Understanding the APRA

I am new to property investing. I haven't bought an investment property yet. I have $300000 in equity in my current home. I've spoken to 3 different mortgage brokers this week (no wonder I'm confused) and no one has mentioned the APRA. Can someone please tell me what this is, or tell me a link I can read. All brokers said I would have no problem borrowing the money. Hubby PAYG, myself small sole trader.
Thanks

 

Just to add - Is there something I'm missing or should I be worried about this?

 

APRA - Pages - Australian Prudential Regulation Authority

They set rules and regulations by which banks lend - In simple terms, APRA became very concerned @ 2.5 years ago that there were far too many I/O loans being offered, and sought to put limits on that. They introduced a limit on what the banks could do with I/O lending. This resulted in servicing calculators being detuned for investors. But because rates are so low, the limits have proven only modestly effective. So @ 2 weeks ago they introduced a 2nd round of tightening, which limit the banks to only being allowed to offer 30% of ALL lending as Interest Only.. In th coming weeks and months you will start to see bank policies being adjusted to deal with these new limits. So far, all we have seen are rate rises for I/O products. But we will see even stricter borrowing capacity rules and it will become more difficult to be approved for I/O lending.

The bottom line is - investor lending is being tightened - quite a lot. Rates for Interest Only products are rising, and will continue to rise...and servicing calculators which have already been detuned, will be detuned further. This means that someone starting out today (such as you) and borrowing in the post APRA era will simply not be able to borrow as much as someone with the same personal circumstances ( income, assets, etc) and who accumulated their portfolio pre APRA, ( such as many members of the forum) was able to borrow.

In other words, you ( and everyone else seeking to borrow on Interest Only terms ) will be operating under a very different, much stricter set of rules than many here operated under when they were building their portfolio's - and the rules are only likely to become even tighter. It may not affect your first or second or third purchase, but eventually you will reach a ceiling - and you will reach it far sooner than you would have reached it pre APRA...and then you are basically stuck until you find a way to get past the borrowing capacity ceiling. That might be a big payrise or a windfall, or it might be through selling... my approach is to reduce debt without relying on any of those things. I do that by using very high cash flow properties as they allow me to reduce debt while simultaneously accumulating properties, without needing to sell or win the lottery .

For this reason, I believe it is foolish to follow the same methods pre APRA investors followed ( albeit successfully) because the rules you are playing under are very different to the rules they played under. I believe that the reduction of debt is now the key to continued borrowing capacity - without which you cannot accumulate . So I believe cash cows - which are properties that generate 7, 8, 9 or10 K of income after all expenses and taxes, are more important now than ever, as they create the extra income required for debt reduction. They dont need to form all of a portfolio, but they need to be part of a portfolio.

 

Am I right in saying the rich will get richer, and the poor will get poorer. So I am being restricted because I am post APRA. Unless I become rich, I won't be able to have a property portfolio. Won't this restrict the number of investment properties that will be on the market to rent. This would push a lot of people out. Some people can't afford to buy a PPOR and there will be no rental properties to rent.
Because of the limitations on IO loans, some banks will be at capacity of the IO loans already reaching their 30% quota, is IO going to be a thing of the past and P&I the future??

 

If all banks are at their 30%, what do we do then? Go P&I? Interest rates will continue to rise on investment properties as these loans we be a premium

 

Not necessarily. In fact, many of those you may consider "rich" - ie those with large portfolios will also face a very difficult future. The rule changes affect them too. Most of them will be forced onto P&I repayments at some point soon, and that will dramatically impact their cash flow. If they have not accounted for much higher monthly repayments, many will have a real realtity check about the importance of cash flow.

Those starting today can still do very well from property over a 15-20 year timeframe if they factor cash flow into their thinking. very well indeed.

 

Correct - which is why paying down debt is so important - and in turn, why cash cows need to be part of your thinking. The broader community- including everyone you have ever met who thinks they know property and are still telling you growth beats yield always , simply dont understand the APRA changes, or servicing calculators. APRA hasnt designed the changes to impact everyone immediately. It is a slow choking of I/O availability. But as the impacts are felt by more and more people, and they are forced to migrate from I/O to P&I - the light bulb will finally start going off for some of them.

Even now, on these forums, where its been very widely discussed- there is still an older generation in denial about what the changes mean to the newer generation. They will still tell you equity from growth gets you into your next property - but without borrowing capacity, equity is useless unless you sell. It worked for them. Wont work for you

If you wish to hold your properties for 15-20 years so they can properly mature, but you also want to continue to accumulate - you have no choice but to run your property portfolio like a dividend reinvestment plan, which means purchasing at least some high yielding cash cows so that you can debt reduce and afford P&I repayments. Otherwise, you need to be earning enough money from salary to do so... which for some is possible I guess, but not for most. Especially in such a low wage growth environment.

I/O terms of 10 years will become extinct, or near extinct. 5 years will become the norm, followed by P&I repayments 40% higher than the I/O repayments. You had better have the cash flow to deal with that, or your investment property portfolio will only become a huge weight around your neck

These changes are deliberately tilted towards halting speculative property investment using I/O loans that are never repaid. APRA is forcing the lenders to adjust pricing and policy to punish that approach. The approach that will be rewarded is the approach that pays down debt, because thats the key to getting past servicing ceilings - in the absence of windfalls or big salary increases.

Love the idea or hate it. Agree thats its right or disagree... doesnt really matter. APRA has made it clear this is not going to change. They have also made it clear they will take further action if this doesnt produce outcomes they want. And dont forget ASIC - they are also right in there, hassling and harrassing banks over the way they asses our real monthly living costs. And then there's the politics of this whole "affordability" debate- while Morrison and Turnbull dither and jawbone and do nothing whatsoever except demand states release more land and regulators bully the banks - all you'll see is more blame game stuff - and that will only force the regulators to have to act further, because Govt policy will offer zero assistance.

