Call us on 1300 794 893

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.

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. 

| More

 

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.

| More

 

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.

| More

 

Investment properties: 4 things every lender looks for

Tuesday, October 25, 2016

By Adrian Sheahan

If you’re borrowing to purchase an investment property or add to your property portfolio, it’s critical you consider if the property you’re purchasing is acceptable to the lender. Almost all residential investment loans are secured by residential property, and lenders will decline an application if they deem the property unsuitable.

In cold hard terms, if things go pear shaped and you cannot make the repayments on your investment loan, the lender may sell the property to recoup their money. When that decision is made, the lender wants to know they can sell the property quickly, and that it will sell for enough to cover the outstanding loan and costs.

Lenders do not like risk, so they will look very closely at the property you are purchasing. The following list outlines their main points of focus.

Loan-to-valuation ratio (LVR)

LVR stands for loan-to-valuation ratio. This is the amount of the loan measured against the value of the property expressed as a percentage. For example, if a borrower purchases a property for $500,000 and obtains a loan of $400,000, the LVR is 80%. If they borrow $300,000, the LVR is 60%. This ratio is critical because it will determine how much that can be borrowed, and often, what interest rate the loan will attract. 

Obviously, the lower the ratio, the less risky the loan is for the lender. Lenders will not lend more than the property is worth and the highest LVR is usually 95%. The most common LVR number is usually 80%.  When the LVR is higher than 80%, the interest rate is usually higher and the loan will attract Lenders Mortgage Insurance, which is another cost passed on to the borrower. Furthermore, the lenders and mortgage insurers will scrutinise the application more thoroughly to ensure their risk is minimised. This makes the loan more expensive and more difficult to obtain approval for.

Location

Location, Location, Location. We’ve all heard real estate agents use this phrase. The more desirable the location, the easier it is to sell the property and the more likely it is to retain or increase in value. In other words, the location of the property is a positive that reduces the risk to the lender.

For that reason, a property in a blue chip suburb in Sydney or Melbourne is considered more favourably than one in a small regional town where the market is less active. As many investors are also finding to their detriment, locations reliant upon a single industry such as mining are also considered risky. If the industry goes into decline or fails, the property will also decline in value. Therefore, lenders may have a lower LVR in certain towns or locations or may not lend in those locations at all. Another example is high-density apartments in our capital cities. As more apartments are completed, supply is rising and prices are coming under pressure. As a result, lenders will commonly only consider applications for those properties with an LVR of 70% or less. Given these projects are commonly located close together, the postcodes in which they are located will have a lower maximum LVR. So do your homework. Look at the supply of properties, the economic features and the long-term market activity of the location. Even if you don’t, the lender will.

Property type

Lenders are wary of what they classify as ‘specialist’ property types. These include properties such as studio apartments under 50m2, mixed zoning properties, titles with multiple dwellings, Off The Plan properties, student accommodation, etc. Why? These types of properties are seen to have a smaller market and consequently, lower demand. That means they may take longer to sell, or may need to be sold at a heavily discounted price to attract a buyer. That raises the risk for a lender, so again, they may limit the LVR, or consider the property unacceptable and decline to fund the purchase. If in doubt, ask your lender before you go to the auction or enter into the contract - it may save you tens of thousands of dollars.

Adverse features

The final item to consider is if the property is negatively impacted by any external features. Lenders will decline applications for properties if they think an external feature may extend the selling period, or lower the value of the property. This may include close proximity to high-voltage power lines, land slip areas, flood zones, bushfire zones, old mine areas, etc. Again, it comes down to doing your research.

Property can deliver investors with terrific yield, but if the lender looks unfavourably on the property after assessing these four key areas, they may decline your application. So do your research and if in doubt, ask your financial adviser or 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.

| More

 

Introductory rate loans: What happens when the honeymoon is over?

Tuesday, September 06, 2016

By Adrian Sheahan

Honeymoon loans are just one of many products offered by lenders. But like all honeymoons, the good times can come to an end, so it’s important to do your homework to avoid getting caught out!

What is a honeymoon loan?

Honeymoon loans are also called introductory rate loans, because they offer a period at the beginning of the contract when the interest rate is lower than the standard variable rate.

