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The Experts

Adrian Sheahan
Expert
+ About Adrian Sheahan
Adrian leads the operations for Switzer Home Loans. He has over 20 years experience in the banking and finance industry and has primarily been involved in lending to the rural, commercial and residential sectors. Adrian has also owned and managed a retail business for five years and has s a Bachelor of Economics degree.

5 reasons to review your home loan

Tuesday, June 19, 2018

This is a much covered topic, but given the slowing property market in many areas, the number of new loans will decline. So lenders will sharpen their pencils to retain their existing business and increase their share of the refinance market.

So, as we are constantly urging, take the time to give your loans a health check.  If you don’t have the resources or expertise to do so, contact your finance professional or the team at Switzer Home Loans and ask them to do it for you. It could the best phone call you ever make.

Here are 5 good reasons why:

1. To Save Money

This is a no brainer.  If you are being charged 1.00% more on your loan than you should be, for every $100,000 of debt you have, you are paying $1,000 per year too much.  On a $500,000 loan, that’s $5,000 per annum coming out of your pocket for no advantage.  Of course, that is a simple example but the message is clear, if you are not checking your loan, you may be costing yourself thousands every year for no good reason.

A word of warning though, if you do want to switch loans for a better rate, check what it will cost you in discharge costs for the existing loan and establishment fees for the new loan.  Also check if there are ongoing fees on the new loan.  These fees and charges can have a big impact on the viability of switching loans so make sure the interest savings you are gaining are not offset by the costs of switching. 

2. Make sure the loan can be managed to suit your needs

Sharp interest rates are only one part of a good home loan.  Having a suitable structure is just as important.  Is the repayment type (Interest only v Principal and Interest) suitable, are the fees and charges excessive and is the interest rate structure right for you?  Other factors that make a difference are simple things like making fortnightly repayments instead of monthly repayments, having access to an offset facility and separating your loan into two or more splits, or portions to reflect the purpose of the funds you obtained with the loan.  For example, if you borrowed against your home for investment purposes, it is much easier to manage the investment accounting and tax if the investment loan is separated from your home loan debt.  A decent mortgage professional can identify a suitable structure for you very quickly, so a short conversation may make your loan easy to manage. 

3. Do you have the most suitable repayment structure? 

Most borrowers are aware that Interest Only repayments are more expensive than Principal and Interest, and that the banking watchdog, APRA has forced a big change in the accessibility and cost of Interest Only loans.

Lenders now encourage borrowers to make Principal and Interest repayments by offering rate discounts for that repayment structure but they will still provide Interest Only loans where it is deemed suitable for the borrower. Suitable purposes include investment borrowings, if the client is having a short term reduced income (eg maternity leave) or they are planning to sell an asset and pay the loan off in the short term.  If the repayment structure is unsuitable, your strategy objectives won’t be met, your loan will be more costly in the long term and as many of those coming off Interest Only repayments at the moment will attest, a poorly structured loan can place you under great financial stress. 

4. Consider Fixed Rate options 

Interest rates are low now but it has not always been the case and they will rise again at some stage, so if rate rises will place you under financial stress, a fixed rate loan may give you the insurance you need for your cash flow.  

Fixed rate loans are less flexible in terms of repayments and usually exclude useful features such as offset accounts. Penalties may also apply if you make lump sum payments or pay the loan out during a fixed rate term.  Care therefore needs to be taken to ensure a fixed rate loan is suitable, but a popular strategy to counter that is to split your loan and have a fixed rate portion and a variable rate portion.  That way you can have the best of both worlds.  Security and an element of flexibility. 

5. It’s easier than you think 

The first step is to call your existing lender and ask them to review your circumstances to ensure you are getting the best from your loan.  Do your homework first and find out what rates are available in the market and compare them to what you are being offered. If your rate is not competitive, ask your lender to provide you with some relief.  If they can’t, or won’t, it may be time to look around. Refinancing does not take too much time or effort, it just takes a little organisation and paperwork, but not as much as you would think.    

It’s becoming an Australian past time  to complain about our banks, and the media are having a field day with the Royal Commission. But perhaps we should be taking some responsibility for our own positions.  The best way to keep your lender accountable and to make sure you are being looked after is to regularly review our own individual arrangements with them. 

If these reasons get you thinking, grab the phone and speak with a mortgage professional and use their experience to give you the right loan structure and pricing for your needs.  Five minutes could save you a small fortune.

