Nila Sweeney

The slowdown in growth across most areas of the Australian residential real estate market offers homebuyers a rare investment opportunity – to secure a second property at prices well under those of 2007.

Owner-occupiers who are looking to acquire a second home could take advantage of this to score themselves a holiday house – or begin building their wealth through a property portfolio. For others, it might be the perfect time to take out another home loan to help a family member or friend to buy their first house or retirement villa.

"No matter who you talk to, you find that most people think the economic times are uncertain," explains borrower's agent and spokesman Michael Lee from Mortgage KeyFacts. "But while some people would advise playing safe and staying out of debt as far as possible, others may feel that the great investment opportunities warrant the risk. It's a very  personal choice."

Phillip Minett, branch manager at Wizard, Sydney CBD, says that while buying an investment property is usually the main reason for taking out a second mortgage, making some sacrifices to help support your family has also become a major reason.

"In some cases, kids want to find a place for their parents to live, and this happens particularly in ethnic areas. Those borrowers from Chinese, Indian and Italian cultures all have very close families, and their communities tend to get together and help each other," Minett explains.

"Personally, I think it's a good time to be thinking about taking out a second mortgage to buy another property," he adds, "especially if parents want to help their kids get their first home and take advantage of the First Home Owner Grant boosts of $14,000 and $21,000."

In a rocky global financial atmosphere, however, care must be taken every step of the way to ensure that you get one to suit your circumstances.

What to consider

1. Cash flow
A second mortgage is going to have a significant impact on your monthly cash flow, so make sure you're in a position to service both of them by having a stable income.

From the lender's point of view, the key to minimising risk as a borrower lies in your ability to earn enough income to service your first and second mortgages successfully on top of the cost of living.

This not only ensures you're ready to take on a second mortgage, but it also satisfies your lender's requirements for approving the additional finances.

2. Rental income estimate
If you're buying a second home for investment purposes, it's essential to get your hands on a rental estimate letter from the real estate agent currently handling the property.

The lender requires this letter at the application stage and it's important to keep in mind that it's unlikely that your lender will take 100% of the rental income into account as part of your serviceability calculation. They generally factor in around 50–75%, depending on the property type and its location. Minett says that ANZ, for example, accepts 75% of an applicant’s rental income.

To ensure that loan serviceability doesn't become an issue, it's imperative you choose a property that's well located and continues to generate a constant income to support itself.

"This means looking for places in areas where tenants are lined up waiting for accommodation and where there's a strong history of growth," explains Minett.

3. Safety buffer
If you are planning to use your existing owner-occupied property as security to fund the deposit for the second one, you are putting yourself at risk of losing both if you find you can't meet the repayments.

This is why it's essential to have a strong contingency plan. Depending on your ability to save, a safety buffer could come in the form of three to six months' worth of repayments and living expenses.

If you're planning a family, you have to have a comfortable financial back-up plan for when your dual income is temporarily whittled down to one wage.

"It's vital that those taking out a second home loan take family planning into account for the future, because this is how a lot of people get into trouble. Not everyone plans to have another child but it happens, and this adds a lot of financial stress to the process," explains Minett.

4. Loan structure
However, consumers who have taken out a mortgage on a residential property to live in themselves are protected by the Uniform Consumer Credit Code (UCCC).

"Home loans that are used for purchasing owner-occupied properties are subject to the UCCC, to protect borrowers to some degree from unscrupulous lending practices," explains Lee.

However, those who have a mortgage for investment reasons are not covered by the same code and Lee warns that, if the loan structure for your second purchase is not set up correctly, you may unwittingly cancel your UCCC rights.

According to Lee, this usually happens automatically if you're using a protected asset – such as the home you are occupying – as security for the investment property.

"If your investment property is secured against the owner-occupied property, and if you’re doing a home loan restructure in the process, your lender would release the one you're living in as an unregulated security. Typically this is going to happen automatically if the investment property loan exceeds 50% of the overall borrowings, including the debt on your owner-occupied one," he explains.

Lee says that the best way to ensure your second home loan is structured correctly is to speak to the lender directly, whether you have used a mortgage broker to arrange your home loan or not.

