Investor Finance: How to Maximize Your Borrowing Power

The purpose of this post is to illustrate differences in serviceability calculators between lenders, and how property investors can use these differences to structure their finances & manage their borrowing power. We also unpack how different lender calculators work & each lenders relative position in the market.

As background to this, in this earlier post, I explained how lenders calculate your borrowing power today. The key takeout from that post was that there’s three groups of serviceability now: APRA lenders, Middle-Tier lenders, Aggressive Non-Banks.

With large pricing & incentive differences in today’s market, there are more variables that will feed into a well-crafted finance strategy. With these added variables & tightened serviceability, finance planning requires far more finesse than it once did. An investors answers to some these questions now play a larger role in crafting their finance strategy:

• An individual investors risk profile: An ‘aggressive’ investor looking to accumulate beyond ‘APRA’ lenders needs to plan their loan set-ups to benefit from aggressive calculators down the line. They also need to prepare for the additional risk they’re taking on. Having clarity on this upfront will align decisions like whether P&I or IO repayments are suitable, what buffers are held, etc - as aggressive calculators generally work best with an IO portfolio & greater buffers.

• Trade-off between rate vs borrowing capacity: Your goals may point to an investment interest only variable set up – an expensive loan option today! Investors may need to trade-off the flexibility they need/desire vs a higher rate tradeoff.

• Equity position: Low equity/deposit borrowers may need to adjust to a lower borrowing capacity outcome as more and more lenders force P&I repayments. If you fall into this category, fixing may be suitable where fixed P&I INV loans are nearly 30-100bps cheaper than variable.

The point is, the additional complexity created by regulatory changes means investors need to be more sophisticated in their planning. Having clear goals & an idea of your risk tolerance is the first step. Dissecting how each component of a lender calculator works helps bring to light next level decisions like lender choice & finance strategy. This requires a clear understanding how lender calculators work.


The scenario is the same as per the previous post, a couple earning $140k gross p.a. split evenly with min living expenses and a 6k credit card, seeking an OO purchase. Note that Westpac & St G have moved down this chart with the rest of the pack since this chart was made. I’ve left it in there, as it’s a good illustration of how lenders change.


What this means for property investors

Investors can manage these differences to multiply their individual lender borrowing capacity. In contrast, they can also utilize these differences to build an expanded ‘APRA’ lender strategy & operate within lender boundaries. Unpacking exactly how lenders work offers scope for tailoring individual finance plans to maximize each investors risk tolerance and plans.

At an extreme end, we’ve done some modelling for a relatively high income household. The results of this case study show a finance multiplier at 200% - that is, an investor making the right decisions can double their lender borrowing capacity.



The has several caveats and requirements though:

1. Larger buffers & deposit sizes; aggressive lenders usually require a 20% deposit.
2. Greater risk appetite; going to the extreme end where there’s limited refinancing options means a higher degree of finance risk.
3. Utilising Interest Only loans; No further changes to lending environment & a clear exit plan to reduce exposure to aggressive lenders over time.
4. In general, I’d caution most investors not to go to this extreme. Just because its available & possible, doesn’t mean it should be done. Some high equity/high cash investors & some property strategies can work though.

Note: Apologies for the a very long post! I’ve done my best to summarize a relatively complicated topic! Part 2 below.

 

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How different lender calculators work

APRA lenders

• ING have an 8% assessment rate across all your debt. Their policy, products and pricing aligns to their target market – set and forget owner occupier mortgages (possibly 1-2 INV properties). Their calculator is so restrictive they don’t particularly suit most property investors who seek to build portfolios.

• ANZ have generally always had a restrictive borrowing power calculator that has been scaled back even further. Their relative conservative position for advanced investors is their negative gearing add-backs and higher than average living expense calculation.
  • Pros: They do have one of the best cash out policies for high LVR loans, so they can be a suitable starting point for investors. Importantly, they do have a smaller investor loan book than their major competitors, so are under less pressure to make changes than others. As a major bank, they do target specific types of loans well with policy niches (e.g. guarantor loans). They also don’t tax rental income, but shade it at 75%.

