While the Reserve Bank is playing nice before Christmas, with many predicting that they’ll keep official interest rates on hold until next year, it looks like the banks will be struck off Santa’s gift list as they play naughty.

It’s expected that a number of the big banks will flout the RBA’s decision to maintain cash rates at their current level (4.5%) during their August 3rd meeting, in favour of an increase in retail rates intended to offset increased funding costs and declining profit margins.

While the banks’ net profits have been in the billions for the most part – as recently reported by the CBA – lenders are now contending with a rise in funding costs as a direct result of the GFC, which forced them to seek more expensive, largely offshore funds. This, combined with the banks competing for business by offering enticing savings deposit rates (in some instances higher than the home loan interest rate), are both taking a toll on banking profits…and we all know how much banks like a good profit!

As discussed in our feature article this month, now might be a very opportune time for borrowers to consider fixing a portion of their debt, before the banks make their inevitable move.

I’m not really a betting man, but odds are pretty good that the experts’ predictions will be realised sooner rather than later, and hedging some of your debt against not only the banks’ impending interest rate rises, but the RBA’s (we all know they won’t be this low forever), isn’t such a bad idea. 

Here is a small snapshot of some of the more interesting transactions we’ve seen over the past few months.

Settlement Date – 3/05/2010

Client – Local Canberra – 1550

Purchase type – Investment

Purchase price – $642,000

Transaction type – off Market – private treaty – used a buyer’s agent to acquire

Suburb – Coogee, Sydney

Property Type – 2 bed apartment + study

Attributes – big block of land with only 12 apartments on the site and communal BBQ area set high on the hill, single lock up garage. Only 400m from waterfront with views of Coogee beach. The client undertook a $26k renovation that included a new laundry (new flooring and installation of a washing machine/dryer combo), built in linen cupboard, new cooking appliances, fresh paint, new robes with mirrored doors and replaced ceiling. The kitchen and bathroom had already been recently updated. The apartment was tenanted in the middle of winter for $550pw, with a 15 month lease, so the property can be re-let during the peak summer period. This is a well located property purchased for capital growth potential.

Settlement Date – 09/06/2010

Client –Local – 1998

Purchase type – Investment

Purchase price – $500,000

Transaction type – On Market private treaty – used a buyer’s agent to acquire

Suburb – Bondi Junction, Sydney

Property Type – 2 bed Unit

Attributes – Bought with the view of capital growth. It is very difficult to secure a 2 bedroom unit in this area for less than $600k. The property, which is in a complex of only 12 units, also has off street parking and is tenanted for $500pw.

Settlement Date – 23/07/2010

Client – Local – 2141

Purchase type – Investment

Purchase price – $500,000

Transaction type – Ballot land release

Suburb – Gungahlin, ACT

Property Type – Vacant residential land

Attributes – This block was purchased for $450k 12 months ago. There is a shortage of land in the location and these clients have enjoyed a nice gain over the past year.

Settlement Date – 30/07/2010

Client – Local – 2240

Purchase type – Investment

Purchase price – $370,000

Transaction type – Private sale

Suburb – Mt Gravatt, QLD

Property Type – 3 bed townhouse in a complex of 20

Attributes – Good location with off street parking. The recent softer market made for good buying, with the added bonus of a motivated vendor and a great managing agent. The client is returning to the property market after a few years’ hiatus to add to their family.

Settlement Date – 25/08/2010

Client – Interstate – QLD – 2287

Purchase type – Investment

Purchase price – $375,000

Transaction type – On market – private treaty

Suburb – Cannonvale, QLD

Property Type – Vacant block of land

Attributes – Expansive ocean views. This property was purchased in a SMSF structure.

Settlement Date – 27/08/2010

Client –International – USA – 2246

Purchase type – Investment

Purchase price – $582,000

Transaction type – On market, Auction

Suburb – Macquarie, Canberra

Property Type – 5 bedroom house with ensuite & double lock up garage

Attributes – The property is located in close proximity to Belconnen Mall (Westfield) and will rent for $440pw. It was purchased by telephone from OS and the owners intend to reside here once they return to Australia.

