Home Loan Repayment
Fears of a possible slowdown in the global economy and the prospect of higher interest rates in Australia are prompting many investors to re-assess their investment strategies.
A time-tested approach to help you weather the volatility is as follows:
1.       Use your existing equity (usually incorporated in your home) to finance your deposit of 10–20% of the cost of your next investment (ie, borrow the deposit of 10–20% plus costs and the 80–90% to fund the remainder from another major lender). At all times (and especially during times of financial upheaval), it is a wise principle not to put all your eggs in one basket (ie, use different lenders for each property and thereby avoid cross-collateralisation).
2.       Avoid the fringe lenders – for the short term at least. It is they and not the major lending banks that tend to get into the worst trouble in the event that finance via securitisation becomes tight (or virtually unobtainable, as in the early 1990s). Also, the major banks are a (little) more sensitive to just “selling clients up” if they struggle to meet their loan commitments.
3.       Buy properties that are in the highest rental demand locations. These are not normally three- or four-bedroom houses in the very outer suburbs but residential accommodation in, or within an 8–10 km radius of, the CBD. Because house prices are so high in these inner suburbs, it is difficult to obtain the necessary yield to support holding such houses as investments. However, one- and two-bedroom apartments (and in some cases townhouses) are less expensive and provide comparable rents (and higher yields).
4.       Consider units. With the occurring and projected population growth, there will be a strongly growing group of suitable renters for the foreseeable future (to at least 2011–12) but an inadequate supply. All forecasters are projecting a further tightening of supply and escalation of rents, especially in Melbourne and Brisbane. The most recent ANZ Australian Property Outlook warns: “A dramatic tightening of the housing market will force already soaring house prices and rents sharply higher. By 2010, we project a record housing shortage of nearly 200,000 homes, which risks becoming an intractable imbalance as renters and first homebuyers become collateral damage inthe Reserve Bank’s ongoing war on inflation.” Any attempt to shift the costs and responsibility onto investors via the taxation system would make a very difficult supply/demand situation infinitely worse.
5.       Buy properties that are and will remain attractive to renters (because they will also generally be attractive to other investors and even owner-occupiers in the event you ever have to sell). This includes convenient location (especially to city, entertainment precincts and transport), new (or at least modern amenities), good design (best use of available space) and opportunity to enjoy indoor/outdoor living with minimum work (eg, balcony or small garden, nearby parks).
6.       Avoid overgearing (ie, only borrow money you can safely service from your cash flow). Your cash flow is salaries, wages, interest and dividends or other cash receipts that you are confident about relying on. Having effectively borrowed up to 100–106% of the cost of the investment property, your biggest outgoing is interest. Other main expenses are body corporate fees, rates and property management fees. In most cases, rent will cover 70–75% of your total costs (based on 100% borrowing) and tax reductions will cover 0–20% or more of your costs, depending on your marginal tax rate. So the balance to be met out of ongoing income is limited (especially compared to the likely annual capital appreciation).
7.       Establish a line of credit or other facility which enables further borrowing in case you experience an unexpected cash flow drop or face an unexpected need.
8.       Take out Landlord Insurance as an absolute minimum. It’s also wise to have life insurance to cover at least the total level of debt, and income protection insurance, in case of accident, ill health, etc.
9.       Always finance the purchase of investment property over the longest term and with interest only loans. The first three to five years are the hardest time to make capital repayments on an investment loan (and make very little difference to the indebtedness at the end of that period).
10.    The question of whether to fix the rate on all or part of the loan is subjective. If you want certainty that rates, and therefore repayments, cannot rise during the fixed term, lock in the rate. However, over many years’ experience I have found very few occasions when taking a fixed rate would have reduced the overall funding cost on a loan. There was a short period in 2007 when fixed rates were clearly favourable but lenders quickly reviewed their fixed rates upwards. The Australian Bureau of Statistics reported that, in November 2007, one in every four new home borrowers took out fixed rate loans (the highest level since 1998) but at current relativities I could not recommend fixing borrowing rates.
11.    Those coming off honeymoon rates to face interest at the full Standard Variable Rate and borrowers at the margin will be primarily affected in the local reaction to the US sub-prime problems. The latter category includes existing borrowers currently struggling to meet their mortgage repayments. The Australian Bureau of Statistics revealed that rising borrowing costs drove 19,443 homebuyers to refinance in November, a monthly increase of 10.6%.
12.    When lending policies are being reconsidered by the major banks there will be an increasing tendency to prioritise the allocation of funds and to generally proceed cautiously. Conditions have tightened for low-doc and no-doc loans, and this will continue. Subtle changes will be made to borrower eligibility criteria and loan servicing calculators to try to further reduce future arrears and defaults. Also, lenders will instruct valuers to prepare more modest valuations: generally, the formula for a valuation for registered first mortgage purposes is market value less 5% and never more than contract price but the discount can be increased when instructing valuers in uncertain times.
See the full story as revealed by Malcolm Reid in the current issue (No 9) of Your Investment Property magazine.

With interest rates at their lowest for more than 50 years, there are some great rates available. The best thing to do is to compare rates from all the lenders. Let us help take the leg work out of doing this - Compare Home Loans now