This period of time can be as short as six months and stretch as far as three years from the start of the loan.

Lenders use the introductory rate as a marketing tool to attract new business and gain market share, but the loans do not come without risk and potentially come with additional costs to the borrowers in the long run. So, before considering this type of loan, it is critical that a borrower understands the product, the long term costs and the risks.

There are two types of introductory rate loans:

1. Discounted Variable Rate. The interest rate is set at a fixed percentage below the standard variable rate for the honeymoon period before reverting to the standard variable rate at the expiry of the introductory term. It will move in line with changes in the variable rate, but the discount will remain in place and the difference between the two rates will be unchanged until the introductory period is over.

2. Discounted Fixed Rate. The interest rate is fixed for a period of time at the beginning of the loan, and like all fixed rate loans, won’t move with changes in the variable rate. The lenders offer a lower rate than the variable rate and at the moment, the fixed rate period is for one, two, or three years.

I don’t know any borrower who would not like a lower rate on their home loan, so why aren’t they more common? The simple answer is that while these loans are appealing at first glance, there are several negative considerations. If borrowers ignore these considerations in the rush to secure a low rate, they may be left with the exact opposite of what they want, that is, a costly and unsuitable loan. Here are just a few of those potential pitfalls.

The pitfalls

1. Cash flow hit. Discounted fixed rate loans are now the most common form of introductory rate loans being offered. Lenders offer a fixed rate below the prevailing variable rate so they can advertise a low headline rate. The problem is that when the fixed rate expires, the loan usually reverts to the lender’s Standard Variable rate and this can expose the borrower to a real hit to their cash flow if rates have risen. Borrowers that are vulnerable to upward movements in interest rates and their loan repayments are therefore at significant risk of not being able to afford their loan repayments.

2. Reduced flexibility. Under the discounted fixed rate offer, borrowers can lose options such as redraw and offset accounts. So they may have a lower rate, but the loan may have no flexibility.

3. Limited additional repayments. During the honeymoon period, particularly for discounted fixed rate offers, the lender may limit additional repayments to the loan, eliminating one of the two main benefits of the product (i.e. the ability to take advantage of the low rate to reduce the loan to a manageable level before the introductory period is over).

4. Higher fees. These loans may carry higher fees offsetting the gains of the lower rate so the borrower does not realise the savings they were banking on.

5. Other penalties. The cost of discharging the loan, or switching during the introductory period, can incur fees. So if the loan is paid out for any reason, there is the potential for the borrower to be hit with substantial penalties.

Despite the above negatives, there are circumstances when the loan can match the needs of a borrower and would be a suitable option.

The lower rate during the honeymoon period may provide two main advantages.

1. Reduced initial costs. It softens the cash flow shock for new borrowers who may be purchasing their first home, starting a family, or early in their careers with lower incomes. The lower rates and repayments give these borrowers the chance to establish themselves, get their home set up and cement their income streams before the loan repayments increase.

2. Accelerated debt reduction. Secondly, the lower repayments during the honeymoon period provides the borrower with the opportunity to make extra repayments while the rate is low (subject to the conditions of the loan) so they can accelerate the reduction of their debt in the early years of the loan to reduce their risk.

Like all honeymoons, the borrower will have to return to normal life at some point and the reality hit may have long term impacts. So if you are considering this type of product, make sure you do your homework first and ensure the specific product suits your personal circumstances. If in doubt, consult your finance expert or the team at Switzer Home Loans and let them do the leg work on your behalf.

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

| More

 

The perks and pitfalls of interest only loans

Wednesday, July 27, 2016

By Adrian Sheahan

Are interest only loans a good option? It's a common question, and the short answer is that interest only loans often provide unintended downside risk, and should only be recommended under specific circumstances.

This stance is backed by the banking regulator, APRA, with lenders now required to detail why they have provided a borrower with an interest only repayment structure, and why it’s suitable for their situation and needs.

So when are interest only loans suitable? First, let’s consider the potential benefits of a loan where the repayments during the initial period of the loan (usually up to five years) are interest only, before converting to Principal and Interest for the remaining term.

