MORE BANKING INFORMATION YOU NEED TO KNOW NOW PART 3
On the 3rd of May we e-mailed out and published on our website (http://www.alic.com.au/news/) “Banking information you need to know now Part 2” to ensure you are up to speed with what’s happening in the financial world as rates continue to rise drastically for interest only investment loans.
The great news is the Sydney market has stopped and the Melbourne market has practically stopped if you speak to 90% of Agents/Buyers Advocates who are walking the streets daily.
So essentially the regulators have done their job over a much longer period than they should have taken but beggars can’t be choosers and at least we have a regulated market to help protect our valued assets we have all worked so hard to obtain.
What does this mean to you? Well hopefully it means the regulators will slow down and let us Investors get on with our work and take advantage of the market where hesitation and cautiousness creeps in to give more astute Investors like us an opportunity to negotiate with less demand. The vendor’s market has been operating for far too long now and it’s now time for the “Buyers Market” to have a go.
APRA/ASIC are still enforcing changes however it should be a little less aggressive. These and other changes they are still looking at –
- Caps on Investment lending with 10% speed limits
- Caps on Interest Only loans at 30% of new loans
- Interest Only roll-over changes YOU NEED TO KNOW
- Serviceability changes
- A far greater defined look at Commercial lending and the practices the banks have used to determine serviceability
- Larger Capital requirements by banks due to the potential down grading of the bank ratings to come
How will these changes affect you and your loan structures currently in play and want to put in play?
- Basically if a bank has exceeded its speed limit, that bank is CLOSED for new business. Not as in the doors aren’t open but by the way it responds to a rate discount or new loan that may be outside of policy. You will certainly get the feeling that they don’t care with generic responses if they are closed. Banks are getting better at managing this now but still have to monitor it closely especially if markets do turn.
- By the 30th of September banks have to get their current lending volumes for Interest Only loans to <30% or they will be subject to strong action by the regulators. This is why you are seeing Home Loan and Investment Loan rates for Interest Only going up significantly, with CBA going up 30% on Friday. The advertised Investment rate now being 6.24% with discounts of only 100-110 in the majority of cases making new lending > 5% for Interest Only. A large uplift from 12 months ago.
Note to counter this, we have second tier banks as low as 3.84% if you have strong equity in your Principal Place of Residence (PPR), this creates serious savings for you. Even if you don’t have strong equity in your PPR, 4.34% is on offer which is not to be sneezed at with 40-100 point savings.
- Interest Only rollovers have changed as mentioned in my Part 2 newsletter. Servicing is being checked for these changes by the majority of banks. In other words, when your Interest Only term comes up you will need to provide full income verification and if the new term does not qualify with the income provided, banks are NOT allowed to rollover an Interest Only period. This will catch out a huge amount of the borrowers in the market and could create some serious issues in the market place. Please don’t be one to ignore this and always keep sufficient funds in the offset account to cover the payment increase if there has been a change in your income circumstances since your last application.
- The banking criteria to check servicing levels has always built in large buffers to ensure you are okay with rate increases, loss of rent and or job changes. This regulation protects us all and is vital to the Finance/Property world. This has been made harder over the last 7 weeks with many banks, with the CBA changing their calculations by at least 20% to align with other institutions. What does this mean? It could mean that you did have serviceability 7 weeks ago and when your approval to buy again expires, the amount approved could and will be reduced to fit under the new model. Please be careful and ensure we hold approval to buy if you are bidding and by all means check in with us if you wish to be sure because we do have other second tier options where the regulation is not so tight.
- Commercial lenders have always had their own ways to determine serviceability and in a nice way of explaining this, have not been as regulated as consumer lending and hence lend money out to parties when maybe the guidelines should have been far tighter. This is being shaken up at present and you will see a lot of commercial bankers saying “no” to what they would have said “yes” to previously. This again is good for the market and ensures all people are on the same page with loans declined that should be declined. The numbers on tax returns and the total debt a Director is associated with will now be the main topic of discussion when applying for commercial loans at least until a lot of this blows over, over the next 2 or 3 years.
- Bank ratings by S&P Global ratings indicate that the probability that our ratings will go down in the near future which will mean higher capital costs which means higher rates on all loans in the future.
In saying that, the Owner Occupied rates for Principal and Interest have headed south with the forecast by the “forgotten” RBA is still down which is a great sign.
Do you stay on Interest Only or start paying Principal and Interest for a lower rate?
Many of our customers are writing in asking whether we should be staying at Interest Only due to the latest changes and increase in rates. This is a tough one and needs to be assessed with the following indicators taken into account;
- Reduced gearing benefits if you go on Principal and Interest
- Interest savings due to a lower interest rate
- What term do you hold the particular asset for
- Is Non-Deductible debt in play and what is the cost of not reducing that with extra payments
- Is enough Cash flow held to manage larger payments
An existing Interest Only loan at a major bank will range from 4.74% to 5.32% depending on when you took out the loan over the last 12 months. The later the loan the higher the rate due to the changes over the last 6-12 months.
For Principal and Interest loans at major banks this will be 4.30% to 4.80%, again depending on the time the loan was taken out.
If you had a $700,000 loan on a property worth $800,000 receiving rent of 4% yield being $615 per week rent with moderate depreciation of $5,000, with a 38.5% tax bracket, then the calculations to assist you with making your decision using the higher of the rates above would be as follows;
- Interest savings annually to go on Principal and Interest is $3,500
- Payments would go up by $754 per month to $3,858 per month from $3,103 per month
- Cost to run property on Interest Only pre-tax is $11,760. With Principal and Interest you would need to add an additional $754 x 12 = $9,048 making it annually $20,808 from pre-tax dollars
- Cost to run property on Interest Only Post- Tax is $5,392 (Tax refund of $6,368)Cost to run property on Principal and Interest is $2,820 (Tax refund of $4,883)Tax refund of $1,485 less each year
- Cost savings is $2,590 to run your property on Principal and Interest rather than Interest Only
(*please note the above is only an example and you should seek tax advice that is appropriate to your situation. The above is not is be used as advice and you need to take into account your personal financial situation.)
In other words, if you can come up with an additional $9,048 in cash flow a year, the savings to you after tax is $2,590 annually less the additional interest you had to pay on your Home Loan if you have one of $362 on the $9,048 of payments that would have gone to your Home Loan.
So in summary, if you can afford the extra payments and want to save $2,228 a year on nett interest while rate differentials are in play like they are today, then by all means change your loan to Principal and Interest and help the banks meet their 30% Interest Only caps.
If you would rather a 3.84% to 4.34% Interest Only Investment rate and you like the sound of moving away from the major banks and dealing with second tiers, please call me or e-mail me. The additional advantage of such a rate is if it is secured by your Home solely (PPR) and Investment rates keep going up, then your Investment rate being written as a home loan will not move outside of Home Loan rate movements. This is a huge advantage in today’s market and should be something all of us should look into if we have strong equity.
I am available all hours over the next 2 weeks before going on leave on the 24th of July. Please call the office on 1300 254 228 and book a time with me to discuss with Amber-Lee.
Have a great day and happy banking in this ever changing environment. Remember change, brings opportunity.