 

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The Royal Commission – A loan writer’s perspective

Tuesday, May 15, 2018

We’ve all heard the admissions of misconduct from major institutions at the Royal Commission, with their statements a sad reflection on the conduct and governance of the banks.  Whilst these revelations have given the media their headlines, the reality is that the vast majority of lenders act with their customer's best interests at the forefront of their thinking. 

Furthermore, it has been interesting to note there has been little or no discussion of the fact that over recent years, regulators have been taking steps to protect the interests of borrowers and address poor lending practices.  As a lender dealing with loan applications on a daily basis, I have seen a quantum shift in policies and compliance as both regulators and lenders move to minimise risk to themselves and their clients as the nation’s home loan debt grows. 

These changes have led to some long overdue reforms and there is no doubt that further changes will be recommended by the commissioner Ken Hayne. But in the interim, borrowers can have confidence in current lending practices and the protections already in place.

Broadly speaking, lending policy and compliance have seen the most change and it’s worth looking at each in isolation and how they impact borrowers.

Lending policies are set by the respective lenders but heavily influenced by regulators who use a number of methods to makes sure that Banks that meet their expectations.  The recent imposition of caps on Interest Only lending being a clear example.  In simple terms lending policies now more than ever ensure the loan provided is both suitable and affordable for the applicants with the following items illustrating that point.

Loan repayment affordability calculations

Lenders now assess loan repayments at an interest rate of around 7.5% to minimise the risk imposed by potential rate rises.   With most new home loans attracting an interest rate of under 4.00%, rates would have to almost double to reach the level that repayment affordability is being assessed at.  Any existing loans are generally also assessed at that level of interest rate for the same reason.  By introducing these measures, lenders are mitigating the risk posed to clients by rising rates.

Living Expense calculations

This was the topic of much discussion at the Royal Commission but it has already been a point of action for the regulators and lenders for a number of years.  The focus has led to lenders applying increasingly tougher assessments on living expense declarations and the application of minimum benchmarks in their assessments with the benchmarks being more sophisticated and significantly higher than in the past.  The outcome of course has been to lower the borrowing capacity of many applicants shielding them from potential financial stress. 

Compliance is driven by legislation and policed by ASIC.  There has been a huge leap in the documentation required by lenders who have reacted by establishing or expanding departments to deal with this specific area.  The purpose of the increased compliance requirements is to ensure that borrowers are clear on the details of the facility being provided, that the lender is doing their due diligence on the information provided and all fees and costs are being disclosed.  It is also designed to minimise the potential for fraud.  Again, this can be demonstrated by using two simple examples.

Statements

Bank statements are a document increasingly sought by lenders to confirm everything from income and living expenses on savings statements to limits, rates, terms and repayment types on loan statements.  By verifying the information from formal documents such as statements, fraud can be minimised and the assessment completed using figures that reflect the applicant’s true position. 

Documentation regarding assessment and decision rationale

Lenders are now required to fully document the loan process from start to finish and provide their applicants with a number of compliance documents during that process.  Not only must they be able to justify their recommendations based on the information obtained and make reasonable enquiries into the accuracy of the information but they also must document that.  Above all, they must be able to demonstrate that the loan recommended will not place the borrower under financial stress and in legislative language that the loan ‘is not unsuitable’ for the applicant.  Good lenders have always done that but the legislative requirements in this area now mean that all lenders are required to provide rational explanation for their recommendations and document it.

So whilst the Royal Commission has exposed some disgraceful conduct that cannot be excused, steps have already been undertaken to minimise those occurrences and lending policies and requirements are constantly under review to ensure better borrower outcomes are ensured.   So if you are seeking a home loan, take time to block out the hysteria surrounding the Royal Commission and take comfort in the fact that you are being afforded more protection than ever in relation to your lenders recommendations.

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7 tips to pay your loan off sooner

Tuesday, April 10, 2018

Debt is a great tool for growing your wealth when used correctly but reducing your Home Loan quickly should be the objective of most borrowers.  A lower debt reduces your risk if interest rates rise or your income drops and of course the additional equity in your home will increase your borrowing capacity for the next purchase or if you wish to use it for investment purposes.  To get that Home Loan debt falling, here are seven tips that can make a difference. 