The benefits

  • As there is no requirement to reduce the loan principal, the repayments during the interest only period are less than those under a Principal and Interest repayment structure, providing improved cash flow for the borrower.  
  • It can be used by investors who rely upon growth in the property value (capital gain) to create wealth, while minimising repayments and maximising tax deductions against the asset in the short term. This is an important tool in a negative gearing strategy.
  • Interest Only loans allow borrowers with reduced income in the short term (e.g. during periods of parental leave or a career break) to minimise their loan repayments. This can release the financial pressure on the borrower until they return to work, or re-establish their income stream.
  • It can allow investors to use more of their income to repay loans where the loan costs are non-deductible, such as their owner-occupied property loan. However this is a strategy that needs to be discussed with a financial adviser or accountant to confirm it suits the applicant’s situation.
  • If the borrower’s property is on the market, or they have a large sum of money due to them in the short term, interest only repayments may be suitable to relieve cash flow pressures pending receipt of the money or sale of the property.

Interest only loans are not without risk however – so what are the pitfalls of interest only repayments?

The pitfalls

  • The obvious negative outcome is that the loan balance is not reduced. Therefore, if the property value does not rise, or worse, it decreases in value, the borrower’s equity in the property may be reduced, or in extreme circumstances, the loan may even exceed the property value. For investors, that leaves their strategy in tatters and for the home owner, it leaves them owning less (or none) of what’s potentially the biggest purchase of their life.
  • When the interest only period expires and the repayments change to principal and interest, the loan repayments will increase significantly, leaving the borrower at risk of being unable to afford the loan and of being forced to sell the property to pay out the debt. The repayments increase for two reasons;
  1. The new repayments will include a principal repayment component over and above the interest amount 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.  

To illustrate these points, consider the following scenario.

Mr and Mrs Applicant sign up for a loan of $500,000 over 25 years with an interest rate of 5.00%. They opt for a five-year interest only period, before converting to principal and interest repayments for the remaining loan term.

During the interest only period, repayments will be approximately $2,085 per month. When the initial five-year interest only period expires, the repayments on a principal and interest basis will jump to $3,299. That’s an increase of $1,214 per month for the remaining 20 years, and a lot of money in anyone’s language.

The overall cost of the loan will also be significantly higher under this scenario.

If the loan was repaid over 25 years on a monthly principal and interest basis, the total cost would be $876,885. By electing repayments on a five-year interest only basis before reverting to principal and interest repayments, the total cost is $916,946, a difference of over $40,000!  

Interest only loans often have a higher interest rate. In response to APRA’s concerns, many lenders now charge a premium on the interest rate for interest only borrowings, lifting the rates by as much as 0.25% on interest only facilities.

So, while there are very real circumstances and strategies when interest only borrowings are the most suitable loan structure, the above example demonstrates the risks associated with interest only loans and why APRA are concerned about their use - particularly when the loan is for the borrowers principle place of residence.   

For Switzer Home Loans (and for any good lender), the primary objective is to provide the loan product that best matches the borrowers needs and maximises their wealth. Interest only loans do not always meet this criteria, so if you are considering a loan with interest only repayments, speak with us, your financial adviser, or a loan specialist to identify the right structure for you.  

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

 

| More

 

Should you fix your loan?

Tuesday, June 14, 2016

By Adrian Sheahan

Should I fix my loan interest rate now?

As a credit advisor, this is probably the most common question I’m asked.

Of course, giving the answer is not as simple as asking the question, and like most problems, the answer will reveal itself after consideration of your individual situation.

You should first consider why you are looking to fix the rate on your loan.

For many borrowers, the decision to fix the rate is all about picking the change in the interest rate cycle. By punting on picking the perfect moment when the fixed rates are at their lowest and variable rates are about to rise, you are hoping to lock in a low rate while the variable rises, thus saving yourself interest costs.

So, what you are actually asking me is, “if I fix my rate now, will it be cheaper than if I stay on a variable rate?”

It’s a fair question and the objective is great, but it’s a tough ask to outsmart the banks when their business relies on getting these things correct. It’s also not the best reason to fix the rate on your loan. The reason you should fix your interest rate is to eliminate the risk of loan repayments increasing as a result of interest rate rises. So the question you should be asking me is; “can I afford to take the risk of interest rates rising and my loan repayments increasing?”

