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The 80-20 rule

Increasing cost of living pressures and rising home prices makes it difficult for some people to get into the property market. No matter how much is saved, it seems as if there is never enough for a deposit.

Typically borrowers should look to save a 20% deposit and a further 5% (if you live in South Australia) for government fees and charges (the amount of fees and charges depend on the state of purchase in Australia). When it comes to purchasing a home, many borrowers are shocked to see much of their hard earned dollars disappear in just paying government fees and charges leaving them little for the actual deposit.

You may wonder what the issue is in not having the 20% deposit. It is about appetite for risk! Lenders typically like lending 80% of the value of a property – and in doing so, will also provide some great deals (as you may see advertised). Go above this 80% ratio and some lenders may charge higher rates for the privilege or have more stringent borrowing criteria that need to be met.

A strategy to retain the 80% borrowing ratio is to use a security guarantee. Essentially this is additional property that the lender can lend against to reduce the borrowing ratio. Security guarantees normally come in the form of a property that family members will allow you (the borrower) to use to borrow against along with the property that is being purchased. For many borrowers, the security property could be a family home that parents own.

The family member guarantees a portion of their property (no more than 20%) to be used as additional security for the purchase. By taking the security guarantee and the property to be purchased, lenders will ordinarily lend against this and the borrower may even enjoy the benefits of reduced rates.

The other benefit to using a security guarantee is that borrowers don’t need to save the full deposit before getting into the housing market! With sufficient security guarantee and the property to be purchased, they typically can borrow enough to cover the full purchase price.

What happens if you are not in a position to utilise a security guarantee? In this case, Lender’s Mortgage Insurance (LMI) may assist. LMI allows you to borrow a higher percentage of a property’s value and thereby requiring a smaller deposit.

The maximum borrowing ratio available with LMI is around 95% of the value of the property. At a minimum a borrower still needs to save 10% (to cover government fees and charges and the basic deposit) however this could assist you in getting into the market sooner.

You may be asking yourself if LMI means that you don’t need to save as much, why doesn’t everybody just save the bare minimum and utilise this? LMI is a fee for risk and is calculated using a number of parameters – including the actual loan size and the lending ratio across bands. The net effect is that lenders mortgage insurance could add tens of thousands of dollars to the loan! Lower borrowing ratios typically means a lower premium, but for those borrowing closer to 95% then the premium can increase almost exponentially! Therefore this needs to be carefully considered as a cost to your purchase.

Remember that in any case, you also need to demonstrate enough income to cover the cost of repayments!

If you are looking to get into the property market but feel you are not making headway with the deposit, consider options such as a family guarantee or LMI. They both have pros and cons and need to be considered diligently but this might just be enough to get you into your home sooner!

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The unexpected rate rise

1501 - interest-rates

APRA – (Australian Prudential Regulation Authority) has recently set some guidance on our lending institutions should be dealing with the recent flurry of lending.

Many lenders have been finding that their lending has predominantly been geared towards investment. APRA has been looking to curb this. In fact, they have imposed some limits on lenders in relation to their investment portfolio. Lenders have been asked to curb their investment lending growth to 10% of their previous year.

How does a lender reduce lending without reducing returns?

Quite simply. They increase their interest rates.

Currently many lenders have been increasing their interest rates for investment loans, intending to slow the amount of investment debt to co-incide with APRA recommendations.

However, the side effect – that many people have not realised – is that this increase to interest rates is not only to new loans, but also retrospective to existing investment loans.

This is where many Australians are about to be caught out. Unknowingly, their investment rates have increased by about 0.3% (on average) in the last couple of months.

Though some investors may not be overly fazed by this, there is a small group of people that will be affected (some unknowingly) by this increase without understanding why.

Some borrowers may purchase a property as an investment initially, but through life changes, may end up moving into the property. Unknowingly, they are living in threir home with an investment loan. Until recently, that wasn’t an issue, but with the recent rate rises, they will have an inadvertent rate rise solely because the loan initially was an investment loan.

PURPOSE OF FUNDS

Lenders determine if a loan is an investment or owner occupied loan by the initial purpose of the loan. If the loan was used to buy a rental property – then it would typically be an investment loan. Of course if you took a loan to buy the place you live in, then it would be an owner occupied loan.

But, you may have purchased a property to rent out intially, but later in time, choose to move into the property. You may have kept paying the loan (which is fine) without too much concern. However lenders have been increasing any loan where the intial purpose of the loan was for investment purposes. This means, if you moved into a property that has a loan that was initially intended to be for investment, the loan may be liable for a slight rate rise.

Why pay more than you need to?

There is no need to so. If you want to find out what you can do to ensure you aren’t paying investment rates for a property that you are living in, contact us today, and we will discuss your situation in more detail and give you options on moving forward.

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