Property investors and home owners were given a much needed reprieve this month as the Reserve Bank decided to leave the official cash rate of 4.5% unchanged for the third consecutive month, at its August 3rd meeting.

The RBA’s decision came as the June quarter Consumer Price Index (CPI) rate of inflation was a lower than expected 3.1%, just outside the central bank’s target band of 2 to 3%.

In a statement regarding the decision, RBA governor Glenn Stevens said, "With (economic) growth likely to be close to trend, inflation close to target and the global outlook remaining somewhat uncertain, the board judged this setting of monetary policy to be appropriate."

While there are now signs of a slow recovery for most of the major world economies, uncertainty surrounding jobs growth and a deceleration in the housing market has seen Australia’s economy soften in recent months.

Australia’s seasonally adjusted unemployment rate increased to 5.3% in July, which CommSec economist Craig James said was not surprising given a slump in retail spending and more caution from the manufacturing and services sectors. 

He said, "The good news from today’s figures, in terms of interest rates, is that interest rates are clearly on hold until at least the end of the year, with most economists talking about 2011 as the next move."

Now is not the time for borrowers to become complacent with regard to the status quo of interest rates though. With most economists predicting that the RBA will take a wait and see approach until the beginning of next year, it’s a good time for those with a home or investment loan to consider restructuring their debt and hedging their bets against the next inevitable set of rate rises, by fixing a portion of their borrowings. 

For the first time in a while, 3 year fixed rates are closely aligned with the discounted variable rates on offer by most lenders. This represents great value considering the economy is likely to strengthen in the near future, causing a rise in inflation and the RBA to hike up interest rates accordingly.

Some estimates suggest that the official rate could peak at 5.5% by the end of 2011. But more concerning is the impending move by banks to increase their retail rates, regardless of what the RBA does, due to higher funding costs.

With these factors in mind, many in the brokerage industry are currently advising clients contrary to our general belief that you will always come out on top if you stick with a variable mortgage. On occasion we see a window of opportunity to fix some debt and actually benefit from such a move – and now is one of those times.

Many borrowers can fix with their current lender without having to change banks, therefore saving on refinance fees; particularly if they are willing to do a bit of negotiating by asking their lender to match, or get close to, some of the more attractive fixed rates on offer.

Some of the more appealing fixed rates right now include the Heritage Building Society (6.95%) and ING (7.09%). If you want to stick with one of the four majors, Westpac comes out on top with 7.19% fixed for 3 years, followed by the CBA and NAB at 7.29% and the ANZ at 7.35%.

These are all quite tempting options, given the current discounted variable rates range between 6.70 and 6.81% and in many instances, the difference between variable and fixed within individual lending institutions is only around 0.5%.

For borrowers who appreciate the security a fixed term brings, or fear the uncertainty of what lies ahead for interest rates; this is an alternative well worth considering. 

As mentioned in my intro and the feature article on mortgage managers, the NAB has recently announced it’s acquisition of James Packer’s Challenger (now known as Advantedge) and made a commitment to fund mortgage managers without the need for securitisation, meaning increased competition in the lending industry and more options for borrowers.

Most banks have increased their stress testing for new loan applications and some of the resulting changes we have seen include; an increase in the living allowance, called the Henderson Poverty Index (AKA HPI) and lenders now assessing the loan applied for and other facilities held as if they were all Principal and Interest, even if the new loan requested is Interest Only.

With the RBA’s three consecutive increases to the cash rate over the past 6 months, fixed rate options from lenders have increased dramatically over the last 8 weeks. As a result it’s very hard to justify taking on a fixed rate loan at the moment. Here’s a snapshot of who’s offering what;

As at 10th December 2009

Over the last 3 months we’ve discussed the first three “C’s” that are used by lenders to assess all loan applications, being Character, Collateral and Capacity. In this issue of the Trilogy Report, we consider the fourth and final “C” – Capital.