Lenders have a legal obligation to tell you that your rights may be forfeited if you use a particular structure for your second home loan. If you’re in doubt, however, talk to the consumer credit action group in your state for helpful, independent advice.

5. Loan type
Variable interest rates are on the downward trend and fixed interest rates were quick to follow. Patrick Clarkson of Australian Mortgage Option says that homeowners with equity and a limited cash flow may want to take advantage of low fixed rates to minimise the risks during the first few years of their second home loan.

"If you're getting a good rate of under 7%, lock it in for a few years. Then you can work out how much your mortgage is going to cost you against how much rent you receive on the property and your risk is minimised in the current market," explains Clarkson.

Borrowers opting for fixed rates, however, need to be aware that there is a hefty break cost if you pay off your mortgage or refinance before the fixed term ends. As always, choosing the loan type depends on your goals and financial situation. If you are in a position to make extra repayments and want to access the money later, a good option would be a variable rate offering these features.

Reassessing your borrowing capacity
Like any other home loan application, your second mortgage is assessed on your overall position in relation to your income versus expenses, and assets versus liabilities.

"This means that if you have a mortgage or other credit already, such as personal loans and credit cards, your borrowing limit is less than if you were debt-free," Lee says.

Your lender will factor in both your deposit and your possible rental income (if applicable) to determine what loan to value ratio (LVR) they are comfortable with for you.

If you are taking out a second mortgage for another owner-occupied property, you may be able to borrow up to 100% LVR – if your lender agrees that you can service the debt. However, for investors your lender is likely to cap this LVR at 80% or 90% to reduce the risk involved, both to you and them.

"Investment properties are by nature bigger risks for lenders," explains Minett. "The property isn't the roof over your head and, if you've got tenants in there and something goes wrong, borrowers are more likely to walk away from an investment property as opposed to their owner-occupied ones."

This usually means that homeowners buying an investment property with their second home loan need to find a 20% deposit out of the equity in their existing property to satisfy the bank's criteria.

"If you've got a high income but low equity in the family home, your borrowing limit is reduced. You have to have that good combination of equity and income," Minett goes on.

"The lending criteria have been tightened all round for those buying a second home. Because of the pullback in the market, lenders and lenders mortgage insurance (LMI) companies have taken more losses, so the underwriting criteria, too, have become a lot stricter. Lenders have become very concerned about non-disclosure of liabilities, such as borrowers who try to hide credit cards and personal loans," Minett adds.

He advises borrowers to ensure that their repayments are always up to date and on time. "If you've been in arrears in the last six months, it's almost possible to get a home loan increase for a second home," he states.

How can you maximise your borrowing capacity?
If your lender has approved your second home loan for less than you expected, and you want to stretch it out further, the first question you must ask yourself is whether you can actually afford it.

Your lender will have set your borrowing capacity at a safe limit that it feels prevents you defaulting if rates were to rise any higher. Lenders usually allow for a contingency of 1.5–2% higher than the interest rate you will be taking the loan at and, as we have seen across 2007 and 2008, this type of rise in interest rates is entirely possible.

Lee points out that the first thing you are actually doing when you increase your borrowing capacity is reducing your protection if your financial circumstances were to change.

However, if you're determined to do that, there are steps you might like to consider. First, make an effort to pay off your credit cards and cancel them, and also get rid of any other debts.

Then, to boost your chances further, think about applying to a different lender. Each lender has different assessment criteria and you may be able to stretch your approval by about $20,000. Be aware, though, that applying to multiple lenders has a negative impact on your credit record as lenders can use your credit record to see how many times you make applications. This could then lead to your application being rejected. A good way to avoid this is to seek help from an experienced mortgage broker who knows which lenders are likely to be more flexible with their borrowing capacities.

"It comes down to the skill of your mortgage broker, because they know which lenders are likely to maximise your loan capacity for the second home loan," Minett explains.

Tapping into your equity
If you've lived in your home for between five and 10 years, you have probably gained considerable equity in it. Tapping into this equity and producing a larger deposit for your second property can help increase your borrowing capacity and your overall purchase budget.

