Finance advice
Kevin Lee

Investors FYI - How the banks work

By Kevin Lee

In the movie 'Wall Street: Money Never Sleeps' Michael DouglasDouglas, QLD Douglas, QLD sums it up perfectly - today's society is ruled by debt and banks are no exception.

Blogger: Kevin Lee, founder, Smart Property Adviser

The Fractional Reserve System (which all banks operate on) is one that allows banks to borrow your funds in order to lend it someone else (technically speaking).

Here's how it works; bank A's fractional reserve rate is 10% and you give them $100,000 of your money to place into a savings account, they're obligated to place $10,000 in reserve ( out of your $100,000) and lend out the remaining $90,000.

Obviously when they lend out the remaining $90,000 they will charge interest. Let's say Bank A pays you 2% interest for saving with them, and charges 6% interest on the $90,000 they lend out.

Over 12 months the bank will pay you (the saver) $2000 or 2% interest for your $100,000 deposit. However the borrower with the $90,000 loan will pay the bank $5,400 interest. So the bank makes money from lending your money to others.

Due to this banking regulation, all banks must ensure their borrowers can repay the funds borrowed funds, plus interest, so they have what's known as a 'risk grade' for different assets.

Here's a tip for all investors: if you're smart about it, you can use this information to identify which asset class is the "safest" place to put your hard earned cash.

Just follow the banks' collective "lead" in relation to where they perceive risk is and where their comfort zone sits.

Remember that our banks and other lenders are in the business of making money by lending money - they're experts at risk analysis. They have to be if they want to get their money back!

So they assess their lending and interest rate on offer using a simple explanation: 'rate for risk'.

Which translated into English means: the riskier the security, and/or borrower and/or business venture then the lower the percentage (lower LVR) we will lend you against that security and the higher the interest rate we'll charge you will be.

How do you follow their lead? By identifying the Loan to Value Ratio (LVR) that your bank will lend against each of the three primary asset types.

Remember - the riskier the bank perceives the asset to be, the lower the LVR they'll be willing to lend against it.

It's interesting that the major banks and other lending institutions will lend up to 95% against prime residential real estate at 3 year fixed rates as low as 4.79%. Some variable rates are now also around 4.80%. These are historically low rates!  However these same lending institutions will lend a maximum of 65% against the value of prime commercial real estate and depending on your risk assessment as a borrower, the interest rate on this commercial property will most likely be between 6.00% and 8.5%. NB - some lenders will still lend up to 75% on commercial property at a higher interest rate: usually an extra 1%.

What about the Stock Market? Everyone knows someone who's made a killing in the stock market over the past year, don't we. Really?

Well here's what the Big Four banks think of shares as security for a loan.

When you borrow to purchase shares and use the shares as security for the loan it's referred to as a Margin Loan. For the uninitiated the maximum LVR they're willing to lend to can be a shock to the system. In fact most shares are not acceptable as security for a Margin Loan - especially if you're purchasing shares in just one company. That's considered to be even more risky.

For example - buy 20,000 Telstra shares on their own and CBA will lend you just 65%. Buy them as part of a portfolio and they'll lend to 75%.

Guess what CBA thinks of CBA shares as the security for a loan - exactly the same. 65% for stand alone shares vs 75% if they're held inside a portfolio.

Want to splash out on some mining shares do you? Maybe you might want to rethink that: shares in many of the listed mining, energy & resource companies will only get a 40% LVR inside a portfolio and zero as a stand alone purchase.

And if you're borrowing on a Margin Loan to purchase shares - be prepared for the interest rate to be upwards of 9%.

Remember - the bank's #1 job is to make money and hand in hand with that is their assessment of risk.
So, what does this all mean for you?

Simply this: If you want to invest wisely and safely, you would be well advised to follow the Banks' lead. If they perceive residential real estate as being the asset class with the least risk, then you should consider residential real estate as your primary investment choice.

Unfortunately not every residential property is a smart investment opportunity. If you don't know how to identify the right properties, you run the heavy risk of investing in a property that is negatively geared, will cost you money and will restrict you from growing your portfolio. But, a smart property adviser can give you the criteria for finding cashflow positive properties that will work for you and your portfolio.

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About the Blogger

Kevin Lee

Kevin Lee

Kevin Lee of Smart Property Adviser is regarded by many as Australia's most trusted property investment adviser. Since 1999, Kevin's been the go-to-guy for people when they need honest finance and property investment advice and guidance.