It is only going to get far harder for investors to build any decent sized portfolio with only I/O, low yielding property. In fact, I would go so far as to say it will become almost impossible for all but very high income earners. You will simply have to use P&I , and that means you need much stronger cash flow.

 

Ultimately, I think these things will really strengthen the market long term. As the investment landscape changes - demographically, in terms of rates, in terms of what sorts of debts people can take on, and with the assertion of the reality of fundamentals - it will become much harder for some. But it needs to be.

Bubbles have the worrying side effect of, to put it bluntly, mixing the wheat with the chaff in terms of investors. During a bubble, banks often lend willy nilly, people with limited skills and lower incomes and small deposits are attracted by the prospect of easy gains, and not because they're willing to do any hard work, but because they see others around them getting rich. With this comes an awful lot of added risk, not just to those newer 'bandwagon jumpers' choosing their investments indiscriminately, buying very high and expecting easy profits to simply fall into their laps, but to established investors who could be caught if the tide turns. Right now, much of the market is distorted, and tighter regulations are the best chance we have of bringing things back into alignment. Investors should be, if not cheering this move on, then certainly accepting it as the end of an era, marking the need for a shift in approach.

In Ireland, a lot of good investors - people who were well prepared, with diverse and carefully managed portfolios - really did well. Yes, in a market that suffered a disastrously steep crash, lots of people still made money. But it's important to remember, a lot of the damage was done well before the crash. The damage wasn't so much the end of the game, but the fact so many inexperienced investors and over-commited buyers were even there in the game at all.

I saw new suburban estates (the worst hit areas) drop 80%, 90%, even 100% on the back of developer discounting, and these areas had attracted the bulk of newer investment. At the same time I saw investors with good portfolios, who owned in good middle income suburbs, where owners were well established, do very well or at worst see only very temporary losses. I have friends who stayed afloat very comfortably because they'd positioned themselves to make rental income their primary goal (during the recession, rents also spiked, as no one wanted all that stalled development - oversupply sort of took care of itself).

I agree, too, that love it or hate it this is the new climate. The investment landscape has changed, and a good investor should right now be repositioning themselves for that reality and, at least in my opinion, should be preparing themselves for the chance that many inexperienced investors will be caught out by these changes - especially those entirely unprepared to pay P&I. It sounds harsh, but knowing this is likely can also present a great opportunity. I'm certainly keeping some cash in reserve right now to expand if the market corrects.

Right now too many newer investors seem fixated on the "buy any asset and accumulate as quickly as possible", and many seem unable to adjust their expectations away from the assumption capital growth will earn them a lot of money.

I'm really fretting right now for those still borrowing big only to buy tiny apartments or new homes on the outer edge of the very bubbliest cities, with no plan beyond using their equity to buy almost identical assets a year later, then to rinse and repeat. But sadly, quantity isn't quality, and it's just not a strategy that's going to cut it if the market corrects which, I think we can all agree, is at least a decent possibility in the near future. These are the sorts of investors who most of the brunt when bubbles burst.

The new landscape is going to take a lot more patience and strategy and, above all, knowledge. People won't be able to just jump right in blind and luck it out anymore. If you're reading this, and you're starting out, do not be dissuaded. Learn. Learn some more. Get together a good deposit and then select the right asset. Look for areas dominated by owner-occupiers, on middle-incomes (people who will hold on for dear life through any correction). Look for quality properties to which you can add value - there are so, so many neglected gems in the suburbs of cities with diverse economies (as opposed to one trick towns). It may take longer to get started, but it's nearly impossible to go wrong with that sort of asset if you're playing the long game.

 

Excellent points @euro73 , do you see IO loans as eventually becoming a thing of the past? Or is it potentially just going to become a tool for the wealthy, and much more difficult to someone to start their investments with?

 

I wouldn't think thats on APRA's agenda... they seem to be more concerned with getting back to a 70% P&I / 30% I/O balance, rather than doing away with I/O lending completely.

What I do think is that many investors used to being able to borrow for an initial I/O period and then extend it, are in for a shock. With a finite pool of I/O money now available as a result of the 30% APRA change, the banks will start adjusting policies which wont allow for a small number of borrowers to monopolise that finite pool of money And lets be honest - they really do have investors over a barrel. If they decline to extend an investors I/O terms, and other banks dont have much appetite for refinanced I/O debt, what choices does the investor have...? suck it up or sell, is the answer.

This is exactly why the banks are able to get away with lifting rates for I/O loans as they please, without losing much business. They have investors in particular, at a disadvantage now. Borrowers in many cases just cant refinance elsewhere, either because of the new servicing calcs or because other lenders are going to have to start to give their limited I/O quota to borrowers less reliant on rental income . Its slowly but surely going to become check mate in many cases. ie the choice will be ; either accept the banks terms, or sell up.

And these are the reasons that debt reduction will be helpful, and equity wont be very helpful , in building a portflio - or in just holding on to one,. If you want to build a portfolio within this framework, or even just manage your existing portfolio better as it is migrated to P&I - you will need to generate extra income. And if you aren't seeing that from wages, you will need to generate it from cash flow. This is why I believe many investors would be wise to inject a cash cow or two into the mix. This may not have been their preferred strategy when they started out, and it may well require a complete rethink /reality check /culture change , but just like insurance - you'll be very glad for the safety net if things get tough.... ie when the P&I monster comes a calling!

Basically, anyone who cant deal with 5.5-6% P&I for 20 years ( if coming out of 10 years I/O ) or 25 years ( if coming out of 5 years I/O ) should at the very least be planning to be able to deal with it , because that's what they should assume the costs of running their portfolio may well be when their I/O terms expire.