If you're looking to do this, you should be prepared for when your lender comes to revalue your property. Minett says that the best way to get the most out of its valuation is to keep it well maintained and make some cosmetic changes to improve the aesthetics of the place.

"By maintaining your property, the value stays up to scratch and this means that you can make the most of the revaluation. You need to keep the gardens neat and tidy, and the quality of the building high," Minett explains.

Staying with your current lender versus refinancing
Making any changes to your financial position – such as buying a second property thus getting another home loan – offers the perfect opportunity to give your existing mortgage a health check.

So, before searching the property market, take some time to reconsider your home loan needs in relation to your future goals and ask yourself how well your current one is performing for you. If you're satisfied with the service your lender is providing and you have determined that the interest rate and fees you’re paying are competitive, there is little reason for you to spend time and money refinancing with a different lender.

If you've reassessed your financial situation, however, and your mortgage is no longer working effectively for you, the next step is to decide whether you're  going to refinance your current home loan (while taking out a second one) with your current lender or start afresh with new one.

Your first move, then, should be to see your accountant or financial advisor. These experts can analyse your cash flow and work with you to establish the right approach to your debt as a mortgagor with two home loans.

To further the process, you can also seek the advice of a borrower's agent. Borrower's agents have emerged in the mortgage marketplace as a service to provide consumers with objective information about home loan products and how best to structure their mortgage or mortgages.

A borrower's agent should be a consumer advocate, whose advice is intended to educate you about the wide variety of home loan products in the mortgage market so that you are better informed when making your final home-loan selection.

A borrower's agent usually charges around $300 for their services. As they're not mortgage brokers or lenders, however, they should not attempt to sell you any home loan products and, if they do, they're not a true consumer advocate. So this would be the signal that you would need to seek alternative assistance.

"Although you have to pay for their services, the costs are far outweighed by the potential savings of having an expert help you with loan selection rather than relying on a salesperson for advice," explains Lee.

Next, your mortgage broker suggests specific mortgage products from a variety of lenders and helps you organise your home loan application free of charge. Their payment comes from upfront and ongoing commissions paid by the lender you choose.

Minett says that it's a great idea to contact an experienced mortgage broker before deciding on any mortgage product.

"For those looking to get a second home loan, it all comes back to your own serviceability. By this time in your life, you have more financial factors influencing it, and your serviceability may have dropped. You may have your existing loan with CBA and go back to CBA – and they could turn you down,” explains Minett. “Whereas mortgage brokers can help you reassess your situation and take a good look at what’s around in the mortgage market."

Refinancing issues
If you choose to refinance your existing home loan when you're applying for your second home loan, you don’t always have to change lenders to get a better deal.

A lot of the time, if you approach your current lender looking for a more suitable home loan product with a better interest rate, they will probably offer a competitive solution to avoid losing you to another lender. If you’re going down this road, your exit costs are usually kept to a minimum, and the lender will only charge an exit fee of between $250 and $350 to close the loan.

However, if you're keen to explore the marketplace to find a better solution 08for both your original home loan and a second one, you should be prepared for the high costs of refinancing.

Exit costs
Refinancing costs come at two different levels. First, all lenders have an exit fee of between $250 and $350 for the paperwork involved in closing a home loan.

The next fees are called 'deferred establishment fees' (DEF) and, depending on the lender and the original home loan contract, the DEF varies considerably in price.

Most of the big banks charge $700–1,000 or more if you exit within the first four years of your contract. And, if you paid no upfront fees to establish the loan, it might be higher. This is why it's essential that you read your home loan contract thoroughly before signing.

Some smaller bank and non-bank lenders might approach their DEFs differently. Some may charge the equivalent of one month’s repayment on your original home loan amount. Others could charge a percentage of the original loan cost. This cost then reduces from year to year, but can be as high as 2% for the first year – and it could mean a fee of $8,000 just to exit a $400,000 home loan.

This cost is similar to the amount you would expect when refinancing out of a fixed rate product within the first three or four years.

Upfront costs
After you've dealt with the exit charges, you come to the establishment costs to set up your new mortgage. The fees for this are between $500 and $1,000. This amount should include your application fee, document preparation, valuation costs and the bank's legal fees.