  1. The first tip is pretty simple.  Just make more than the minimum repayment.  Most lenders now assess your capacity to repay your loan at a rate of around 7.5%.  They do that to ensure you will not be placed under stress if rates rise, but this indicates you could be paying significantly more than what the loan repayments actually are.  For the sake of example, let’s consider the impact on a $500,000 Home Loan at 3.75% over 30 years. Making repayments at the banks ‘stress rate’ of 7.50% will cut the $500,000 Home Loan from 30 years to just over 15 years and save over $170,000 in interest payments.  That’s $170,000 in your pocket.
  2. The second tip is a commonly used one and it has a negligible impact on your day to day cash flow. Halve you monthly repayment and make fortnightly repayments instead of monthly.  By doing so you will make 26 payments of half the monthly amount, or 13 full monthly payments; 1 more than if you had stuck with the minimum 12 monthly repayments. It also suits the pay cycle of most borrowers so it makes sense from a cash flow point of view too. Going back to our example, that change will save you 4 years on the loan term and over $50,000 in interest payments.
  3. Tip number 3.  Have a loan with Principal and Interest repayments and not Interest Only.  The Banks are making this decision easy now by charging a premium for Interest Only loans but too many people use Interest Only loans inappropriately and their debt never reduces.  That is fine in some specific circumstances but for most, it just means their debt takes longer to repay and they pay significantly more in Interest repayments.
  4. If you have surplus cash at any time, put it into your Home Loan.  Most Home Loans have a redraw facility that will let you draw on those extra repayments if needed so you are not locking it away.  Going back to our $500,000 loan example, if you make a $10,000 extra repayment after year 1 on the loan, that deposit will save you almost $20,000 in interest and cut a year from the loan term.
  5. Tip 5 is an easy one.  Loan repayments are made in arrears so the first repayment is due 1 month after you settle the new loan.  If you make a full repayment on day 1, it will save you almost $5,000 over the life of the loan in interest and reduce the loan term by 3 months.  You will always be ahead in your repayments and that can be handy if you need extra cash or some repayment relief at any time.
  6. Tip 6 should be an annual event.  Review your Home Loan and make sure it is suitable for your needs and that your rate is competitive.  If in doubt, ask your lender to do it for you.  Your objective is to keep your loan costs to a minimum by getting a competitive rate and the right loan structure is in place.  New loan products are continually being developed and everyone’s circumstances change from time to time so a quick check is just common sense. 
  7. The final tip is to refinance if your current loan is poorly structured or too expensive and your current lender will not assist.  You don’t have to have the cheapest loan in the market but the rate needs to be competitive or you are simply throwing money away. Using our example again, a reduction in rate from 4.25% to 3.75% would see your repayments drop by $138 per month if you refinanced at year 5 of a 30 year loan.  Be careful though; there are two important things to remember when refinancing

o   Make sure switching does not cost you more in fees than you are saving in interest

o   Keep making the same payments that you were making on the old loan otherwise it will still take you just as long to repay the new loan.

Actioning only one of these strategies could cut years from your home loan and save you thousands; just imagine what applying several of them will do.  

If you would like to see how changing your rate or repayment structure would affect your loan, visit our website www.switzerhomeloans.com.au and experiment with the calculators on our advice page.  If you would like advice call your finance expert or contact the team at Switzer Home Loans on 1300 664 339.

 

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New Year financial resolution No 1: Review my home loan

Tuesday, February 06, 2018

The holiday season is now behind us and most of our New Year resolutions have been consigned to the rubbish bin already. 

These resolutions usually revolve around our personal habits: I’m going to lose weight, drink less, stop smoking etc. But how many of us have a look at our finances and in particular, our Home Loans?  Not many!!  So here’s my recommendation for the New Year.  Resolve to undertake a review of your Home Loan and do it every year. 

And here’s the best part, if you use a professional, they will do most of the work for you.  It’s quick and maybe one of the easiest resolutions you will ever have to fulfil.  Here is a quick look at why and how to review your home loan.

Why?

Everyone’s circumstances change from time to time and the lending landscape also changes so it’s inevitable that your home loan at some stage will become too expensive and/or structured in a way that is unsuitable for you. 

 

  • Rates and costs.  You should review your home loan rate at least every two years (every year is better) as products evolve and lenders alter their rate structures from time to time and you could be eligible for better interest rates either with your current lender or failing that, by refinancing to a new lender.   I don’t recommend that you go chasing small improvements in rate every year but if you can save 0.50% on your interest rate, that can add up to tens of thousands over the life of your loan.  The other thing to check is your fee structure.  The annual fee of $395 that many loans attract adds up to over $11,000 for a 30 year loan term.  The Home loan market is a competitive place so you need to make sure you are getting value for that fee.  If not, take action.
  • Interest Rate type.  If things are tight with your cash flow, it may be time to fix the rate on your loan to make sure you are not left in trouble if rates rise.   See what the market is offering and compare that to your loan and the repayments you currently make.  A fixed rate will not suit everyone but it may save you a lot of stress if rates move upwards.
  • Repayment Type.   Are you suited best by Principal and Interest repayments or Interest Only repayments?   There are many factors that influence the answer to that question but what is certain is that lenders are providing discounts for those who are on Principal and Interest repayments, especially if the loan is a Home Loan.   The difference in rate can be over 0.50% so if your loan has Interest Only repayments and you don’t need that structure, a switch will save you heaps.
  • Loan features.  Older loans do not have many of the current loan features such as offset accounts, redraw and the capacity to manage the loan via the internet.   Again, you could save significant amounts of your hard earned money by using these features so ask the question of your lender and find out if your loan features can help you.

