Why rate cute can lower our borrowing capacity, Saturday fun read

Why rate cut can lower our borrowing capacity

The potential rate cut from RBA next week is a hot topic ATM. Paying less interest seems in our favour, who wouldn't want to pay less interest? Surely it will help.

The question is help with what?

Cashflow or borrowing limit.

Reduced interest repayment definitely helps cashflow, lower interest repayment means less out goings, and more money in our pocket.

HOWEVER, with borrowing limits, it might be a different story.

For First Home buyers, it does not change anything.
F
investors, it can actually reduce the borrowing limit, here is why:

1. Banks assessment our existing debts at 7.25% (in most cases) on remaining loan term (remaining Principle and Interest term) regardless our actual interest rates.

2. Banks calculate our actual repayment at actual rate for negative gearing purpose, so the higher the repayments, the higher the negative gearing add back.

3. When banks pass on the rate cut, our interest rate on our investment properties reduces accordingly, thus LOWER the actual rate & repayments, thus less negative gearing addback.

4. Less negative gearing addbacks, means lower “assessment income”, thus lower borrowing limit.

You see, in a nutshell, banks assess repayments at 7.25%, but assess negative gearing addbacks at ACTUAL rate, lower actual rates, lower addbacks, thus lower “income”, lower borrowing.

now I am not sure whether I want a rate cut or not.

 

Negate this effect by spending money on home improvements. You may get further interest and depreciation deductions. Plus your property may increase in value. Pretty cute eh?

 

Except firstmac/loans dot com who load negative fearing at their assessment rate of 7% Cue @euro73

 

Freudian slip ?

 

Not any more - unless you were the first owner

 

#gearing
Though it is pretty scary losing money week to week.

 

This is a very simple riddle to solve, in my view. Servicing Calcs reward debt reduction . Investors who dont want to suffer a loss in borrowing capacity need to stop buying loss making property exclusively.

 

@Eric Wu what are your thoughts on if the property is neutrally/positively geared?

 

hi James, most of them only take 80% of rental income, and some cap the rental yield at 6%. if the property it neutrally / positively geared, I assume the yield will need to be 7% and above.

if it is neutrally or positively geared, it may not have much impact, but each case is different, difficult to say yes or no, the personal incomes is a major factor.

 

I don’t think you can compare the economic benefits of a rate cut compared to a .25 NG addback benefit on some lenders calculators?

Pretty sure I know which one your clients would prefer

 

that was my "tongue in cheek" comment,

 

Rate on hold

 

To be clear - If you spent the $ on IP Reno’s as Datto suggests, you can still claim depreciation & interest deductions.