Kevin hosts a regular Investors' Boardroom and investors from around the world fly in to Sydney to attend. More information is available at www.smartpropertyadviser.com.au

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Tune in to the latest episode of Property Showcase, the podcast with the inside track on the products and businesses that will help turbocharge your portfolio, maximise returns and make your overall investment experience seamless and stress-free!

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To hear more about these services, make sure to tune in to this episode of Property Showcase!

 Make sure you never miss an episode by subscribing to us now on iTunes!

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Son Pham is the accredited Head of Mortgages at Rethink Financing\/Rethink Investing. He has over 6 years\u2019 experience writing loans, over 12 years in the wealth management industry working for the likes of CBA, AMP and private practice and he is also a licenced financial planner (AFSL 326450). He has multiple investment properties that are cash flow positive which help pay his mortgage on his home and fund his lifestyle.<\/p>\r\n

Son is able to write all types of residential and commercial property loans.<\/p>\r\n

In this episode of Property Showcase, head of mortgages at Rethink investing Son Pham joins host Tim Neary to unpack how an investor should approach getting a mortgage in place with banks tightening down on serviceability.<\/p>\r\n

Hear from\u00a0Son\u00a0about:\u00a0<\/p>\r\n

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    In this episode of Property Showcase, director of investment services for Open Corp Michael Beresford,\u00a0joins\u00a0editor of Real Estate, Tim Neary to share why he disagrees that the cooling market means that the best times are behind us.<\/p>\r\n

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Mortgages in a tighter lending economy and why Brisbane is a good option
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Will Magee has had ambitions to enter into the Australian property market for quite some time, but it has been more than just finances holding him back.  Having been granted permanent residency just two weeks ago, Will is wasting no time and is now in the process of signing papers and finding his first investment property.

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In this episode of the Smart Property Investment Show, Will joins host Phil Tarrant to share why he is purchasing his first property in partnership with his brother, discuss the complications that can arise from such a strategy, and unpack the ongoing plan for building a joint property portfolio with his brother.

Will will also share how they approached saving for their first property, why he is taking out the mortgage in his name exclusively, and share their savings plan for the year ahead.

If you like this episode, show your support by rating us or leaving a review on iTunes (The Smart Property Investment Show) and by following Smart Property Investment on social media: FacebookTwitter and LinkedIn.

If you have any questions about what you heard today, any topics of interest you have in mind, or if you’d like to lend your voice to the show, email [email protected] for more insights!

RELATED AREAS OF INTEREST:

From property in Australia to a ski lodge in Japan
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A property investment plan years in the making
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  ["title"]=>
  string(75) "Regional Victoria showing up Melbourne in price performance, new data finds"
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Median house prices in regional Victoria outperformed that of Melbourne in the June quarter, the latest REIV figures reveal. 

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Median house prices in the regions rose 4.0 per cent to $419,500 but in Melbourne they dipped by 0.6 of a percentage point to $840,000.

The result in Melbourne was due to a 0.8 of a percentage point fall in prices achieved at auction; this was despite a lift of 2.3 per cent in private sales.

Inner Melbourne suffered due to auction prices, where median prices fell by 4.9 per cent to $1,459,000 but it was middle Melbourne that was hardest hit, with a 5.4 per cent drop to $974,500.

Outer Melbourne had a good quarter with the median rising by 0.5 of a percentage point to $681,000.

Apartment prices in regional Victoria grew by 3.7 per cent to $304,500 while the metro media was up by 0.5 of a percentage point to $604,000.

REIV President Richard Simpson said that despite fewer sales, many sectors of the market were performing well.

“2017 was a bumper year and while the trendline has flattened, despite the fall in median house prices in the June quarter, median prices are still up this calendar year for both houses and units, in Melbourne and in the regions,” Mr Simpson said. 

In particular there was been strong growth in regional centres which is probably due to the first-home buyers’ concessions said Mr Simpsons.

“The first-home buyers’ concession has been a boon for regional areas. A new entrant to the property market buying a house at the regional median will pay no stamp duty, while a first home buyer of an apartment in Melbourne at the median price would pay stamp duty of nearly $25,000,” he said.

Mr Simpson said that more prospective buyers are looking towards regional Victoria which is also having an effect in Melbourne.

“Melbourne’s outer perimeter continues to grow. Small increases in the June quarter mean that the median prices for both houses and units have risen over 10.5 per cent from a year ago.

Mr Simpson said moving forward that vendors need more realistic expectations as the highs of 2017 are now over.

“Negative chatter about the future of the sector coupled with stronger lending controls by financial institutions has created some uncertainty and vendors need to be realistic with their price expectations,” Mr Simpson said.

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Regional Victoria showing up Melbourne in price performance, new data finds

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