• Macquarie are reasonably similar to ANZ in terms of their calculator. They were previously one of the most aggressive lenders in the marketplace but have had a massive scale-back in borrowing power for investors. A decent policy suite and a number of niches (e.g. contract valuations for OTP’s, equity releases) make them a lender to use for some circumstances. You can literally have 100 offset accounts too, 10 per split & 10 splits. Handy for some who like to track everything.

• NAB were one of the last lenders to change their calculator and have had a massive reduction in investor borrowing capacities from December 2016. Their HEM calculations rise as income rises, which again, hurt property investors who earn significant rental income. Once again, given they are a major bank, they do have some nice tools for property investors (e.g. desktop valuations, COS acceptance). They have adjusted to their lower borrowing power potential by being quite competitive for a major bank on pricing (e.g. first home owner fixed at 3.69%) as they try and realign their loan book to have greater weight on owner occupier/P&I debt.

• St George take new and existing debt at 7.25%, like all the APRA lenders. They were previously very strong for first time investors with their large negative gearing add-back, but they have changed this since August 2017. This was a clear sign of a lender following APRA’s guidance which specifically states to take negative gearing at the actual rate, not assessment rate.
  • Pros: Good clear consistent policy. Desktop valuations at varying LVRs.
  • Cons: Back end does lack some oomph for investors and they do have a few clunky product features.

• Westpac have typically been a ‘rolls-royce’ lender for investors and had the best of the lender calculators when modelling was done. Since then they’ve scaled back significantly and have a fairly common ‘APRA calculator’. For those that are interested, the previous calculator worked by taking 80% of net rental income, previously making them very powerful for those with positive yielding portfolios and investors with debt in general.
  • Pros: Good service, consistent policy.
  • Cons: Recent changes bring them back to the pack.

Middle tier lenders

• CBA very much have an APRA calculator too, except for one noticeable difference to their loadings that they have on types of OFI debts. Low rate P&I debt is treated relatively favorably compared to most lenders (@ about 5% P&I vs 7.25%). They also have a decent negative gearing addback. This makes them relatively more powerful for investors who want to extend their borrowing power but do so in a conservative manner (P&I lending & APRA lender calculators only). I.e. those who have a non-tolerance for risky lending.
  • Pros: Importantly, their policy, technology, products, multiple offsets, cash out requirements, valuations – make them one of the lenders of choice for investors. Strangely, their desktop valuations produce favorable results too. In my opinion, they have been the best combination of policy and flexibility for property investors for quite a while.

• FirstMac have a decent lending calculator that works well for stretching serviceability for constructions & non stable income sources. They are ‘sensible’ for a non-bank, but with some common‑sense treatment to different income types. Given they’re a smaller non‑ADI, some of their policies can be a bit backward (e.g. 50% mat leave income, insurer approvals on constructions, etc), but overall a decent offering and at sharp rates.
  • Pros: Good mix of borrowing power and sharp rates. 100% of other income used.
  • Cons: A bit clunky, not so good for cash outs (purpose required), better suited to small time investors.

• Qudos are probably the pick of the bunch at the moment – cheap rates, decent policy, allows construction, good fixed rate offers, etc. 25% loading on actual repayments. They do have DSR ratio restrictions and can have case by case assessment, which adds uncertainty to high debt investors.

Aggressive lenders

• Pepper’s calculator is very strong and one of the best in LMI territory (it doesn’t change much). 100% of other income, large negative gearing addbacks, about 30% loadings on existing debt repayments, lower living expenses than some. Rate is also decent at lower LVRs, but can get punishing at higher LVRs. Interestingly, they do have an 85% OO P&I no LMI offer that can be useful, particularly for those that are stuck post APRA changes and looking to upgrade the family home.

• Liberty – well as you can see by the calculator results, it’s a bit crazy. This is quite similar to how Macq, NAB, AMP, ME, etc operated 3 years ago – the difference is massive! Nonetheless, the more debt you have with decent rental income flowing through, the more you can take on. It’s simply because they take your debts at actuals and have a favorable assessment rate/policy in general. Restricted to 80% LVRs and very expensive option for most that need to go here (5.5%+).

