Major lending changes… will they put a dint in your plans?

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Over the past few weeks the banks have made some significant changes to their lending policies – probably the most significant changes in at least the last 13 years since we’ve been in business. The aim of these changes is to temper the demand for housing by investors.

These changes have been pushed through by the government (APRA) in an effort to reduce the amount of investment mortgages so that the housing sector (particularly in Sydney) do not get overheated and overvalued. Most lenders have been writing twice the amount of investment loans compared to home loans and the government is concerned by this. There is pressure on the banks to significantly reduce investment loans… by half.

The government hopes that if demand for housing by investors is reduced, then the housing market and housing affordability won’t get out of control.

This is good news for investors, not bad

A housing bubble is in no one’s interest. It is preferable to have sustainable housing price growth. Of course price growth is never going to be linier (perfectly uniform). There are going to be times when prices increase strongly, times where prices are stagnant and the odd year of small price falls (5 out of the past 34 years have been negative growth years in the property market – click here for an interesting chart). A bust nearly always follows a boom and that’s why we want to avoid a property boom.

Putting pressure on the banks to reduce investor lending is probably the best solution in my opinion – as opposed to blanket and codified restrictions like the ones implemented in NZ. The government needs to keep interest rates low to stimulate the economy but one of the negative side effects is that borrowing to invest becomes more attractive to investors. Pro-active and early intervention by the government is a very good thing.

What has changed?

Different lenders have made different changes to different extents. It is not important to go through each and every change however a summary of the main changes includes:

  • Reduction in loan to value ratios e.g. restricting the amount you can borrow for investment to 80% of a property’s value. This means you’ll need more equity in existing property (or cash);
  • Reducing the amount of income that they will include in their assessment e.g. some banks will only take into account 60% of gross rental income for some properties (it used to be 80%);
  • Some lenders will no longer take into account the tax benefits (negative gearing) associated with investing in property;
  • Increasing the cash flow impact of loan repayments. For example, most lenders will test your affordability assuming you have to make principal and interest repayments at an interest rate of 7.5% whereas most lenders would test affordability at interest only repayments at say 5.0% interest rate. The difference is an annual commitment of $42,000 versus $25,000 – a $17,000 p.a. increase; and
  • Lower interest rate discounts offered to investors. Previously an interest rate discount would be based on your total lending (irrespective of the spit of investment and owner-occupied lending).

As I said at the beginning of the blog, these changes may have a material impact on some borrowers. However, the borrowers that have a safe and disciplined plan to build wealth will be impacted less by these changes.

Will it impact you and your plans?

The short answer is that I wouldn’t expect that these changes have a huge impact on 95%+ of clients. There might be shorter-term implications e.g. slight changes in investment budget and timing, slightly higher interest rate, etc. – but no “game changers”.

  • Borrow when you don’t need to – I have always said that the best time to borrow is when you really don’t need it or have any plans for the borrowings. Put differently, proactively access equity in property and don’t leave it until you want to make an investment. Click here for an article about this which I wrote for Smart Property Investor
  • Don’t worry about interest rates – focus on longer term plans – if you are an investor it is likely that you’ll be a long term borrower. That is, you are likely to have investment mortgages for all or most of your life. Over this time, interest rates will be high and low and medium. Your starting interest rate isn’t really that important and certainly doesn’t have a large impact on whether it’s prudent to make an investment now or not. The only thing you need to be confident of is that the interest rate you are paying isn’t materially higher compared to what other lenders will charge you. It is all swings and roundabouts and eventually investment and owner-occupier rates will be even again. Also, don’t forget about the after tax cost of debt too. If you are paying 4.75% p.a. on your investment loan and you are on the highest marginal tax rate, your after-tax cost of debt is only 2.42% p.a. (which will be lower than your owner-occupier loan).
  • Let us proactively manage your borrowing capacity – as discussed in the article mentioned above, there are many ways to increase/manage your borrowable equity. ProSolution deals with over 35 lenders and our aim is to work closely with you to deliver the best outcomes. From our selfish perspective, we don’t care which lender/s you use, as long as it’s best for you. This is a value proposition that cannot be matched by the lenders themselves. A banker at Westpac isn’t going to tell you that CBA has a better credit policy for example. If it is “doable”, I’m very confident that we can find our clients a solution.

Interest rates are at historic lows at the moment which is attractive to investors. For example, a $500,000 investment property will cost you slightly more than $300 per month after-tax – it’s not going to get any more affordable! However, eventually rates will rise. Therefore, please ensure that you can afford all debt at normalised interest rates. I would suggest you ensure you can comfortably afford debt at 7% p.a. and still manage debt at 8% p.a. (even if it’s a bit of a stretch). If you cannot afford the debt at this level, don’t borrow.

Where’s the silver lining? I predict that upgraders will return

Most changes that occur tend to have negative and positive effects. So where’s the positive in these changes? There are a few things that seem obvious to me:

  1. The government is very keen to see investment lending reduce and they will make this happen either by pressuring the banks (which seems to be working) or imposing strict lending rules – either way, they’ll make it happen;
  2. The banks have a lot of pressure on them to continue to grow their home loan book and consequential profit. If they fail to meet market expectations, their share price will fall. So if they can’t grow their investment lending book then the only segment left is owner-occupier housing. I predict that the banks will be doing whatever they can to encourage owner-occupier transactions; and
  3. Since the GFC (2007-2008), in our business (and I suspect the wider market), there has been a significant reduction in the number of clients “upgrading” their home. We used to do quite a bit of this type of business but we do a lot less now. I suspect that there’s a lot of pent up demand from home upgraders.

Owner-occupiers are typically emotional purchasers e.g. they fall in love with a property. Emotional purchasers tend to pay more than investors i.e. they are less price sensitive. I predict that owner-occupiers will soon replace investors and as such, I think the $1 million plus housing sector will benefit (given most investments are made in the < $1 million price bracket). If you have been contemplating upgrading and spending more than $1 million, you might benefit from doing this sooner rather than later (assuming you agree with my prediction).

Some property is overpriced and some just seems overpriced – the distinction is critical

Today I read an excellent blog by Seth Godin. He noted that property always seems overpriced. For example, buying a 2-bed Victorian cottage on 200 sqm of land for $1 million might seem overpriced. But if we could somehow be certain that the property would be worth $2.2 million in 10 years’ time (year 2025), then today’s price looks reasonable. To quote Seth: “The challenge is in learning to tell the difference between the ones that feel overpriced and the ones that actually are.”

Anything you need to do now?

If you have plans to change your borrowings in the next few years e.g. either to invest in property or upgrade your home, then please get in contact with us. We will identify if there is anything you need to do now to position yourself to best implement your plans.

If you are not sure if you should invest, upgrade or what your next move should be, I invite you to book a meeting with me and I’d be happy to spend some time with you to assist you in understanding what your best option/s may be. Simply contact the office and they can help you arrange a meeting (either by phone or in person).