As a property investor, you soon realise the huge importance that finance plays. Finance determines if and when you can achieve your property investment goals. It is often borrowing capacity that stands in the way of growing portfolios as quickly as you would like. It certainly pays to have an understanding of how the banks will view you as an applicant.
What is borrowing capacity?
Borrowing capacity is the amount of money a bank or financial institution will lend to you. This is normally based on your current financial position. Your borrowing capacity is not a fixed amount, but a picture of your present financial health.
How do banks calculate borrowing capacity?
Your borrowing capacity with each bank may vary (based on how they calculate it). At Rise High we have access to over 60 lenders so we can work with you to find the best result!
To determine your borrowing capacity, the bank will take the following three things into consideration:
- Credit Score
In other words, the lender wants to know you have adequate security/equity for the loan. This proves that you have the ability to meet the loan repayments, have a good credit history and track record.
To determine your strengths and weaknesses as a loan applicant, I recommend the following steps:
- Review your equity/security position
- Understand and improve your servicing capacity
- Understand and improve your credit score
Step 1 – review your equity/security position
The first step is to determine the amount of cash and/or equity needed for your property investment purchases. To learn more about property investing, click here.
Most lenders will lend up to 90% of the value of the investment property. There are a couple of exceptions to this where you can potentially borrow up to 95% if required.
To approve a home loan or investment loan application the bank will want to see that you have a enough deposit to cover the shortfall in the purchase. In addition to that, the purchase costs (which on average equate to about 5.00%-5.50% of the purchase price). In other words, you will need a deposit of at least 10%-15% of the purchase price to purchase the property.
Here are the possible positions you could be in:
- If you are purchasing your first property, traditionally, this deposit will come from your cash savings. However, if you don’t have much in the form of savings but are keen to get started, there are some other options that you should consider. This includes a gift from family or a security guarantee from family, which allows your parents to offer one of their properties as security for a small portion of your loan.
- If you are already a property owner, you may be able to use the equity available in a property you own to allow you to borrow up to 105% of the value of the investment property you are buying. If you want to use equity in your property(ies) to fund the deposit and costs on future property purchases, it is important to know what the true market values of your properties are. A good mortgage broker specialisesing in property investment should be able to order free bank valuations for you before submition of your loan application. This service is very valuable as it enables you to accurately understand the value of your properties in the bank’s eyes. It also shows you how much equity you have available to you.
- If you already have loans exceeding 80% of the total value of your current properties, the best way to increase your equity and ultimately allow for buying more properties in the future is to look for cheap ways to add value to your current properties to lift their market value. For example, cosmetic upgrades or adding an extra bedroom or bathroom. If you are going to attempt this, ensure you do your research so that you only spend money on areas that will result in an increased valuation of your properties, otherwise you could be overcapitalising.
Step 2 – understanding and improving your servicing capacity
Once you have enough deposit/equity to add to your investment portfolio, the next step is to ensure that you can service the new debt that you require to purchase your next investment property.
Every lender calculates servicing capacity differently. As a mortgage broker, I am constantly amazed at the variance in maximum borrowing capacities for different types of clients amongst the different lenders.
Each lender looks at every scenario and situation differently. They all consider the following factors in determining your servicing capacity:
- Income – including:
- Profit plus add backs if self-employed
- Rental income
- Family tax assistance
- Pensions/Government assistance
- Expenses, for example:
- Living expenses – Most lenders will now ask you to disclose your actual living expenses
- Child support
- Childcare/private school fees
- Liabilities – other home/investment loans, personal loans, car loans, HECS/HELP debt
- Credit Cards – Many people think credit cards don’t matter if not used. However, banks look at the limit of the credit card, not the balance.
- Age – Whilst lenders are not legally allowed to discriminate based on the age of an applicant, most lenders will require the loan to be paid in full before an applicant reaches retirement age of 75 years. As a result, applicants over the age of 50 years will have to be able to show how they are going to service the debt or clear the debt once retired.
- Dependants – Anyone that is financially dependent on you
The large variances in servicing capacities between lenders are due to the different credit policies each lender applies. For example:
- Rental income – Some lenders will only accept 70%-80% of your rental income.
- Negative gearing – Some lenders are more generous with negative gearing add backs in their servicing calculator than others.
- Bonuses/overtime – All lenders have very different rules around what percentage of bonuses and overtime they will accept for servicing purposes.
- Family tax assistance and child support income – Different lenders have different rules as to the maximum age of the children before they will stop accepting family tax assistance and child support as income for servicing purposes.
- Assessment rates – When determining whether you can afford the loan repayments, the bank looks at whether you can afford the repayments at their assessment rate rather than the actual interest rate you are paying. The bank’s assessment rates vary between lenders but can be more than 1.5-2.5 times more than the actual interest rate you will be paying on the loan. If you are already a property owner and have property loans, some banks will incorporate the repayments of these existing debts at their assessment rate whereas others will use the actual repayments, which significantly increases your borrowing capacity.