• There are others that join the party and then leave shortly after. The commonalities are lower buffers on existing debt repayments.

 

Interesting (very good article). Liberty has me confused. APRA has to ask - why ?

 

Your posts are always the best. You take really technical stuff and explain it in really easy to understand language.

 

crazy that with liberty, the more debt you have, and being positively geared, the more you can borrow, like @Paul@PFI said, APRA surely wants to restrict them? haha

 

They have a number of restrictions that block their use - 80% LVR's, higher rates, etc. They're filing a gap & covering their risk. Also APRA don't currently have legislative authority to apply same guidelines to them, although they are acutely aware of them.

Funny thing is - if you look at the chart, Liberty are a great example of how things have changed.

Putting a story to it, the chart show's a couple things:

- Many lenders were simply to Liberty a few years ago. They seem wild today in a relative sense, but 3 years ago that type of calculator was commonplace. Look at the difference for someone with a 2mill portfolio - its simply massive. It shows the total portfolio impact of APRA.

- Westpacs recent change shows late change pieces associated with the revised prudential practice guideline. Essentially APRA came out with a round of changes a few years ago, but left a little bit of wiggle room. Some lenders used this wiggle room to have some nice tricks to their calculator. APRA came out in early 2017 again with new guidelines that are far more tight and leave very little interpretation room. Again, a downward revision to the pack for ADIs. Give the inflexibility of their guidelines, most ADI's have very similar calculators now.

 

thanks for that @Redom is there any chance that APRA will ever have authority over liberty or the like? is it possible at all?

 

Anyone still believe they can bake the same cake as the pre APRA generation of investors, using such a completely different set of ingredients?

Within the next few of years almost all borrowers will come face to face with these new servicing calculators. It may be 6, 7 or 8 years away for some with longer term I/O facilities in place, but at some point everyone's going to see their I/O expire and when they seek to refinance or extend, both of which will require reassessment, that's when you'll start to see the post APRA rules start to disrupt fragile business models, built on low yields and speculation.

For the first time since banking deregulation in the mid/late 80's, you will see that equity means little, and debt servicing ratios are all that matters. A significant difference has already evolved between the portfolio building capabilities that were afforded to the pre APRA generation, and those which are now afforded to the post APRA generation. And while the pre APRA generation still doesnt acknowledge the role credit played in their success, for the most part, preferring to believe their skills had more to do with their assets appreciation in value than they really did... ( rising tides lifting all boats etc etc) in the end everyone will come to learn the value of cash flow for debt reduction, in this regulated credit era. There will be a different kind of tide to worry about when that happens...the one Warren Buffett talks about . Thats when we will see who is who in the zoo... Only those with very mature, high yielding portfolios or high incomes or both will be immune (ish) from the new credit era's servicing constraints.

And even if Im wrong and growth soldiers on... you just wont be able to harvest it .

Debt reduction is king. Has to be. The servicing calculators make it so.

 

Awesome post @Redom!
Just had a question:

With the APRA lender calculators is it possible to combine these to stretch a persons servicing to purchase another property before moving onto a mid-tier.

For example say a couple had the capacity to get 3 properties with ANZ. An owner occupied and 2 investments before drying up servicing.
Before moving onto CBA/Firstmac/Qudos is it possible to get another APRA lender such as say NAB.

Or are the differences only small and enough to only perhaps purchase that second investment at a higher purchase price?

And that being the case, and obviously this is a very basic example, how would you find the servicing in your scenario pan out.
For example the couple could buy an owner occ and two investments at the APRA level. They then could squeeze another from the mid-tiers, they then get another one from Pepper and finish off with 1 more at Liberty??

 

This is most instructive.

 

There's not a lot of difference between the bottom two tiers that have been described. The policies that differentiate the NAB and CBA for example are fairly small and under many circumstances the NAB will service better than the CBA.

If you're starting with nothing, a portfolio could be designed to make the most of servicing policy as you describe. The reality is that I see new investors focusing more on things like rate and prior relationships which effectively sabotages the ideal scenario.

On top of that, the margins are very tight and it's a difference of one modestly priced property. If you spend a bit to much on a prior investment, or go to the wrong lender too early, you'll miss out on that next deal with a mid-tier lender.

