is used for interest rate. This makes a huge difference to investors.
  8. Removal of negative gearing benefits - Lots of banks are no longer using negative gearing benefits to help investors. This makes a huge difference to your borrowing capacity as you cannot add back all the tax you will likely get back from investing. A big difference to your borrowing capacity.
  9. Removal of depreciation benefits - Some banks used to include depreciation benefits in servicing. Something very few do now.
  10. Reduction in rental benefits - Some banks are now only taking 75% of your rent and even capping it for higher rents. Some used 100% before but now most are using 80% or less.
  11. Higher Assessment Rates - The assessment rates at all banks are usually now all closer aligned to over 7%. So even though rates are at all time lows of 4%, banks are making sure you can afford them at 7%. This gap was only around 2% above the current interest rate up to a couple of years ago. Some banks had assessment rates at 5-6% range, but not over 7%. This means you can borrow less, a big difference.
  12. Higher minimum LVR - Some banks will not lend on investment assets more than 80%. This is far cry from days of 97%.
  13. No investment lending - Some banks are no longer doing investor lending at all. This is crazy when you think about it in comparison to a few years ago.
  14. Not lending on assets in certain postcodes or under size - Many banks have a growing blacklist of postcodes that they will not lend to. Some are also not lending to apartments that are under 50sqm. This trend will continue and I can assure you, you don't want to go on this list.
  15. Limited Pricing on Investment loans - Investor loans once got the same discount as home loans. Now that's definitely not the case and banks are not giving great deals to investors anymore. It's pretty clear, they do want your investment loans but your home loan, that's a different story.
  16. Non-Resident or Foreign income - Some banks, literally overnight decided to no longer lend to people on VISAs and only permanent residents. Some banks also said they no longer will accept foreign income in servicing or at 100%. It can be very hard for Australians living overseas who want to buy property back here now.
  17. Banks pulling out of SMSF lending - Some banks have decided that this is not a space they want to play in and pulled out altogether. A sign that lending is tougher and their risk appetite is decreasing.
  18. Cash out more difficult, if at all - Banks are looking at files deeper and cross referencing a lot more. Cash out is not as simple as a valuation and no questions asked. They have lots of questions they need answered now.
  19. Family guarantor becoming tighter - Some banks have changed their policies to be much more conservative. Once you could use parental guarantor to buy an investment property, those days are almost gone. It's always needed to make sense to use family guarantor but banks are bringing in more restrictions.
  20. Outside Net Income Surplus (NIS) - Sometimes borderline servicing could be over-ridden by credit if they believed it was a good applicant. This is now under watch from APRA and becoming something that one day I believe will be a forgotten memory.
  21. Retirement Strategy - Borrowers in 50s, now need to have a clear strategy for loans that go in to retirement. It usually wasn't needed in any real detail.

What's this all mean? Lower Credit Growth is coming

So I think by now, you can see that it is now becoming even more strict to borrow. This in my eyes only means one thing, lower credit growth.

One of the biggest things that drives capital growth in the property market is credit growth. If the banks, keep on lending more and more money, the property market will likely keep rising. If the banks slow down, so will the property market.

The most important thing that I want you to get out of this article is that your borrowing capacity is going to be your opportunity and you need to use it wisely.

Based on your income, you will have a limited capacity. My advice for all investors is that you now need to make sure that you do not to waste a single dollar of it on a poor investment.

If you can borrow $1,500,000 and you have debt against the home of $750,000. You need to be very careful not to waste $400,000 on a poor asset, leaving only $300,000 available for another poor asset.

Going forward, unless you are expecting major income rises, your borrowing capacity may be going down not up. If you are thinking that next year you will buy another property when equity rises, and another when equity rises. You will need to get huge pay rises as well.

Things on the horizon?

It's clear the government has a social issue and there will be more to come.

The government is or might consider higher land tax for investors, changes to negative gearing, first home buyer benefits or higher stamp duty for investors.

Part of what i've written about above could be trumped by what was introduced in the UK and that was a maximum of 4.5 x Income. This would be change things dramatically if it was implemented here and not in a good way for property prices.

So going forward, the biggest risk I see going forward is on top of this reduction in potential demand is a supply shock. If the demand goes from the investor market and more supply keeps on coming, there will be many at the mercy of the market and you will need to be very careful that your investments stay strong in this environment.

To give you further insight in to everything I recommend this fascinating read from APRA and the review itself.

The Research

As part of this research, I decided to do hypothetical borrower exercise like APRA did.

I checked the 9 biggest banks on what would a family with two kids be able to borrow.

I said they earned $150,000 and $75,000 and had expenses under bank minimums.

The scenarios I look at

  1. Buy a home,
  2. Buy an investment property
  3. Buy an investment property after owning a home.

These are three common goals for my clients.

Scenario 1

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This is off a combined income of $225,000, so bank 1 is lending 5.79 times income whereas bank 9 is lending 6.62 times. That's a big difference and in other words, Bank 9 is lending 15% more.

Scenario 2 + 3

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As you can see above, a couple of banks clearly will lend less if your are an investor then the rest of the market.

One in particular will lend you a lot more.