The loan interest rate is not the only factor when assessing if your loan is the right one for you but it is a great indicator, so a simple check is well worthwhile. 

How?

OK, so it’s worth having a review of your loan, especially if it hasn’t been done for some time.  But how do you do it and how difficult is it?  Basically you have two ways of going about it.

  1. Make a lot of phone calls to various lenders and find out what they can offer you (including your current lender)  or,
  2. Call a finance professional like a loan broker or the team at Switzer Home Loans and get some expert advice.  At Switzer we do this every day and can usually let you know if your loan is right for you with a 10 minute phone conversation.

A 10 minute phone call has to be the easiest New Year resolution you will ever have so if it isn’t on your current list of resolutions, do it and start this year.

https://www.switzerhomeloans.com.au/

Call us on: 1300 664 339

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Tips for dealing with lenders over Christmas

Wednesday, December 13, 2017

By Adrian Sheahan

December is peak hour for banks and lenders and despite their best efforts every year, property buyers and sellers alike often miss their Christmas deadline and with solicitors taking time off over Christmas and New Year, that can delay the property settlement by weeks.  Banks and lenders put on extra staff to cope with the December rush but inevitably, settlement processes slow down because of the Christmas bottleneck.  

So what can you do to make sure that your application or property sale goes through smoothly?  The simple answer is, be prepared and make it easy for the lender who is dealing with your transaction.  That applies all year around though, not just Christmas, so here’s a few tips to help you get a good outcome from your lender.

Applying for new finance

Primarily lenders are concerned with your ability to repay the loan you are seeking and what security you can provide for the loan.  To meet their documentation requirements, have the following items ready:

Income and expenses

If you are employed on a PAYG basis, have your last two payslips and employers payment summaries. 

If you are self employed, have your last two years personal and business tax returns available.  If you don’t have them handy, get your accountant to email you a copy

Rent income.  Supply a copy of the rent statement from the property manager, the lease or the two most recent rent receipts.

On the expense side, lenders will quiz you on living expenses and existing loans so have a budget prepared and bring along the most recent statements for all of your loans and credit cards.

Loan security  

If you are purchasing a property, provide the contract of sale and a copy of the receipt for your deposit.  

If you are using an existing property as security, supply a copy of the most recent rates notice for that property.

Objectives  

Finally, have an idea of what you are trying to achieve and how you want the bank to assist.  A good lender will try and find a pathway to the outcomes you are seeking and if you have made it easy by supplying the information they need, the process can be quite smooth.

Selling your property

When you have sold a property a lender holds as security, they need to prepare a discharge of mortgage, organise settlement etc. 

They often employ solicitors to act for them and the whole process can take up to 4 weeks so if you don’t tell them immediately upon sale of your property, you run the risk that your tardiness may delay settlement.  You can ask for the matter to be attended to quickly, but at times like Christmas when they are flooded with requests, that is sometimes just not possible.

To minimise this risk, as soon as your property sells, provide the lender with a copy of the contract of sale, your solicitor’s details and sign the lenders discharge authority. 

Make sure you take care to provide full and accurate details.  If you have a personal manager or contact person with your lender, ask them to lodge it for you and keep an eye on its progress.  There is also no harm in your solicitor checking with the bank once the request is lodged to make sure all is in place.

Loan refinance

For the new lender, these matters are a priority but for the lender you are swapping from, property sales and purchases are more important so don’t expect them to fall over themselves to complete the refinance.   My main tip if you are considering a refinance is to speak with your existing lender first and see if they can satisfy your concerns. 

They may be able to provide what you are seeking, eliminating the need for the refinance in the first place.  If they can’t, you will have at least removed the step where they should try to retain your business.   Once you have decided to go down the refinance path, complete a discharge authority for your existing lender and lodge it with them as soon as possible. 

You can ask the new lender to do that for you but preferably, once you have made the decision and have the approval for the new loan, lodge the request so the old lender can attend to their process whilst you are completing the mortgage documentation for the new loan.  That can save you weeks.