The non-conforming lenders are still available if you've still got the deposit. They'll lend over double what some of the others will in some instances. The challenge here is that people don't have the borrowing capacity to release equity for deposits at this point.

In summary most investors are already constrained by what they've got. The decisions they made years ago may have been good ones at the time, but they had no way to predict the environment we'd be in today. My suggestions for investors are as follows:

* Don't over extend yourself. The median house price might be $800k, but if you want to continue to grow the portfolio, a debt this size will likely hamstring your efforts for years. Fine if it's your 'forever home', but understand it will create limits for you. If you're using a lender like Liberty for 'one last deal', understand that it probably is going to be the last deal for a while.

* Try to manage your cash flow with each purchase so you can continue to pay down debt and save. If you can pay off your own home and/or save cash deposits instead of equity deposits, you're way ahead of the curve.

* Cash flow is incredibly important, but rental yield isn't the only game in town. A 6% rental yield isn't going to get you into the next property, a $10 per week increase in rent is inconsequential. Consistent growth in rental income due to high rental demand is what will improve your cash flow over time to the point where it's high enough to make a difference.

 

I'd go one step further @Peter_Tersteeg - in particular this advice pertains to those investors carrying PPOR debt, which I agree is the single biggest borrowing capacity impediment to growing a portfolio, especially for newer investors trying to do so in the post APRA credit era. Purchasing 2 or 3 cash cows that generate 7,8,9K CF+ per annum will allow for that PPOR debt to be reduced aggressively. By doing this, newer investors will give themselves the best chance to succeed. They will create equity faster and give themselves the maximum possible chance to harvest it. Importantly, they won't have to sell anything to grow.... and the strong surpluses also act as a hedge against rate rises and P&I cliffs. You don't go broke when you have more money coming in than going out

 

Possibly - depends how far you are off a third with ANZ - if it's only failing slightly there, you may be able to go to NAB or Westpac, and if not there, CBA or FM.

If they are IO at ANZ, they will be able to buy more at both Pepper and Liberty, but using those lenders comes with it's own inherent risks.

This is why portfolio planning is more important than ever - not to stretch as far as possibly like it was previously, but to manage the risk of stretching. There's not point going gangbusters with Pepper and Liberty only to find you can't hold the ANZ loans once they turn to P&I - your only option at that point is to refi to Liberty, assuming you're under their max borrowing limit.

 

They are winding back slowly too - their living expense treatment which ASIC have been closely monitoring is adjusting to industry standard shortly.

So far, its been regulated under responsible lending and ASIC's purview. This is different to the Prudential Practice Guideline that APRA have been using. Hence the difference in outcomes between non banks & ADI's re serviceability.

 

Hi, great info. I was wondering if you could explain it in relation to developing rather than buy and hold investing. Eg, using your earlier example of 140k household income, but also add a ppor debt of 600k (with equity that can be released). What is the best way for someone to finance small developments? 3-4 lot unit developments in middle ring melbourne (assume a 15-20% return). And to set up to continue to be able to finance these types of projects, rather than just a one off.

I know my question is pretty broad, and there is probably not enough info to give a specific answer, so if anyone good enough to answer could just give their own scenarios where they helped developing clients and what was needed to continue their developing. Thanks!

 

So really at the APRA level on a vanilla type of deal (PAYG with good employment and equity) lender choice for servicing becomes fairly irrelevant. You may be able to squeeze a slightly higher purchase price by going to say a Westpac on your last one but your not getting an extra IP before needing to move onto CBA/Qudos.

I'm just curious with that being the case what do you brokers value the most in your APRA lenders? If you had to rank your top say 5 policies to help investors. Cashout and upfront Val's seem the obvious ones.

 

Yep - also the ability to do a lot post settlement - split, fix, sub security.

 

I know. Right now I'm doing a super complex restructure of 12 properties - there's no servicing apparent, x-coll like you've never seen - seriously, it's and all fixed rates bar one - and I'm uncrossing the lot without having to do an application. Fees will be minimal. And it's possible because they're with the right lender.