How Can Property Investors Work Out How Much They Can Borrow?
In the wake of the APRA’s 2017 regulation changes, investors may wonder how much they can borrow. It’s a difficult question to answer. This article examines the techniques used to find out. Plus, it looks at some tips for increasing your borrowing power.
The Australian Prudential Regulation Authority (APRA) has made 2017 a tough one for investors. It’s created a new set of regulations and imposed them on lenders. The most important of these is a restriction on interest-only loans. Such loans can now only make up a maximum of 30% of a lender’s output.
The knock-on effect of this may affect your borrowing power as an investor. Lenders are now less likely to accept applications for interest-only loans. Those asking for loans with a loan-to-value ratio (LVR) of 80% or higher may find things even more difficult. So could those trying to use their equity to expand their portfolios.
This leaves many property investors with one question – how much can I borrow?
This article tackles the question from two angles. Firstly, it examines the techniques that lenders use to determine your borrowing power. Secondly, it offers some tips on increasing your borrowing power if it’s not where you need it to be.
Lenders use special calculations to determine your borrowing power. The problem is that these calculations differ depending on the lender. Some may only accept part of your rental income as income for the loan. Others may allow for negative gearing. It all depends on the lender.
Generally speaking, these calculators fall into one of three categories:
- APRA calculators
- Generous calculators
- Aggressive calculators
Let’s look at how each may affect property investors.
As the name implies, these calculators most closely mirror the APRA’s guidelines. This is also the type of calculator that most major banks use. The calculator gets updated every time the APRA releases new guidelines.
The good thing about these calculators is that they set specific rules for determining your serviceability. Your serviceability is your ability to meet the repayments of your home loan. Lenders typically look at the loan amount, your income, and your expenses to generate a figure.
APRA calculators have two key components. The first determines your ability to repay your existing debts and the debt that you want to take on. Namely, the home loan. Roughly, this means your lender will double the actual amount that you repay. The aim here is to ensure you can repay comfortably without stretching yourself too thin. The amount they use may increase when you apply for an interest-only loan.
Secondly, the calculator looks at your income. Typically, only 80% of your rental income gets included. The same goes for other alternative income streams, such as bonuses and commissions. This means you need a solid income stream beyond property to raise your borrowing power. Some lenders no longer incorporate negative gearing into these calculations. Those that do usually tie it to your interest rate. This part of the calculator also takes your living expenses into account.
On a very general level, lenders want to see that your income allows you to repay the loan with money left over. The closer you are to the threshold, the less likely you are to get a loan.
Some mainstream lenders are more generous in their calculations. Typically, they’ll use the APRA calculator as a base. But they may depart from the guidelines in a few key areas. Take note that they’ll only make the slightest of changes if they do this. But the end result is usually an increase in your borrowing power.
Examples of such differences include the following:
- Only including a percentage of your repayments for other home loans in their calculations. APRA calculators look at the entire repayment amount. Generous calculators may look at between 50% and 70%.
- They may use negative gearing at the assessment rate, rather than your actual rate. This is a positive because it reduces the amount of tax that you pay on your income. As a result, you have more income, which raises your borrowing power.
- The calculator may factor in all of the income you get from rental properties and other sources.
It’s important to note that generous calculators rarely offer a large combination of such differences. Often, you’ll only benefit from one. But they can prove beneficial when trying to increase your borrowing power.
Of course, you also have to find a lender who uses such a calculator. Such lenders typically fall under APRA guidelines. They’re just slightly more willing to stretch those guidelines. A mortgage broker may be able to help you locate them.
You’re less likely to come across such calculators today. This is particularly the case if you work with a lender operating under APRA guidelines. When you do find an aggressive calculator, it’s usually used by a non-bank lender.
Such lenders don’t fall under APRA’s jurisdiction because they don’t take deposits. However, this also means that they take on more risk when they accept you for a loan. As a result, you may face higher interest rates. Moreover, they’re often less flexible when it comes to discounts and features.