As the term suggests, “capital” is all about how much you are able to contribute to the transaction. In other words, how much cash are you chipping in as a deposit? Capital is the bank’s barometer that helps them to assess how committed you actually are to the deal and as such, it speaks volumes in your application.

For instance, are you seeking 100% finance or are you only asking for 60%? Now, picture yourself as the credit officer; are you more likely to approve a loan at 60% or 100% of the asset’s total value?

As you are probably already aware, the lower the level of funding sought (what we call the Loan to Value Ratio or LVR for short), the less risk the lender is taking, as a higher degree of risk is transferred to the borrower.

This is essentially due to the fact that if you default on your loan and fail to make the repayments, forcing the bank to sell off the asset, the bank risks losing less of their funds if a larger deposit (or a higher proportion of capital) is offered by you at the outset.

In other words if you pay a 40% deposit and the bank provides you with the balance of 60%, while you will lose your contribution in its entirety, the bank only has to recoup 60% of the original sale price of the asset in order to break even and recover their funds. Hence, a larger deposit and therefore a smaller LVR makes your loan application more appealing, as the banks have greater peace of mind in knowing that should things go pear shaped, their money is more likely to be safe.

What you, as the borrower, need to realise is that Capital is effectively the lynch pin of your deal and depending on the size of your deposit, can make or break your loan application. Basically, a substantial deposit can pretty much get any loan over the line.

I once heard someone say, “You can insure a burning house for the right premium” and essentially, the same applies to getting the nod from your lender; you can virtually get any loan approved with the right amount of deposit or Capital.

So let’s have a look at some examples of how Capital can sway the banks in your favour, even though your application may be lacking when it comes to any of the other three “C’s”…

Assuming your loan application is light on Character (you might have defaults on your credit report, be new to the country, have slow credit accounts, etc). An offer of more upfront Capital can override these glitches and persuade the bank to say yes. This is because you are reassuring them that although you may have made some mistakes with credit in the past, or they may not be certain as to your commitment to the deal, your contribution of a larger deposit is proof that you are indeed a “safe bet”.

What if your application is supported by security (Collateral) that will be difficult for the lender to sell in the event of a foreclosure? It could be a retail shop front in a street that has a high level of vacancies or a block of 6 units in a small country town for instance. From the lender’s perspective, both of these scenarios carry a higher level of risk than normal residential housing in the suburbs. They might look at that collateral unfavourably because if they are forced to sell and recoup their debt, they could have trouble finding a buyer willing to pay the necessary price.

In this situation, the lender will ask you to assume more risk and contribute more cash (AKA “hurt money” or “skin in the deal” for obvious reasons), thereby lowering the LVR and reducing their risk. By failing to provide the extra cash, you are essentially sending a message to the lender that you are not as committed to the whole transaction as you expect them to be.

In recent times, many property investors were unable to provide evidence of Capacity in the conventional way; in other words, they could not necessarily assure the banks that they could meet the required repayments for the amount they were seeking.

This may have been due to the fact that a large portion of their income consisted of cash, or they were behind in their tax returns. In this situation, the lender would ask the borrower to increase the deposit on their application to assume more risk and in turn, they would overlook this Capacity shortfall.

They would offer the applicant a “Low Doc loan” and although these still exist to some degree today, the banks now require extra evidence in order to get them across the line. They have also reduced their exposure to them by forcing the borrower to contribute more cash to the deal; hence lowering the LVR “just in case” the borrower cannot meet the repayments.

Now throughout these last few paragraphs I’ve been using the terms “cash” or “deposit” when discussing the possibility of reducing the LVR to entice the lender into approving your loan application. What I have failed to mention however, is that this money can actually be borrowed from another source or against other security. This means you can still gear at a higher level, say 100% or even 106% to cover all costs; it just might mean you have to approach two different lenders to secure funding.