It’s an important distinction because fixing the rate on your loan has wider implications than just locking in your rate and loan repayment amounts for a set period of time.

The pros and cons illustrate just what those implications are;

Pros

  • Certainty of monthly repayments for the term of the fixed-rate period
  • Insurance against rate rises, which will increase your loan repayments
  • The peace of mind that the above two outcomes provide

Cons

  • Additional repayments and lump sum reductions may attract penalties
  • If a loan is paid out during a fixed-rate term, large penalties may be incurred
  • If interest rates fall, you will not receive the benefits of lower interest rates
  • Redraw and Offset accounts are commonly excluded from fixed rate offers

So if you fix the rate just to save interest, you may lose the benefit of your offset account, lose the ability to redraw your advance payments, and you may face hefty penalties if you sell your property and pay the loan out before the fixed rate period expires.

Therefore, even if you have picked the rate cycle perfectly, the interest savings could all be washed away by penalties and your loss of flexibility. Furthermore, if you get it wrong, you will achieve exactly the opposite of what you have set out to do because you will pay more interest than if you had stayed on a variable rate.

On the other hand, let’s assume you and your partner purchased a home three years ago with a substantial loan to finance the purchase. You have decided that now is the time to start a family and your partner is taking extended leave care for the new arrival. The extended leave means that your partner’s income is substantially reduced and the surplus cash you have previously enjoyed, is no longer available. You now face the very real risk that increases in rates and monthly repayments will have a significant impact on the core items of the family budget. Can you afford this, or will it place you under significant financial stress? If the answer is yes, fixing the rate on your home loan may be the tool to eliminate that risk until you’re in a position to reduce your debt or your income rises again.

So when asked “should I fix my rate now”, I will ask the following types of questions;

  • Are you likely to make additional repayments or pay the loan out in the short term?
  • Are you looking to sell your property in the short term?
  • Is there likely to be any change in your income, or that of the household?
  • Are you a risk-averse person who is happy to pay a slightly higher rate to guarantee certainty over the loan repayment?
  • Do you use an offset account or a redraw facility?

Although the response to these questions will provide direction, my primary consideration is always, “can you afford the increased loan repayments if rates rise?’

If you are still not sure which path suits you, there is a third option that, under the right circumstances, can provide you with the best of both worlds. Most lenders will allow you to split your loan into separate portions with one having a fixed rate and the other a variable. By having a split loan, if rates rise, you have ensured some level of certainty and protection. But if they fall, you receive some of the benefit from lower loan repayments. By having a variable rate portion, you also maintain a level of flexibility because you can still make additional loan reductions, use redraw etc., on that portion without penalty. Again, this will not suit all borrowers, but it allows you to have your cake and eat it too.

Still not sure if you should fix or not? For some, the lure of potential interest savings will always be the motivation for their decision, but for those who need a little guidance, the best advice I can give is don’t take a punt, but speak with your finance professional or give one of the team at Switzer Home Loans a call on 1300 664 339.

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

| More

 

What your lender really thinks about negative gearing

Tuesday, May 10, 2016

By Adrian Sheahan

In investment terms, gearing means borrowing. So when you engage in negative gearing, the borrowing expenses for the house or property you purchase with the loan exceed the income earned from the property. 

For example, if you borrow to purchase an investment unit and receive $10,000 rent per annum but your costs, such as interest, agent’s fees and rates amount to $17,000, you’re losing $7,000 per year. The Tax Act allows you deduct this $7,000 loss from your wage or salary. So, if you’re currently receiving $50,000 a year in salary, you now pay tax on $43,000 ($50,000 minus $7,000). 

The strategy is only to make a loss in the short-term. In the long run, the value of the property that you hold for say, 10 years, can rise significantly and deliver you a large capital gain, especially if you buy in an area that becomes the next hot spot. In the short-term, you’re still losing on the property, but you are betting that the capital gain on the house or unit outweighs the loss and the eventual capital gains tax you pay. 

So how do lender’s view negative gearing?