Of course, if you're borrowing more than 80% LVR of the purchase price of your new home, you are also going to be hit for LMI. If you’re buying a $600,000 property and taking out a $500,000 mortgage, you should be paying around $4,200 in LMI.

If you've got huge refinancing charges but you're determined to change lenders and mortgage products, make sure you can recoup your exit costs within 12 months. This should be your golden rule when refinancing.

If you're saving $200 a month by refinancing with a new lender at a lower interest rate, you're saving $2,400 in your first year. If your refinancing costs are similar to your savings, refinancing with a new lender might be the option for you.

Quite often, you can find other home loan products just as appropriate to your situation, with interest rates that are often 0.7–1% lower than your current rate.

Home loan options for second-time buyers
Finding the right home loan product for your financing needs depends entirely on your current financial position and your short- and long-term goals. This is why the right advice is imperative when taking on a higher amount of debt across two different properties.

That said, there are a few mortgage products that are worth discussing for those who are thinking about getting a second mortgage. For example, Lee says that borrowers with one or more mortgages might like to consider a packaged banking solution.

"Packaged banking solutions can offer reduced interest rates that can cut down many of the daily fees and, in some cases, eliminate them. The discounts depend on the amount you borrow, your profession, the lender you’re dealing with and the ability of your negotiator," explains Lee.

"Although times are a little tougher, it's still possible to get an effective rate close to 1% below most lenders' standard variable," he adds.

Professional packages
If you're looking to get a second home loan and reassess the first at the same time, it’s worthwhile considering professional packages, or pro packs as they are commonly called.

They can be great for owner-occupiers who have borrowed a large sum of money for their second home loan and want the flexibility of multiple features.

How they work
A pro pack is an overarching product that offers a range of discounts while you continue to pay an ongoing monthly or annual fee. These fees start at $25 per month, and vary between $300 and $395 per year.

This annual charge covers a range of other banking fees that you might encounter throughout the life of your mortgage, and it also waives fees charged to use features such as your credit card or redraw facility.

Although the annual fee might seem like a large chunk of money, the potential savings from the reduced interest rate can help offset it. For lenders, the size of the discount is generally linked to the size of your overall borrowings and the real savings usually come for people who are borrowing more than $250,000.

Savings vary for borrowers, depending on the size of their loan and the discount they receive with their pro pack. This is not the type of product you jump into before considering your other options, Minett says.

"Pro packs are worthwhile for high-value home loans but, for smaller ones, the annual fee can easily offset the interest rate reduction. I can compare this by using two of Wizard’s products: the VIP Advantage (pro pack) and the Smart Advantage products.

"The VIP Advantage has a rate reduction of 0.10% lower than the Smart Advantage, although it has an annual fee of $295. So, if you're going to borrow $300,000 for a saving of 0.10%, you're going to be paying $295 a year to save $300 a year – so it's not worth it," Minett explains.

The large range of features offered on a pro pack provides a lot of flexibility for borrowers who have multiple properties and who like the freedom to vary their home loan. Generally speaking, a pro pack includes:
• Interest rate discounts on variable rate home loans
• Up to four credit cards with no annual fee
• Free or discounted offset and savings accounts
• Discount on insurances including building and landlord protection insurances
• Fee waivers or reductions on valuations, top-ups and switches

How much could this save you?
Pro packs can generally save you around 0.7–1% off the standard variable rate (SVR) and about 0.2% off fixed rates.

The range of the discounts depends on the lender and the size of the loan – the bigger the loan, the larger the discount.

This example takes into account only the saving on the loan, just using the interest rates. It does not factor in the savings you might receive on transaction fees, credit cards, financial advice, life insurance, income protection, home insurance and any insurance you may have on other investment properties.

Basic and standard variable products
The other home loan product that Minett says could benefit second homebuyers is a standard or basic variable rate product.

If you are just starting out as a firsttime investor or you have bought a second owner-occupied home for a family member to live in, you might not need the flexibility of a professional package.

In this situation, as an alternative you could consider taking out a standard variable home loan, or even a more discounted basic variable product.

If you're an owner-occupier who is buying a second home for investment purposes, a simple standard variable rate home loan with worthwhile features (such as additional repayment and redraw facilities) can provide the flexibility you require, without charging an annual fee being charged.

