Tighter lending guidelines: what they mean for you

“The times, they are a ‘changing ...”, as the song goes. So much so that it’s hard to keep up with changes to lending rules that banks and other non-bank lenders have recently adopted. To understand why these changes have been introduced you have to consider the current economic dilemma in Australia.

On the one hand, the Reserve Bank of Australia (RBA) needs to keep interest rates low to free up cash, to encourage people to spend more to bring cash back into the economy. They also want businesses to borrow to invest, so that they can grow, increase productivity and employ more staff. On the other hand, record low interest rates are fuelling house prices – at alarming rates in some areas – and the regulators are concerned that some property investors may be taking on more debt than they can really afford.

In an attempt to address these problems, lenders have been encouraged to take steps to tighten lending criteria. There are four main ways that they propose to do this:
• Lend at no more than an 80 per cent loan-to-valuation ratio (LVR)
• Increase the stress-test threshold
• Stop offering discounts on new loans to investors
• Cease lending on property to self-managed superannuation funds (SMSFs)

Let’s take a look at what this all means.

An 80 per cent loan-to-valuation ratio
Lenders are comfortable with lending on an 80 per cent LVR because it means that if property prices fall, they would have to drop by a substantial 20 per cent before the owners are left with ‘negative equity’ – that is, the loan amount exceeds the value of their property.

Before these changing times, many investors were cautious anyway and would only borrow 80 per cent of a property’s purchase price – funding the balance plus costs by way of a deposit or equity in another property they own. This is fine if you have the 20 per cent deposit or equity, but it discriminates, to a certain extent, against high-income earners who are less risk-averse. They are confident they can meet repayments, even when interest rates start to climb. They are prepared to wear a fall in property prices in the short term until the market picks up again and they start to see some capital growth. One way lenders used to accommodate investors buying on an LVR greater than 80 per cent was to insist they take out mortgage insurance. This is costly – but again, if that’s the price of entry into the market, there are investors who will take this option.

Tighter lending guidelines now make it more difficult to borrow on higher LVRs. Right Property Group can discuss your options with you if you easily meet serviceability criteria, but fall short on the deposit.

Increase the stress-test threshold
The standard variable home loan rate is about 5 per cent (you may be paying less if your broker has negotiated a better rate for you). When banks decide whether to approve your loan application, they do some modelling to see how your cash flow will cope with higher repayments when interest rates rise. They usually apply an increase of one to two percentage points. This is referred to as the “stress test”. Since lending criteria have been tightened, the stress test rate has been raised to a minimum 7.5 per cent, making it harder to qualify for a loan.

Sensible investors and their mortgage brokers already calculate repayments at higher rates than are currently on offer, but now banks are imposing their more conservative view across the board. Previously, most banks only “stressed” the money you were borrowing from them and took the other lenders monies at the actual repayment. Now, ALL borrowed money is “stressed” in their calculations.

No more discounts
If you have more than one loan with a lending institution your mortgage broker will most likely have been able to negotiate a discount for you off the standard variable rate. Some property investors with a considerable property portfolio could expect to pay rates 0.5 to 0.75 per cent lower than the standard rate. Not anymore. While discontinuing this practice going forward, no changes will be made retrospectively. This blanket approach again might seem unfair, particularly if you have a strong history of always meeting your loan obligations. Before giving up entirely on the idea of securing discounted rates, speak to your mortgage broker. Those with strong relationships with lending institutions might be able to find some leeway.

No more lending to self-managed super funds
Not all lenders have adopted this approach but some have. There has been concern for some time that there have been property spruikers targeting the superannuation savings of potential investors. They have encouraged them to set up an SMSF with the express purpose of using it to invest in property. For many investors, this means that their superannuation fund is not adequately diversified and it may well not be the best structure for them to invest in.

As well as this, the legal compliance attached to borrowing to invest through super is stringent. Lending to SMSFs has sometimes been at a lower LVR and higher interest rates have applied. Now some lenders have decided to move away from this part of the market altogether and have chosen not to lend on property to SMSFs at all. As we said, an SMSF may not be the best structure in which to buy property anyway – something to discuss with your accountant and/or property adviser BEFORE you buy the property!

As you can see from this discussion some of these steps are sensible and many investors apply these limits on themselves. The difference now is that it is not at the borrowers’ discretion – they may not have a choice.

There’s no denying that record low interest rates mean there’s never been a better time to invest. But these are changing times, so make sure you seek professional advice from people who know your individual circumstances. Coming into a new financial year, the lending constraints need to be taken into account when re-aligning your property investing goals.