Let’s look at an example of how you might do this if you decided to purchase a retail shop front for $600,000;

In Diagram 1, we are contributing the deposit and closing costs using our “saved up cash”.

In Diagram 2, we buy the same property but pull the deposit from another property that has a Line of Credit against it and is possibly held with another bank.

As you can see, the lender is happy with a reduced LVR at 70% and the borrower wins too as they essentially managed to secure106% funding.

Of course there are some industry standards applicants must meet when it comes to the amount of deposit required to buy a property. Here’s a bit of a guide as to how much deposit lenders will ask for on individual securities, assuming the applicant’s Character, Collateral and Capacity are favourable.

Keep in mind as you read through the following that your closing costs, such as legal’s, rates adjustments and stamp duties, are payable in addition to the deposit. As a guide, approximately 6% of the property’s purchase price is usually ample to meet all of these and in some states you’ll need a bit less. It goes without saying that you should cross check all associated purchase costs before you buy. Now, back to the required deposit amount for various securities…

• Residential houses in the suburbs – 20% to as low as 5%, depending on whether or not you want to incur a lender’s mortgage insurance fee.
• Block of 6 units on single title – Typically 40% is needed, but some lenders will go as low as 30%.
• Commercial property such as a retail shop – same as per a block of units in the above example.

With the understanding that Capital is effectively the make or break aspect of your loan application, you have the capacity to buy any property you like – as long as you are prepared to save the necessary deposit to get the bank’s nod of approval. In other words, the property you can buy will only be restricted by the amount of deposit you are able to contribute.

As a rule of thumb, a smaller deposit paid to the lender usually equates to a higher interest rate and additional fees. It is very much user pay and remember – there are no free lunches when it comes to the banks!

Settlement Date – 30/10/2009
Client – Interstate Brisbane – 1783
Purchase type – Investment
Purchase price – $526,000 -
Transaction type – On Market – private treaty
Suburb – Clear Mountain, near Brisbane
Property Type – Vacant Block of Land
Attributes – Large elevated block of land with city and farmland views, purchased to build large owner occupied Taj Mahal.

Settlement Date – 30/10/2009
Client –Local – 2019
Purchase type – On Market private treaty
Purchase price – $335,000
Transaction type – Owner Occupied work transfer
Suburb – Port Macquarie
Property Type – Established
Attributes – 3 bed with ensuite and double garage in a nice part of town near the water.

Settlement Date – 27/10/2009
Client – interstate Brisbane – 1638
Purchase type – Investment
Purchase price – $690,000
Transaction type – On Market – Private Treaty
Suburb – Currimundi, QLD
Property Type – Currently a 3 bed with ensuite shack made of Bessa blocks
Attributes – Located 150m from the beach, this property was bought for the land content only. The client intends to demolish the existing dwelling to construct a new home at a cost of $400k. it is expected that the property will be worth approximately $1.1m upon completion. The client specialises in purchasing tired houses, renovating or redeveloping them and revaluing to extract equity. They typically buy 1 to 2 properties a year and have successfully done well with more than 10 such deals across the Brisbane area.

Settlement Date – 23/10/2009
Client – Interstate – 1602
Purchase type – Investment
Purchase price – $380,000
Transaction type – On market – Private Treaty
Suburb – Manly – Inner Brisbane
Property Type – 3 bed townhouse with 1 bath and single lock up garage, 100m2 living area
Attributes – Four streets back from beach, the client used a buyer’s agent to source this property as they are in the Army on deployment. Currently renting for $380pw.

Settlement Date – 09/10/2009
Client – Local – 1545
Purchase type – Investment
Purchase price – $485,000
Transaction type – On Market
Suburb – St Kida, Melbourne
Property Type – 2 bed unit with single bath and off street parking
Attributes – Car space has its own title. St Kilda is a very trendy and popular area and it is anticipated that this property will rent for $470pw. The client used a buyer’s agent to source this investment property as she was buying into an area she was unfamiliar with.