Investors receive tax benefits from the interest payable on their investment property mortgages. So, in order to keep their cash flow strong, it can be beneficial for them to make repayments of interestonly (IO) and leave the principal at the original borrowed amount.

This means that they are paying out less each month and keeping a good cash-flow position.

There's no need for investors to pay down any of their principal until required, usually at the end of their five to 10-year term, when the repayment schedule switches back to principal and interest.

"Borrowers with investment properties really only need a very basic product because they want something with long stretches of interest-only years within the 10-year period," Minett explains.

"Most investment properties are looking for the tax benefits, and that means basically only paying off the interest," he continues.

If you've bought a second owneroccupied property and you’re keen to pay off as much of these loans as soon as possible, a standard variable rate product might also be the go for you. Most standard variable rate products allow borrowers to make unlimited additional repayments free, and to use a redraw facility to access the additional repayments, if required, at any time.

Clarkson says that it's good for owner-occupied borrowers to take advantage of products such as this, so they can relieve themselves of debt held on the properties that's over their heads.

"Have the owner-occupied home loan as your action loan and take the best possible home loan product to get it paid off as quickly as possibly," Clarkson advises.

If you have taken out a second home loan for owner-occupied reasons to house family members or help one of your kids into their first home, you might find that your cash flow is also restricted.

If this is the case, a basic variable home loan allows you the flexibility of making some additional repayments if you require them, but it typically has an interest rate about 0.5% lower than standard variable rate products.

Fixed rate home loans
A fixed rate option can be a great idea for second homebuyers who want the security of knowing exactly what their monthly repayments are going to be. Usually your lender allows you to take a fixed rate for a term of one, three, five, seven or 10 years.

Typically, fixed rate home loans have a lower interest rate than variable rate ones. For example, Commbank’s current standard variable rate is 8.53%,* while its one-year fixed is just 7.14%* and the three-year fixed just 7.69%*.

Westpac's current standard variable rate is 8.36%,* while its one-year fixed is 7.19%* and the three-year fixed is even lower at 7.09%*.

In the current market, fixed rate home loans have been dropping as fast as variable rate home loans, which means that, if you're risk-averse and want to play out the economic turmoil in safety, it could be a good strategy to fix your rates for one to three years.

Although many Australian economists believe that the average standard variable will be between 5.5% and 7% by the end of 2009, there’s no guarantee that it won't rise again.

However, there are four catches with fixed rate home loans. These are:

1. High exit fees
Exit fees for fixed rate products can be extremely high and, with most of the large banks, this is going to cost you around $1,000 in charges – including the DEF and the mortgage discharge fee.

On top of this, your bank may also levy an 'early repayment fee' when a fixed rate is broken. This is a very difficult amount to calculate and it would be individual to the particular borrower.

For example, if you took out a three-year fixed rate at 9% a year ago, your early repayment fee would be calculated by comparing 9% to the three-year fixed rate today (let’s say of 7%). The lender takes the 2% difference between the two and calculates 2% of $300,000 – the original home loan amount.

This is then multiplied by the amount of years left on the fixed rate term and could add $1,200 to your exit costs, bringing the total up to $2,200.

2. The variable revert rate
The revert rate is the interest rate that you begin paying when the fixed term is finished. A one-year fixed rate term usually reverts to the lender's standard variable rate at the time your fixed rate contract was signed. The revert rate may be lower for longer fixed rate terms. For example, Westpac's one-year fixed rate is 7.19%* with a revert rate of 8.36%* (the current standard variable rate), while its five-year fixed rate of 7.39%* reverts to 8.04%.*

3. Lock-in fees
Most lenders give borrowers the option of paying a 'lock-in' fee, which locks your fixed rate in as at the time of preapproval, instead of at draw-down. This eliminates the chance of the fixed rate increasing while you’re looking for a property. Westpac charges 0.15% of your original home loan amount to lock-in their fixed rates. This is $450 on a $300,000 home loan.

4. Limited features
Most fixed rate borrowers are limited to making $10,000 worth of additional repayments a year, and don't have access to a redraw facility.