No matter what you are doing, my number one tip for saving time in any dealing with lenders is to call them and establish what they require to action your request. 

Make a list of what they need and then satisfy that list to the letter. I recently had the pleasure of listening to a successful developer speak and his advice when dealing with governments, councils and banks was not to fight them, get what they want and work with them. 

The time savings are enormous.  If they request a letter from your accountant, get it for them, if they ask for two current pay slips, don’t provide one from two years ago. 

The easier it is for them, the sooner your settlement will happen. 

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3 things to consider if you have a home loan

Tuesday, October 31, 2017

By Adrian Sheahan
 
For most people, their home is the biggest asset they will own and the loan used to purchase the property, the biggest debt they will carry. They look after and maintain the property but too many don’t bother to monitor and manage their loan once they have the home. Everyone’s personal and financial circumstances evolve, even if they don’t switch properties, so regular reviews of their home or investment loan structure are a must to ensure the loan matches their circumstances. Borrowers should regularly ask themselves and their lender, does my loan structure and rate match my needs and circumstances? If change is needed, in most cases it should be neither costly nor difficult. On the other hand, not reviewing your loan regularly could prove both costly and give you plenty of headaches down the track.

Here are the three main loan features we constantly review.

Repayment type

The Australian Securities and Investments Commission (ASIC) and the banking watchdog the Australian Prudential Regulation Authority (APRA) are now placing huge pressure on lenders to reduce the number of Interest only loans they provide. In response, lenders are using both the carrot and the stick approach to push applicants and existing borrowers alike towards principal and interest repayment loans. The carrot comes in the form of reduced rates for principal and interest structures and the stick is the loading of the rates for interest only borrowings, amongst other restrictions. The result is that interest only loans can carry a rate as much as 0.70% higher than the same loan on a principal and interest repayment structure. Many borrowers are unaware of the difference and that can be costing them thousands every year. If you have an interest only loan, particularly an interest only home loan, ask your lender what rate reduction you will receive if you switch to principal and interest repayments. It could be the greatest question you have ever asked.

Fixed or variable interest rate

The most common question we are asked about loan structure is ‘should I fix the rate on my loan’?  This is more complicated than just changing repayment type and must be considered carefully. When a loan is under a fixed rate contract, additional repayments may be limited, redraw and offsets restricted and should you pay the loan out before the fixed rate expires, the penalties could be significant. There is always the risk too that the rates may drop, leaving you paying more than you need to. Fixed Rate loans are best suited to borrowers who cannot afford to take the chance on repayments rising as a result of rate increases. I have written previously about the pros and cons of fixing rates but if you have the capacity to make additional repayments or think you may sell your property in the short term, a fixed rate loan may not be for you.

A popular alternative is to split your loan and have part fixed and part variable, giving you the flexibility of a variable rate loan but the security of a fixed rate on a significant portion of your debt. A rare example of being able to have your cake and eat it too!

Loan refinancing

The rate on your loan is of course critical. If you are paying more than the market rate for a standard loan, you are costing yourself hard earned cash for no good reason.  A lower interest rate will put more money in your pocket and gives you the option to reduce your home loan faster. There will be some costs to refinance your loan such as legal and registration fees, so care needs to be taken to ensure you are not offsetting any interest savings with the costs, but your finance expert will be able to detail these for you so you can make an informed choice.  The bigger then loan, the more important the rate is and even a small reduction in rate could save you plenty.

Changing loan structures or even refinancing is not a difficult process. There may be a little paperwork, but that is a small price to pay for a change that could relieve your financial pressure or save you thousands.  All you need to do is make a call to your lender, a finance expert or the team at Switzer Home Loans and they will get the ball rolling. The discussion you have may be best five minute chat you ever have.

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4 reasons why investment loans are now harder to get

Tuesday, October 03, 2017

By Adrian Sheahan

Investors are aware that their loans now attract higher interest rates than home loans and most are aware that the banks are also restricting the LVR or Loan to Valuation Ratios for Investment Loans. What is less obvious is that banks are also applying tighter assessment guidelines when assessing the applicant’s loan servicing capacity, or in simple terms, their ability to make the loan repayments when all of their income and expenses are considered.

This is leading to confusion and frustration for many applicants who know they can afford the loan sought based on the money going in and out of their bank account. So what are these changes and how do lenders now assess the capacity of Investors to repay the loan sought?