Settlement Date – 23/10/2009
Client – Local – 1120
Purchase type – Investment
Purchase price – $195,000
Transaction type – Off the plan town house
Suburb – Queanbeyan, ACT
Property Type – One bedroom unit on first floor with LU garage.
Attributes – Living area is 35m2. The property was bought from a developer around12 months ago, but has only just settled due to garage and boundary issues with Council. Rented at $245pw.

Settlement Date – 23/10/2009
Client –interstate, Victoria – 1678
Purchase type – Block and build
Purchase price – $295,000
Transaction type – construction
Suburb – Point Cook, VIC
Property Type – 3 bed with single garage, entry level property
Attributes – Located close to a new shopping centre and public transport and only 20 minutes from Melbourne CBD.

Settlement Date – 13/10/2009
Client –Local – 2004
Purchase type – Investment
Purchase price – $445,000
Transaction type – On market, Private treaty
Suburb – Flynn – Canberra, ACT
Property Type – 4 bedroom with ensuite, double lock up garage and in-ground pool
Attributes – Close to Belconnen Mall (Westfield), this property will rent for $440pw

Settlement Date – 26/10/2009
Client –interstate – Sydney – 1653
Purchase type – 2 bed unit
Purchase price – $255,000
Transaction type – on market found through realestate.com
Suburb – Wiley Park (Punchbowl area), Sydney
Property Type – 2 bed unit wit off street parking
Attributes – Renting for $340pw, the property had been re carpeted and painted by the vendor.

Settlement Date – 13/10/2009
Client –interstate– Victoria – 1618
Purchase type – Investment
Purchase price – $350,000
Transaction type – Auction
Suburb – Soldiers Hill (near Ballarat), VIC
Property Type – Two x 2 bedroom units and one x 1 bedroom unit
Attributes – 3 units on a single title which means multiple tenants and multiple income. All three are currently renting for $355pw, but with a cosmetic make over this is expected to increase to around $520 pw.

Settlement Date – 27/10/2009
Client –Brisbane – 1562
Purchase type – Block and build
Purchase price – $484,000
Transaction type – construction
Suburb – Warner, QLD
Property Type – 4 bed ensuite with double garage and attached 2 bed flat with single garage
Attributes – Comparative sales in the area suggest that this property will be worth approximately $550k on completion, with the flat renting for $300pw and the house for $370 pw.

Settlement Date – 26/10/2009
Client –Local – 1627
Purchase type – Investment
Construction price – $157,265
Transaction type – Construction of dual occupancy on back of existing investment property
Suburb – Hamlyn Heights (Geelong area), VIC
Property Type – construction of a new 3 bedroom home with ensuite + double lock up garage – around 123m2
Attributes – This client specialises in buying large blocks in this area, building on the back and then splitting the titles. They bought the original house in June 2008 for $245k and the end valuation for both properties upon completion will be around $490,000, which spells an $88k gain over both. They will be held and tenanted for $250pw for the old front house and $350pw for the new back one. The client’s wife does it all by satellite!

Over the last few years Developer’s Edge have managed to help many clients achieve extraordinary results in property by using developer strategies with their next property investment. The team at Developers Edge provide a one stop shop approach in helping investors create wealth in property. The key services that the company provides are:

• Identifying suitable properties
• Conducting a feasibility analysis
• Assisting with negotiation
• Conducting a due diligence investigation in order to determine the suitability of the site
• Assist with town planning applications
• Construct dwelling
• Provide regular feedback
• Co ordinate sales or rental

Nick approached us initially in 2005 after a recommendation from Ed Nixon. Nick lived in Canberra, where he worked as a contractor assigned to work for the Defence department. We had several conversations over the telephone on the type of development opportunities available and the funds required for each. In the end, it was decided that we were to look for an old house in an established area that could be subdivided to create two new detached dwellings.

