How Do Banks Assess Investment Loans In 2018?
Many investors are complaining that it’s harder to get an investment loan in 2018. Yes, banks have tightened up on investment loans, however there are still many options available.
Things to consider when applying for an investment loan
When it comes to investment loans, try to put yourself in the credit assessors’ shoes and think about how banks assess investment loans.
1. Loan To Value Ratio (LVR) – the key to your interest rate
If you ask a bank: how do you assess an investment loan, one of the top factors listed will include LVR. LVR, or Loan to Value Ratio, is necessarily the amount of your loan as compared to the total value of your property. It primarily represents the amount that you’re borrowing from the bank, which is represented as the percentage value of the piece of real estate you already own (or is being used as security for the loan).
To calculate LVR, a bank divides the amount of the loan by the total value of the real estate. The greater the LVR, the greater is the risk to the bank or lender, and thus, this changes and limits the types of products available.
In some cases, we have seen interest rates based on different tiers of the LVR that is 50%, 60%, or 80% and above.
2. The 5 key criteria banks use to assess all mortgages
If you want to learn how to get an investment loan for sure, on your first application, make sure you know all about the Five C’s of Credit. This is a very elaborate system devised to help lenders gauge a client’s credit worthiness in order to get a rough estimate of the possibility of a default by a borrower. The Five C’s include character, collateral, capacity, capital, conditions.
2.1 Character – your reputation
This is the borrower’s (your) credit history. It’s mainly your reputation with the bank and other creditors, such as utilities, credit card, other loans or services in which you have established by your record of paying back your debts. Each borrower has credit reports maintained by the credit bureaus of a country. This report outlines all the information necessary to calculate a credit score. Think of it as a cover letter of sorts for your investment resume, after all, it is the very first thing a lender will look at in order to evaluate your investment loan request.
2.2 Capacity – your capacity to repay the mortgage
The capacity is essentially the measure of a buyer’s ability to repay the loan they’re taking. It uses the client’s income, job, and job stability, comparing it against the total amount of debt to assess the borrower’s financial standing.
Most investors are under the impression that it’s the existing assets that bankers first take into account when assessing an investment loan, but it’s actually the net income that is evaluated first.
2.3 Capital – your savings or equity
This refers to any monetary contribution the buyer has made towards their investment, for example, a possible deposit or your equity. While a deposit may be the down-payment you’ve made towards acquiring your new property, the equity refers to the existing value of any other property which you may own. The capital can often shift the decision of the lender against you – especially in case you don’t have enough. The capital indicates your loyalty towards returning the bank’s money. The lesser the capital, the greater the chance of you defaulting on your loan, and the lesser your chances are for loan approval.
2.4 Collateral – security
This is the assurance offered to the lender that you can pay off the loans in time. If you are unable to follow through, the lender can repossess the collateral to recover their investment. Think of it as a guarantee or security offered to the banks that you’ll be timely with your payment, just because you have something to lose.
2.5 Conditions – the conditions of the loan
The conditions lay out the details for the lender about how the borrower intends to utilize the loan and for how long. They don’t necessarily have anything to do with you as an applicant for a loan, but rather they’re more concerned with the factors directly influencing the loan itself that you have applied for. The usual conditions are the amount of principal, interest rate, and the lender’s choice of financing a particular buyer’s investment loan. This is mostly for assurance purposes to ensure that the money is being used towards the intended objective.
Other factors lenders consider when assessing investment loans
3.1 Rental Income
When considering an investment property for a standard rental agreement, appraisal from an agent would generally suffice. However, if the client is looking at different types of incomes from the property i.e. boarding, serviced apartments or AirBnB’s, then different policies will come into play. In such cases, some lenders may not even use or accept this as a form of investment income. As such, it affects a buyers borrowing capacity, directly influencing the amount they can borrow.
Moreover, different lenders use different percentages of the income – this means some lenders will use 80 percent, or even 75 percent only, thus changing the borrowing amounts yet again.
3.2 Cross securitisation or split facilities
Cross-collateralisation, or cross securitisation, is a specific investment strategy which refers to borrowers using more than one single property as security to acquire an investment loan. This is mostly bundling your loans together and lowering your LVR.
Split facilities is where we access equity from property and arrange a separate loan on the new purchase not connected to the original property purchase. It is a ‘standalone’ product. This means if you sell or refinance each loan, they remain independent of each other.
When lenders assess your investment loan, they take into account cross securitization when approving or rejecting an application.
3.3 Negative gearing
The concept of negative gearing is applied when a potential buyer borrows money to invest, but at the end of the financial year, has the interest and running costs collectively add up to become more than what their investment income is. This effectively has them running at a loss. A borrower can use this net loss in order to claim a tax deduction against their other incomes. This factors into investment loans because not every lender takes into account negative gearing benefits for loan approval.
3.4 Assessment rates – RBA cash rates + buffer
Every lender in Australia has a standardised variable interest rate as per the interest rate policy. Using the cash rate policy of the Reserve Bank of Australia, the bank calculates a base interest rate which applies to all of their borrowers. However, when lenders assess your home and investment loan, they don’t determine a buyer’s capacity on the base interest rate. Rather, they normally add an extra 2% or 3 percent points or what is called a ‘buffer’ to the official Standard Variable Rates during their calculations.
This added percentage is a bank’s cushion. It is their way of mitigating risk in case the standard variable rate was to suddenly fluctuate. This is also their way of covering their funding costs as well as their profit margin per application. The combined rate, used as a buffer, is a bank’s assessment rate. These ‘buffers’ can be applied to other loans not being refinanced, or to the loans taken from other lenders. Irrespective, these buffers can and do affect your borrowing capacity.
3.5 Loan terms – the length of your loan
If you’re wondering how to get an investment loan for certain, think about the loan term before you apply for one. That is because this is one of the factors that lenders seriously take into account before accepting or rejecting an application.
A loan term is essentially the duration of time the loan lasts. If the overall period is quite long, a lender automatically assumes that due to the minimal monthly payable, there are fewer chances of complete investment recovery – mostly due to the high probability of a borrower’s circumstances changing over time.
As with the majority of the investment options, it seems to be more favourable to take an interest only approach if you have your own home loan, too. Most lenders offer terms ranging from one to ten years, which then converts to principal and interest. The longer the interest-only term, the higher the payments will be when it converts into principal and interest.
However, while a shorter loan term does translate into a higher monthly payment for the borrower, it means greater security for the bank, thus effectively increasing the chances for an investment loan approval.
3.6 Serviceability – ability to repay
One of the last, but by no means the least, important factors are taken into account when lenders assess your investment loan is serviceability. Simply put, a borrower’s serviceability is their ability to meet all the requirements of loan repayment.
By factoring into the equation the potential buyer’s income, their credit history, their current commitment and expenses, amount of loan, and percentage required, a lender calculates whether or not, you, as a borrower, will be able to make returns on their investments in a timely, profitable manner.