Rental income – When assessing an applicant’s rental income, lenders do not use the full gross rental income figure. That figure is instead discounted to allow for vacancies and the costs associated with the investment property. Commonly a discount of 20% is applied to the gross figure (some lenders apply an even greater percentage) meaning that when the bank looks at an applicant with $500 per week rental income, they will only use $400 in their servicing assessment, wiping $5,200 per annum from their assessable income. The more properties held and the more rental income the applicant relies on, the more impact this has on their cash flow forecast and the more difficult it is to pass the assessment.

Loan repayment calculations - All loans are now assessed using a ‘stress interest rate’ that is much higher than the actual interest rate applied to the loan. Typically, this is around 7.50% and is used to assess future loan repayments. This is also applied to any other loans the applicant may have. In some cases, these rates are almost double the actual rate being charged. This is done to allow for potential rate rises over the life of the loan. The outcome is that all of the assessed loan repayments for the applicant are significantly higher than the repayments the applicant is actually making, increasing the expense figure in the banks servicing calculations. So now the applicant is faced with the income figure used being reduced and the expense figure inflated. Again, the more properties and borrowings the applicant has, the more the impact on their ability to obtain a loan.

Interest only repayments – A little known but very significant shift in the assessment process has been in the way banks treat interest only repayments. Previously, interest only repayments were included in the assessment at the actual repayment figure. No consideration was given to repayment of the loan principal or the significant lift in repayment amount when the repayments reverted to principal and Interest repayments at the expiry of the interest only period – repayment shock. To cater for that outcome, not only is the ‘stress rate’ applied to the interest rate calculation but the repayments are based on the principal and interest amount that will be applied when the repayments come off the interest only period. This makes a huge difference to the expense calculations of the applicant.

Living expenses - This has recently been a focus of the Australian Prudential Regulation Authority (APRA) and the Australian Securities and Investments Commission (ASIC) with the lenders again responding to pressure from these bodies. Prior to the spotlight being shone on this issue, lenders commonly applied a benchmark living expense figure to their calculations for simplicity but these have now evolved to more detailed calculations depending upon individual applicant circumstances such as location and income. The lender will also ask the applicant to provide an estimate of their living expenses. This figure is compared to the benchmark established by the lender and the higher of the two is used in the calculations. This has led to a marked increase in the expense figure of a large number of applicants. So again, this application of policy has led to a negative impact on the applicants borrowing capacity via an increase in the expense figure.

These are just a sample of the factors that have impacted the capacity of investors to obtain loans. Add to these the increased rigor of verification of the information provided by applicants, higher property values in Melbourne and Sydney, the scaling back of assessed gearing benefits and it is clear why it is more difficult for investors to borrow now than just a few short years ago (despite what some in the press claim). Although frustrating for many, in the main the changes provide additional protection for investors and they have certainly contributed to the slowing of investment borrowings. If you’re unsure of your borrowing capacity or how the changes affect you, use a trusted finance expert and get them to walk you through the assessment.

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Interest-only loans: Why all the fuss?

Wednesday, July 26, 2017

By Adrian Sheahan

If you are a potential property buyer or investor, you will be aware that the banks are putting the brakes on interest-only lending. So why (and how) are the banks doing this, and are interest-only loans still a viable option for property purchasers?

If you were to approach one of the four major banks for an interest-only loan, they would apply an interest rate of up to 0.66% higher than for the same loan with a principal and interest repayment structure. They have also tightened their lending criteria for interest-only loans, making the assessment process tougher for many applicants. These changes include tightening the method used to calculate the applicant’s capacity to repay the loan, and reducing the LVR levels acceptable under this product type. They can still provide loans for those borrowers who need them, but the reality is they are now more expensive, and the qualifying conditions are tighter.

Why the fuss?

The increase in the cost of the loans, and the tighter lending policies, are all designed to reduce demand for, and supply of, this type of facility. Why? Because the banking regulator, APRA, is concerned about ‘heightened risk in the housing market’ (and the impacts on both borrowers and lenders alike) should there be a significant interest rate rise and/or a downturn in the property market.

While they are concerned with protecting the integrity and strength of Australian banks, APRA are also trying to change the borrowing habits of Australians by making interest-only loans less prevalent and are doing so via the banks. Of all new residential loans, only 30% may be written on an interest-only basis under new guidelines implemented by APRA. Lenders are now also more closely scrutinised to ensure that interest-only loans are only provided to those deemed suitable.

The banks have no option but to slow their interest-only lending. By tightening policies, they reduce the number of applicants eligible for those loans. By increasing the rates, they reduce demand, steering applicants towards principal and interest repayment structures.

This stance is perhaps long overdue, because for some time, many lenders have been too liberal with the provision of this type of loan without due regard to the risks to both themselves and their borrowers.