We spent a few weeks looking for an available site and eventually found an old run down house that had been on the market for several months. It was initially listed for $340k however, the vendors were motivated sellers and through some good negotiations we managed to help Nick secure the block for $290k.

We chose to focus our research in the Redcliffe area, as we identified this as an undervalued suburb that had good scope for future growth. Redcliffe is located approximately 30km north of Brisbane and is a highly desirable locality due to its proximity to the water. The other main feature of the area is its position; being on a peninsula and surrounded by water means land supply is limited. Most of the land there has been developed and the way forward seemed to be through redevelopment.

Demolition began soon after settlement.

The site was acquired in November 2005 and the project was finished in August 2006. The total time for the project was ten months. The feasibility report below shows a summary of all the costs associated with the project and the overall profit in the project. The end values were determined by a bank valuation on project completion which was conducted by Nick’s bank.

At the end of the project we were able to organise tenants for Nick and each property was rented out for $360.00 and $340.00 per week.

As we were nearing completion Nick decided that he would like to repeat the process again. Therefore, soon after we were able to find a site in Scarborough, another suburb in Redcliffe. This time the 809sqm site was acquired for $329,250, however it was on a single lot. This means we had to apply for a Development approval and pay extra council contribution charges. The project also took a lot longer to finish. Regardless of the extra costs associated with this project, Nick still made a profit of $110 000.00 on completion.

Currently, Nick and his partner Jill are having time off investing while they focus on a new arrival in the family. They have accumulated a lot of equity as a result of using a developer strategy with their property investing and once Jill is back at work, they will be ready to continue with their winning ways.

Mortgage managers are finance specialists who organise funding for property investors and home buyers from numerous sources. Their role is to not only arrange the necessary funds for your property loan, but also manage and administer your loan for its duration, from credit assessment right through to monitoring your repayments, applicable insurance and renewals, interest rate adjustments and any variations for the life of the loan.

Many prospective borrowers are not fully aware of how mortgage managers operate (or even their existence for that matter!), and as such are concerned as to their safety and reliability. The fact is mortgage managers do not represent any type of issue for borrowers and can be of great benefit, as they do not lend their own money for home or investment loans, but instead source their funds from a variety of independent lenders. In other words, they do not act as banks or take deposits.

Mortgage Managers use many different sources to arrange funding for home and investment loans, including unit trusts, superannuation funds, securitised funds and even the banking sector. In fact a common source of funds for mortgage managers are some of the smaller banks that do not have extensive and costly branch networks, which allows mortgage managers to pass on their more competitive rates to clients.

The mortgage manager is not responsible for any funding at the end of the day, as the original provider of the funds (who works through a trustee) owns the mortgage in entirety. The trustee’s role is to ensure that the mortgage manager is professionally and appropriately managing your mortgage on a daily basis.

For instance, if your mortgage manager ceased operations at any time over the duration of your mortgage, the trustee would appoint another mortgage manager to continue administration of your mortgage under new management.

Mortgage Managers are a great asset to borrowers, for two reasons.

Firstly, because they have their own DLA’s (Delegated Lending Authority), if they like the application they can approve it on the spot without referring to the funder. This usually results in faster approvals and gives them the ability to pick and choose the type of business they’d like to have on their books.

And secondly, they are competitively priced. An example of this is a mortgage manager called Choice Lend (Funded by NAB), who are currently offering investment loans for 5.80%, which is not bad when you consider that Westpac are charging 6.06% for their comparative product.

Mortgage Managers are certainly worth considerating now that NAB is one of the major underwriters in the market.

Last month I said that lending policy had normalised… How wrong was I? Since making that announcement, the Westpac group (Westpac, St George and Rams) have announced major changes to Low Doc loans and want to see Business Activity Statements with all new applications.