When considering this question, it is critical to recognise that first and foremost, lenders are required to prove that their applicant can afford to meet the repayments of any loan they are providing. This is done by calculating the applicant’s after tax income and deducting their living expenses and the payments on any other loans, credit cards, etc. After this calculation is complete, the applicant must have sufficient remaining cash to meet the proposed loan repayment.

How does negative gearing meet this requirement then, if it adversely impacts an applicant’s taxable income (at least in the short term)? To account for the strategy, a lender will make adjustments to their income and expense calculations for a borrower seeking funding for an investment property. They do this by adding the rental payments from the property to the applicant’s income and by making allowances for the tax deductibility of the interest expense. They will, of course, also allow for the added expense of the loan repayment.  

Simple really! But following the pressure from the banking regulator APRA, lenders are taking a more conservative stance in respect to investment lending and the tax benefits of gearing. This has resulted in changes to the way lenders view the following aspects of the income/expense calculations for investors. In particular, 3 main factors have been impacted:

Rental Income Assessment

Lenders now discount the rental income from investment properties in their calculations.  

That is, they reduce the amount of rental income they will use for their assessment. For example, many lenders discount the rental income by 20%. So if an applicant receives rental income of $20,000 per annum from their investment property, and the lender discounts that amount by 20%, the lender is only including $16,000 of the rental income.  If the applicant has several rental properties and each is subject to the same treatment, this can reduce the income in the eyes of the lender by tens of thousands of dollars. 

Tax benefits of interest cost

Under our tax legislation, the interest expense attributable to investment property loans is tax deductible. Although allowable, lenders are now very cautious in using this tax allowance when calculating an applicant’s after tax income, i.e. the cash they have left to pay their loans. If an applicant is relying on a negative gearing benefit to prove their capacity to meet the proposed loan repayments, lenders will have a heightened level of caution and scrutinise the loan more closely, as it is considered a higher risk. Some lenders even exclude this allowance altogether.

Assessment of existing loan repayments

When assessing a residential loan application, lenders add a loading or stress margin onto the interest rate of the loan they are considering. For example, the interest rate most lenders apply to assessment of the new loan is currently in the region of 7.5%, not the 4 -5% the applicant is actually going to pay. Why do they do this? In simple terms, it is to allow for the negative impact on the applicants expenses due to the inevitable rate peaks and troughs through different economic cycles. It is prudent lending to minimise the risk to both the borrower and the lender. Whilst many lenders previously used this practice, the loading that they now apply has increased significantly. To give you an example of how this can impact an applicant’s repayment capacity calculation, I recently reviewed a request where the applicant was paying $1,800 per month on an existing loan. After the lender applied their interest rate loading, the figure they used was almost $3,200 per month. This simple policy rule had added over $14,000 to the applicant’s annual expenses for the loan assessment.

When all of these factors are applied to the calculation of an applicant’s capacity to make their loan repayments, the disparity between actual current income and expenses can be immense and the more investment properties and investment loans they hold, the bigger the difference becomes. When a property (or properties) is negatively geared, this gap is magnified and is often the reason for an investment loan application being declined.

So how do lenders view negative gearing? The answer is that they make allowances for the taxation benefits of negative gearing, but their risk preferences and their policy settings are biased against negatively geared and towards positively geared investors.

If you would like to discuss this further, or want to calculate your borrowing capacity, you can contact the team at Switzer Home Loans today on 1300 664 339.

 

| More

 

7 reasons to refinance and save thousands

Tuesday, April 05, 2016

By Adrian Sheahan

Last year Peter wrote an article under this headline outlining why those of us with residential loans should be giving them a financial health check.  He asked the question ‘Could you tell me your mortgage rate off the top of your head? No? When was the last time you checked it? Last week, last month or last year?’ 

He then provided seven good reasons for you to review your current loan and pick up the phone and talk to a mortgage professional.  Given the changes in the lending landscape over the past six months , now is a great time to review that message.

1. The first, and obvious reason is to save money.

Most people don’t understand how much they can actually save by getting a better deal on their borrowings.  The sums are quite simple and quite surprising. Let’s assume  you have a $500,000 loan and 25 years left on your mortgage. If you go from a 5% rate to our 4.09% rate*, your monthly repayments will drop from $2,922 to $2,664 and you’ll save nearly $78,000 over the course of the loan. 