These risks include;

  • If the loan is not reduced during the interest-only period and the property does not rise in value or indeed falls, the borrower’s equity may be reduced, or in extreme circumstances, the loan may even exceed the property value.  This is a concern if there is any correction in property values (particularly in Sydney and Melbourne, where prices have skyrocketed, along with loan sizes). Perth provides a stark example of this, with the decline in property values following the end of the mining boom leaving many property owners in the red.
  • When the repayments revert to principal and interest after the interest-only period, the repayments will increase significantly and may be unaffordable for the borrower. This is called "payment shock" and is a specific concern of APRA. The repayments increase for two reasons:

1. The revised payments will include a principal repayment component, in addition to the interest amount that was being paid prior to the change. 

2. The principal and interest repayments are calculated on the remaining term of the loan, not the original term. So, the borrower has the same amount of debt to repay as when they took the loan, but a shorter period to do so. 

Interest-only loans are still the right option for some borrowers, including;

  • Investors with strong income who rely upon a negative gearing strategy.
  • Borrowers with reduced income capacity in the short term (e.g. those taking periods of parental leave, or career breaks) who need to minimise their loan repayments during that time. 
  • Borrowers looking for tax-effective structures that allow them to focus their cash flow on loans where the costs are non-deductible, such as their owner-occupied property loan, rather than investment loans where the interest is tax deductible.  

These borrowers can still access interest-only loans, but the simple fact is the application process will be more rigorous and the rate will be higher than it was before.

The primary objective of any good lender is to provide a loan structure that best matches the applicant’s needs and maximises their wealth. Interest-only loans are part of that product mix. So, if you are considering a loan with interest-only repayments, don’t let the higher price and the tougher guidelines scare you, as your circumstances may still be best suited by that type of facility. If in doubt, speak with a Switzer Home Loans specialist to identify the right structure and options for you. 

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Are you too old for a home loan?

Tuesday, March 07, 2017

By Adrian Sheahan 

Obtaining a loan is linked to the income that’s needed to meet the loan repayments. So if you are approaching, or have already made the step into retirement, could you still obtain a loan? The simple answer is yes, but of course this comes with some caveats.   

Older applicants seek loans for a number of reasons. They may want to expand their investment portfolio, they might be recovering from the financial effects of a divorce or failed business enterprise, or they may just wish to purchase a new home. These are all valid reasons for seeking a loan for residential property, and indeed, can be an integral part of retirement planning.

Whatever the reason, lenders must assess your request for finance by looking at your capacity to repay the debt. This is true for every application, regardless of the applicant’s age. They will also consider factors such as your credit history and the security offered, but first and foremost, they must consider how you can repay the loan. They do so to ensure the loan will not place you under financial stress, and of course, to ensure the loan is not a risk for them.

So if you are at - or approaching - retirement and your income is about to change, how can a lender justify granting you loan with a 25 or 30-year term? The answers lies in considering how the loan is to be repaid in the long term, and not in the assessment of your current income. Yes, the lender will look to your normal income to clear the debt, but if you plan to retire before the debt is cleared, they will then look at what income sources will remain past that date. These might include rental income, investment income or a generous superannuation income stream. A detailed plan from an accountant or financial planner is a helpful tool in these circumstances, but it needs to demonstrate that not only can the loan be paid from your post-retirement income, but that you can maintain a lifestyle without undue financial stress.

If that can’t be demonstrated, lenders will assess if you have an alternative exit strategy i.e. another way to clear the debt. This usually takes the form of the sale of an asset such as shares or an investment property, or if required, the part redemption of some of your superannuation assets.  

Critical in this assessment is asking the question: how long until you expect to retire? This will determine to what extent you can build the value of your assets and how much your loan will reduce by. For example, if you are a fit 55 and expecting to work until you are 70, you have significant time to not only reduce the loan balance, but also build up your superannuation balance, your share portfolio, and other assets. If, however, you have only two years until you plan or are obliged to retire, you will need to have an alternative exit strategy in place.

The most common asset put forward as an alternative exit option is superannuation. Be aware however that lenders are very cautious about this. Indeed, many lenders will not accept superannuation as a legitimate source of funds to clear debt unless the holdings are very large. Why? Because superannuation is, by definition, designed to meet your living needs in retirement, and not to pay off debt.

So, if you are retired or nearing retirement and looking for property finance, the assessment by your lender will be completely different compared to that of a younger applicant. While this may sound like common sense, many applicants don’t consider the pitfalls of new borrowings or the many options available to them. To address this, banks often request that applicants at or near retirement seek financial advice prior to entering into a loan contract because it is a critical decision, and financial mistakes heading into retirement can be devastating. As always, we recommend you use a professional such as a financial planner to assist you to build a strategy, and a trusted finance consultant to get the right loan advice, not just a loan.