Now I know I’ll get chastised by investors, but in my opinion this is a good move. The fact is Low docs have been abused by brokers and consumers for too long and I can comfortably make this claim because we fielded many phone calls from investors we simply couldn’t help because of decreasing property values and the fact that they were too highly geared in the first place. With the new rules in place, if you want a fair interest rate on your low doc loan, you need to provide BAS statements for a 12 month period. There are still Low Doc loans about that don’t impose this BAS requirement, but the interest rate reflects the risk, with the average rate on one of these packages currently at around 6.87%.

Now on to this month’s gossip that we are hearing around the traps…

• NAB has been given the all clear from the ACCC to acquire the Challenger group
• The Bank of Queensland is still for sale
• Suncorp still cannot find a buyer

To keep you informed and in the bank loop, so to speak, here’s a snapshot of some the lending policy changes we’ve seen recently;

Adelaide and Bendigo Banks

With rising interest rates, these two banks are well positioned to reclaim some market share this new calendar year, as they are 96% retail funded by depositors; meaning as rates rise, so too will their margins ahead of deposit rates. They have reported that their focus this new calendar year is on growth through home lending via their third party and direct channels. Let’s hope they can create some competition for the majors.

ANZ

ANZ have made a change to their professional package, reintroducing the 0.7% discount if you borrow over $250,000 in aggregated borrowings. Whilst they are saying this is a special offer, the last special they ran lasted for 2 ½ years!

Bankwest

Bankwest withdrew their rate tracker product, which guaranteed to be 0.9% below the 4 majors for the first 3 years before reverting to their basic discounted rate. This has been a popular product, but due to poor service levels in processing the loan wasn’t supported as well as it probably deserved.

ING

Released their online everyday account (Orange Everyday) which will become very popular; it doubles as a Visa debit card and soon to be announced offset facility. There are also some very attractive features like access to 26,000 ATM’s in the country fee free (as long as you do cash outs of more than $200). In addition, there are a bunch of other attractive offerings including a payment from ING to you, the customer, if you withdraw funds via EFTPOS. ING finally have a full banking solution for investors. Look out majors here come the Dutch!

Actually I’m so impressed with it that I’ve opened one myself! If you want to know more about this facility, please click here.

NAB

I usually don’t have much to write about the NAB because they are a relatively bland lender when it comes to investor offerings, but this month they have brought something out which is of interest to the beginning investor. If you borrow over $250,000 and keep your Loan to Value Ration at or below 75% they will give you 0.8% off their standard variable rate. Usually this sort of “extra” discount is reserved for someone borrowing in excess of $1,000,000. Well done NAB!

St George / Westpac

The Westpac group tightened Low Doc qualifying criteria by requesting Business Activity Statements for all new loans where self certification of income is used. Unfortunate, but it is a sign of the times. If you need a low doc loan there are still options available outside of the majors.

Rams

Increased their rate by 0.35% off the back of the RBA (everyone else just went the 0.25%). The media gave them some negative press, but neglected to mention that they still have a cheaper rate than the majority of lenders! No more low docs in company names over 60 % and all require BAS’s.

Collateral

Last month we discussed the second “C” of credit – Capacity and this month we’ll take a closer look at the third critical “C” – Collateral. Put simply, collateral is what you offer the bank as security over the loan you are applying for and could be a term deposit, a business (as security for a business expansion loan) or commercial or residential real estate, to name a few examples.

All of these represent potential collateral that you can offer your lender as security, in the unfortunate event that you cannot honour your repayments.

The type of collateral you present to the bank will dictate the lending percentage they will approve against that security for your new loan. This is known as the “Loan to Value Ratio” or LVR. Essentially, the lender will assess the security you are offering over the loan (generally by sending out an independent valuer to conduct a sworn valuation) to determine whether its value is sufficient to cover your required borrowings, as well as how easily they can liquidate (or release) it to recover their debt if necessary; the latter being of the most significance to the lender because let’s face it, that security is their only fall back option if you default on your loan and they need to recoup their loss.