If you want to maximise your servicing capacity so that you can achieve your goals sooner, I recommend the following:
- Look for investment properties with strong rental returns.
- Reduce your unused and unnecessary credit card limits.
- Spread your debt over multiple lenders who will assess your other debt at its actual repayment rate rather than their assessment rate.
- Eliminate or reduce personal loans as quickly as possible – and/or consolidate these debts into your home loan to reduce the interest rate and help you pay them off quickly. Your dedicated Rise High broker can provide you with great information to learn more about refinancing or debt consolidation.
- If you are an employee, ensure you are getting regular payments and pay slips from your employer.
- Declare all your income and keep expenses to a minimum. This maximises your profits. To sure to make sure your financials are always up to date.
- Most importantly, make sure you are working with a great mortgage broker who specialises in property investment. Going directly to a bank, can only tell you what your borrowing capacity is according to their policies.
Step 3 – understanding and improving your credit scoring
Banks are increasingly letting computers determine whether a loan application should be approved or declined. Whilst there are still a few lenders who do not rely on credit score and will assess your loan application with a human credit assessor and common sense, the majority of lenders put every application through an electronic credit scoring system before the application is looked at by a human.
The credit scoring system will give the application a credit score and will decide whether it should be declined or referred to a human credit assessor for assessment or approval. If your application is declined by the computer, it’s very difficult to get that decision overturned by the lender. If that happens, you may have to look at other lender options.
Most people think if they don’t default on their financial obligations, they will have a strong credit score. This is however most certainly not the case. Doctors earning $600K per year get declined for finance due to a poor credit score. This is even when the applicant had strong security and strong servicing capabilities.
A poor credit score may be assigned because net assets were low in comparison to age and income. There could also be a history of shopping around for finance, and as a result, there were numerous credit enquiries. As another example, I have seen active property investors’ finance applications declined due to credit scoring. This is mainly the case for applicants that have multiple personal debts (e.g. credit cards and personal loans).
Like their servicing calculations, every bank also has a different credit scoring system. This places different importance and weighting on different factors.
Some of the factors that contribute to your credit score include:
- Your age.
- Your marital status.
- Net assets you have accumulated (many credit scoring systems will rank your net worth against your age and income to develop a picture of whether you are a spender, saver or investor and this will play a contributing factor towards your credit score – e.g. an applicant in their early 40s earning $400K per year with little assets to show may have a credit score lower than an applicant in their early 40s earning $50K per year with a house plus a couple of investment properties and savings).
- Credit history – Especially if there have been any previous defaults, court judgements, bankruptcies, etc. Sometimes, damaging items can be removed with the help of credit repair specialists and this is worth exploring if your credit history is stopping you from moving forward.
- Number of credit enquiries – Many people do not realise that every time they apply for finance an enquiry is permanently lodged on their credit report. This is also the case for purchasing things on interest free terms, applying for personal loans and credit cards or doing credit card transfers. Most credit scoring systems are harsh to applicants with many recent enquiries. This includes enquiries relating to personal debt, including purchasing items with interest free terms, and tend to result in lower credit scores.
- Length of employment with existing employer.
- Length of time in current residence.
- Personal loans and credit cards.
To ensure you maintain a strong credit score I recommend the following:
- Ensure you are meeting all your financial commitments on time every time.
- Do not submit a loan application that you are not certain will be approved. – i.e. make sure you are working with a reputable mortgage broker who has pre-ordered the valuations, done his/her research for your scenario, and is confident of approval before the loan application is submitted.
- Do not apply for pre-approvals with more than one lender.
- If you are submitting an application, include as much detail as possible in your loan application. For example, at least two phone numbers, email addresses, account numbers of credit cards, personal loans, savings accounts and other housing loans, previous addresses and employers, details of nearest relative not living with you etc.
- Do not apply for personal loans/car loans (if you can avoid it).
- Pay credit card debt in full every month. If you are finding this difficult, then you may be spending more than you can afford. Cut up your credit cards if you are serious about getting financially ahead. Focus on paying down any accumulated debt and adjusting your daily spending to eliminate your reliance on credit cards.
- Do not buy items on interest-free terms.
- If there are any enquiries or defaults that you believe should not be on your credit report, follow the process to get these removed.
- If you have any concerns about your credit history or credit report, then be upfront and honest. You can then find the right lender who will accept your credit history and application, increasing the likelihood of approval.
How do you maximise your borrowing capacity?
Getting the right personalised advice about your best finance options from an experienced and reputable mortgage broker also helps achieve your goals faster. It helps if your mortgage broker is also a property investor and who understands property investing. With a great mortgage broker by your side and a good understanding of your current situation and your goals, you can work towards building the property portfolio you desire and achieve all your property and financial goals. Things like learning how you can be in the best position to negotiate house prices successfully can also help.
Keen to get started? Get in touch! Our team of experts would love to help.