Adrian Sheahan is the manager of lending operations at Switzer Home Loans. Contact him today for a free loan health check.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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Lenders Mortgage Insurance: What you need to know

Tuesday, December 06, 2016

By Adrian Sheahan

An interesting part of the debate on the difficulties facing first home buyers is the application of Lenders Mortgage Insurance (LMI) and its pros and cons. But before we delve into that discussion, it’s important to understand exactly what it is.

Lenders Mortgage Insurance 101

LMI is insurance a lender takes out against making a loss on a loan they provide. In simple terms, if a borrower defaults on their loan and the lender is forced to sell the property that secures the loan, in some circumstances, the sale proceeds will not cover the amount owed to the bank. When that occurs, the lenders mortgage insurer will cover the lenders shortfall. 

Most borrowers understand that, but what many do not know is that the mortgage insurer can, and will, pursue them for the amount of the shortfall.  LMI is therefore protection for the lender only – it does not offer any protection for the borrower at all. Furthermore, a common misconception is that it covers the loan payments if the borrower is unable to because of illness, losing their job, etc. It does not cover those risks, they are covered by separate policies such as income protection insurance that the borrower must arrange themselves.

When is LMI required?

Lenders usually require LMI when the loan amount is greater than 80% of the security value. This loan amount/security value ratio is called the “Loan to Valuation Ratio (LVR)” and it’s a critical figure when assessing if LMI is applicable, and if it is, what the cost will be. 

Like all insurance policies, there is a premium or cost for the policy, and in most cases, this is passed on to the borrower. The cost of the premium depends upon both the amount of the loan and the LVR. The higher these are, the higher the premium will be. This is a reflection of the risk to the lender. The higher the LVR, the higher the possibility the lender will make a loss if they are forced to sell the property to recover their money. The higher the loan amount, the greater the potential loss.

Paying the premium

The premium is payable by the borrower at settlement of the loan. The borrower can pay that from their own funds, or it can be added to the loan amount. That is termed as “capitalising the cost” and can be done provided the policy for the lenders maximum LVR is not exceeded. Of course, if you choose this option, you are repaying the amount over time, and paying interest on the monies owed (which includes the LMI premium).

It sounds very one-sided in favour of the lender and it is, but it does have its advantages.  

Let’s consider two scenarios:

1. Purchasers can buy into the market sooner if they are having difficulty saving for a deposit

This is a significant positive and commonly applies to first home buyers. If the first home buyer is buying into a rising market, they will not need to save as much. Additionally, the capital gain generated in the time it would have taken to save the 20% deposit (plus costs) may, in fact, be more than the premium they pay. This has been evident in the property markets of Melbourne and Sydney over the past few years. 

Breaking it down

Let’s assume you want to purchase a unit in a market growing at 10% per annum, and the unit price is $500,000. To avoid LMI, you will need to meet the 20% deposit and the costs including Stamp Duty. Using round figures, you will need $100,000 to avoid paying LMI.

If it takes you two years to build your savings to $100,000, in that time, the property will increase in price to $605,000. So, you would then need $121,000 to avoid paying LMI, i.e., you are still not in a position to buy the property, and have wasted two years!

Alternatively, if, at the time, you put together enough funds to pay 10% plus the costs and taken a loan with Lenders Mortgage Insurance at a 90% LVR, the LMI cost would have been approximately $8,500. Given the gain in property value over the two years was $105,000, obtaining the loan initially and paying LMI would have left you well ahead.

Sounds great, but remember, not all property values rise in this way, and the booming markets of Sydney and Melbourne are not typical of the overall property market. So do your homework and use a professional to help you.

2. It enables you to preserve your cash/savings for other use

If you have significant cash reserves, but have them earmarked for other purposes, you may be able to borrow more than 80% of the property value and not have to use all of your hard-earned savings.  This can be advantageous from a tax point of view if purchasing an investment property, as the borrowings will carry some tax benefits, and the savings can be used for non-deductible spending.  As always, you should check this strategy with your accountant to ensure it suits your circumstances.

So, under certain circumstances, LMI is an excellent tool to help buyers achieve their property goals.  But there are many factors to consider and each individual has different circumstances. Like all lending decisions, there are implications for the borrower no matter which course they take, so use a finance expert to guide you, or speak with the team at Switzer Home Loans.

Adrian Sheahan is the manager of lending operations at Switzer Home Loans.Contact him today for a free loan health check.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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