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The borrowing traps that cost investors their portfolios
Making just one wrong borrowing move could derail an investor’s portfolio, causing poorly structured loans, negative equity, and missed opportunities. This is how you can avoid the worst mistakes.
As investors’ borrowing capacity becomes restrained following recent interest rate rises and tax reforms, failing to structure loans properly can lead to further costly consequences.
According to Strategic Brokers director, Hung Chuy, the top three borrowing mistakes among investors were using cross-collateralisation, failing to have a buffer in place, and not considering all their loan options.
Ultimately, he said that to deliver on their wealth-creation, investors needed to avoid poor loan structuring and financing decisions that can create long-term risks.
Here is how to avoid making mistakes:
Cross-collateralisation
While using equity to fund another property has been a winning strategy, Chuy said using cross-collateralisation was a mistake.
He said that through cross-collateralisation, investors chose to link the properties together through their bank, instead of being separate loans.
While investors might use the strategy to gain extra borrowing capacity, Chuy warned it was a “trap” that made it difficult to leave bankers, and could force people into a difficult position.
“If one property goes down and you need to sell another property, you can’t sell it unless you sell both, so that’s a big problem.”
Chuy said during the last mining boom, many investors fell into negative equity after using the strategy, as towns’ economies collapsed, with some million-dollar properties falling to just $200,000.
“You’re literally stuck in the bank until you can pay your mortgage down, or the property values go up, which they might not ever go up.”
“With what’s happening right now, if you bought a really bad property and it’s gone backwards and you all of a sudden want to upgrade your house, you’ll be stuck.”
Failing to have a buffer
While some investors borrow without knowing whether they can meet their commitments over a prolonged period of time, Chuy said having solid buffers was key to financial security.
To determine the right buffer, he said investors needed to work out how much security they would have if any possible situations caused them to be unable to work or earn an income.
“Circumstances are going to be different for people who are salaried or self-employed or anything else.”
Chuy said investors in commission-based roles in high-risk industries may require a larger buffer due to the uncertainty of their income situation.
“If you’re self-employed, you need a substantial buffer; if you’ve got to pay taxes, if you have staff, if you’re going to have a month or bad six months, you need as many buffers as you can.”
Aside from income considerations, Chuy said buffers were essential in a high interest rate environment.
“If you forecast your repayments based on the current environment, then we get further rate rises, all of a sudden, all of your properties have a rate rise, which is really going to hurt your cash flow.”
Settling for only one opinion
According to Chuy, another potentially costly mistake was when investors only went to one broker to find out their loan options, rather than thoroughly considering a range of choices.
“They’ll get their first answer, and then they’re like, ‘that’s the be all and end all’, and they won’t try again to find the solution to get to somewhere.”
Chuy said that if a broker hadn’t shown the investor a product that suited their needs for their portfolio, they should ensure to get a second opinion.
He said that a good broker would take the time to talk to the investor and understand their situation before explaining their options in detail.
“For instance, you might have earned commissions during that year, and the four major lenders might look at your commissions completely differently.”
“One lender will look at the last three months and annualise it, another lender will look at the last 12 months, while another lender will look at the last six months.”
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