If you’re smart, you will maintain the $2,922 repayments you are currently making and that will take a further $47,000 from the total loan payments over the life of your loan.

Of course there are some basic assumptions with these numbers as Peter put asked,  If somebody was to hand you a cheque for $135,000, or even $78,000, in 25 year’s time, would you say no?

2. Check the comparison rate

The interest you pay on your loan is not the only cost.  Fees such as establishment fees and monthly fees are a direct cost to you.  These need to be taken into account when you compare loans. 

For that reason, over a decade ago, a law was introduced that required lenders to use rates that incorporate all fees and charges of their product into the one flat rate.

This is called the comparison rate. It meant that if Lender A offered a rate of 6.9% and fees of 0.5%, while Lender B offered a 7% rate but fees of just 0.1%, then Lender B would be able to show it was the cheaper offering by using one flat rate of 7.1%, compared to Lender A’s 7.4%.

If you really want to get an accurate figure of the loan cost, make sure you look at comparison rates – not just the advertised  rates – and ask your lender for a key facts sheet.

3. Simplify the administration of your investments

I’ve seen some awful messes when it comes to loan structures.   Many of the borrowers I speak with have single loans that incorporate both personal and investment debts but can’t tell you how much is attributable to each purpose.  That makes it very difficult to manage your finances efficiently and helps line the pockets of your accountant when you need them to sort it out.

Most residential loans have the capacity to be split into portions.  Use these portions to define the amounts  you have borrowed for different purposes.  That way you can track the expenses for each purpose easily, allocate payments accordingly and save a lot of money in accounting fees.

A jumbled structure can also leave you paying too many loan fees.”

4. Is the repayment structure right for you.

Last year, APRA, the banking regulator turned up the heat on lenders in respect to investment loans and interest only borrowings.  The goal of course was to secure the health of Australia’s banks but it also focussed debate on how loans are, or in the case of Interest Only loans, how they are not repaid.  

Many lenders now encourage borrowers to make Principal and Interest repayments by offering rate discounts for that repayment structure.  This doesn’t mean that a Principal and Interest loans are better,  there are a number of reasons why Interest  Only repayments might be more suitable; but it does mean that you should be reviewing your repayment structure and the options available.

Either way, if the structure is wrong, your strategy objectives won’t be met so ask a professional who can give you the right answers..

5. Moving from a variable to fixed

With interest rates so low, it’s a great time to lock in a fixed rate if that suits your circumstances. 

If you speak with someone who had loans during the days of 15- 20% interest rates, they’ll happily tell you how low rates are at the moment and how much it cost them back then.  Nobody who has borrowed in the past thinks they’ll be at these levels forever. So if you are looking to secure your repayments at these low levels for the next 5 years, why not consider a fixed rate loan.  Fixed rate loans are less flexible in terms of repayments and redraw 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.

6. Security

When investors purchase their first investment property, they commonly use the equity in their owner occupied home to support their new borrowings.  This satisfies the lender’s security requirements, but leaves them with  a mortgage over both their home and their investment property.

The past few years have seen significant growth in property values in many areas with corresponding increases in home owner and investor equity.  If  the borrower has also reduced their debt, they may be in a position to discharge the mortgage over their owner occupied home leaving just the mortgage over their  investment properties.

For many borrowers this is a significant personal goal and financial milestone and one that they are not aware they can achieve right now.

7. It’s easier than you think

A common misconception is that refinancing will take a lot of time and money.  Yes, there is a little time and paperwork but not as much as you would think.    The first step is to do a quick health check to establish if your current loan is unsuitable or too expensive.  That can take as little as 5 minutes and won’t cost you a cent.  As highlighted in point 1, if you could save over $135,000 by making a 5 minute phone call, why wouldn’t you

If these reasons get you thinking, grab the phone and speak with a mortgage professional or go to the Switzer Home Loans website for information on what you should be considering.  5 minutes could save you a small fortune.

*Variable and comparison rate

| More

 

MORE ARTICLES

4 tips to finding the right home loan

Pixel_admin_thumb_300x300 Pixel_admin_thumb_300x300 Pixel_admin_thumb_300x300 Pixel_admin_thumb_300x300 Pixel_admin_thumb_300x300