Typically, you’ll only use a lender with such a calculator when borrowing without any money. Or, you may use one when trying to secure a high-risk loan that APRA guidelines prevent you from getting.
There are benefits to these types of calculators though. They usually offer the following:
- Low assessment rates when compared to APRA calculators.
- They may not include certain items in their living expenses calculations.
- They load less of your current debt repayments into the calculator
- You can use negative gearing to your advantage.
This means you can use such lenders to secure more financing. The trade-offs are the tighter restrictions and the increased amount that you’ll repay. Such calculators are also becoming rarer in the wake of the APRA’s newest guidelines.
Tips for Increasing Borrowing Power
As you can see, the type of lender that you use has a huge effect on your borrowing power. Going for a more aggressive lender may increase your borrowing power. But it can also make things harder for you in the long run. You’ll usually secure a better loan product with an APRA-regulated lender.
Thankfully, the type of calculator the lender uses isn’t the only thing that affects your borrowing power. There are other steps that investors can take in the wake of the new guidelines.
Here are four tips for doing that.
Tip #1 – Lower Your Outgoings
As mentioned, most lenders look at your other loans when calculating your borrowing power. The more you owe to other people, the lower your borrowing power.
The simple tip here is to repay more of the loans that you already have outstanding. Clear as many personal debts as possible. This includes credit cards and other personal loans. Moreover, show that you make consistent on-time payments for every property in your portfolio. Missed payments can lead to defaults, which seriously damage your borrowing power.
You can also take more active steps with your credit cards. Many lenders use the maximum borrowing limit of your card in their calculations. You may not come anywhere near that limit with your actual spending. Contact your credit card provider to lower the limit so that it’s in line with what you actually spend.
Tip #2 – Get Your Tax Return in on Time
This is a particularly important tip for self-employed people and those whose primary income comes from rent. Lenders rely on your tax returns to make their calculations. If you don’t file yours on time, they can’t work from them. They may use older figures, which may not be as favourable to you.
Moreover, many lenders have cut-off points. They want to see your most recent figures. As a result, they may not accept tax returns from two or three years ago. If they do, they may judge them more harshly. This is because you’re forcing them to make assumptions.
Go to your lender with your most recent tax returns in hand. This provides the most accurate documentation possible for determining your borrowing power.
Tip #3 – Flipping Property
This is a tip that’s best used by experienced property investors. Property flipping involves buying a property, making improvements, and then selling it on for a higher price.
Investors can use this tactic to generate more equity. More importantly, this is cash equity. You can use this money to clear debts or to help you to fund new purchases.
Of course, this strategy also comes with a lot of risks. You have to feel comfortable in your ability to flip a property. Plus, you have to have the money to do it in the first place. But some investors can use the tactic to flip low-cost properties. They then use their improved borrowing power to fund bigger purchases.
Tip #4 – Improve Your Rental Yields
As mentioned, many calculators only take a percentage of your rental yield into account. While you can’t change that, you do have control over your rental yield. Any steps that you take to improve it reflect positively on your application.
For example, those who negatively gear their properties can use this tactic to great effect. Maximising their rental yield reduces their losses. This improves their borrowing power. Of course, it also means that they can’t take advantage of the tax benefits of negative gearing. Still, the APRA regulations have forced changes in how banks look at negative gearing. You may have to make that sacrifice to improve your borrowing power.
The Final Word
Every lender uses their own calculations to assess your borrowing power. Going with a mainstream bank usually means you’re meeting tighter guidelines. This can reduce your borrowing power. More generous lenders can help you to improve your strength. Non-APRA lenders can drastically improve your borrowing power. But this comes with more catches that you may want to deal with.
On the plus side, you can also use the tips in this article to improve your borrowing power. In particular, those using negative gearing may want to change their strategies in light of the regulations.
Once you know your borrowing power, you need to find a suitable property. That’s where Cohen Handler can help. Call our buying agents today to find a property that suits your needs.