When a valuer visits one of your properties to make their assessment, they are not just putting a price on it. Rather, there are a number of factors taken into consideration when they write their report to the lender, including;

• recent comparable sales that have occurred in the area,
• the likelihood of the value of your property reducing over a given time.
• the marketability of the property if a sale is required
• overall location and neighbourhood and how these factors could impact on resale
• a risk rating
• any environmental issues that could impact the value of your property over time

As you can see from the above list, the valuer’s assessment is largely seeking to determine how well the property offered as collateral would retain its value, along with its potential for resale over the long term. From the valuer’s report and depending on the property’s liquidity, the bank will determine its acceptability as sufficient collateral for the loan you are applying for. However a word of warning – not all lenders like all forms of security and many have certain preferences.

Because liquidity is really the key to the lender’s acceptance of any type of collateral over your loan, let’s consider this factor in more detail. The term deposit you offer as security would be able to secure a loan of equal value because it is highly liquid – in other words the funds can be released and secured by the lender relatively quickly. On the other hand, that small student accommodation you’re looking to buy and offering as collateral may only be able to support around 50% of the loan because it is perceived as a risky investment that could be difficult to resell given certain market conditions. All of this is about liquidity.

So how is liquidity determined? Here are some of the common factors considered by lenders when assessing the liquidity of the collateral on offer by loan applicants;

• How many comparable properties have sold in the last 3 months? In other words – is the area popular with buyers and therefore do properties move within a reasonable amount of time on the market?
• Can the market absorb the sale in a timely manner?
• Is this a common type of property for the area or is it an orphan that could take longer to move?
• Are there buyers willing to purchase this property?
• How might the local economy impact on the property’s resale potential? Eg. Regional areas that have only one industry propping up the local economy can be seen as carrying higher resale risk and less liquidity by the banks.
• Market segment conditions, ie. what segment of the market is this property in and how is that segment performing overall?
• What is the state of the market at the time of valuation – buoyant, balanced or declining?
• What is the predicted state of the market for the next 2 to 3 years?
• What other properties of a simular nature are coming up for sale? Ie. A large release of units in a CBD area?
• What condition is the property in? Does it need major repairs, is it tenantable, etc?

Collateral is one of the easier “C’s” to grasp because there are some general rules of thumb when it comes to determining loan to value ratios and it is quite a simple issue to discuss with your lender. Basically, all you have to ask of your bank is, “Do you lend against this type of security and if so what LVR would you borrow up to?”

So what are those general rules of thumb that the bank considers when it comes to collateral assessment? They include;

• Term Deposits – up to 100% equal loan to value ratio
• Median priced residential real estate – up to 95% LVR
• Fixed and floating charge over a franchise business – around 50 to 70% LVR
• Commercial office space with a tenant – up to 70% LVR
• Single student accommodation – around 50% LVR
• Speciality security like gymnasiums, caravan parks, service stations, hotels, rural holdings, vineyards and undeveloped vacant land is all assessed on a case by case scenario, but as general rule – maximum funding of around 50% LVR

With the radical shake up that has occurred within the lending market off the back of the global economic crisis and last year’s mortgage meltdown in the US, banks are undeniably beginning to reduce their appetite for risk and tighten their purse strings. As a result, we have recently seen a marked reduction in the types of security they will accept and a much more cautious assessment of collateral offered by finance applicants. An example of this is properties held in regional, single industry towns where the LVR has been reduced in many instances from 95% to 90% or sometimes even 80 to 85%.

The bottom line is; the more attractive, sellable and marketable and therefore the more liquid your collateral is, the more likely the bank is to say yes to a higher loan to value ratio and your overall application.

As I present each of these four critical “C’s” of Credit, you are probably beginning to realise that the initial 3 “C’s” – Character, Capacity and Collateral all play an important role in your loan application. Next month, I’m going to cover the final and fourth “C” of Capital. This is the one “C” that is the most negotiated within your loan application and if you are deficient in any of the other three “C’s”, Capital represents your bargaining chip to get the bank to buy your deal.