When you’re ready to purchase a property, you go to your bank or mortgage broker and apply for a loan.
It’s as simple as that, right?
Wrong – nothing about applying for property finance is that simple. And in fact, if you approach your first or next home loan without having a full understanding of the key factors involved, you could end up making some serious mistakes that could ultimately cost you a fortune.
I’m not saying this be alarmist; I’m sharing this because over the years, I’ve met too many investors who have ended up in a dire situation due to some small yet significant mistakes made at the beginning of their property journey.
Six of the most common mistakes investors should be aware of when applying for finance include:
Mistake #1: Cross-collateralising your loans
In simple terms, this is the process of giving your lender additional security or collateral over the property you’re purchasing, by offering cross-collateral over two or more properties on one loan.
A simple way to understand this is with the following analogy: imagine buying a second car for your family. When you finance the car purchase, would you offer the lender your existing car and your new car as collateral against the new loan? Not likely!
Then when follow this process when financing a property? It makes no sense for anyone except the lender, and there are myriad ways to avoid cross-collateralising while still getting access to your equity. Consult an experienced, trusted mortgage broker for advice before you consider going down this path, because the long-term impacts can be brutal.
Mistake #2: Failing to crunch the numbers
Many property investors fail crunch the numbers properly, as you need to be incredibly thorough. Your idea of crunching the numbers can’t be a ‘guestimation’ of what things will cost, but should include a full and accurate run down of all the costs involved.
For instance, if the agent tells you the council rates are “around $2,000 per year”, that’s not actually good enough. You should request to see a copy of the last two rates notices so you can verify the actual costs involved. I have done this myself and have discovered that the agent’s idea of “around $2,000” was actually closer to $2,500. It doesn’t sound like much, but that’s an extra cost of $10 per week – a figure that needs to be accounted for when calculating my offer.
Crunching the numbers effectively not only allows you to optimally leverage your borrowing power, but it could save you thousands of dollars over the life of your loan if you get the calculations wrong. Not understanding your rate of return on a property purchase is like gambling and in my view, there are just too many zeros involved to get it wrong.
Mistake #3: Thinking the bank is on your side
The way the banking industry operates has changed. Our parents’ generation had a very different experience, as they were able to develop relationships with their local bankers, which could in turn influence their ability to get finance, personal loans, credit cards and overdraws.
But these days? Let’s be realistic: banks are a business. A very profitable business that turns over profits worth billions of dollars every year. They are in business of making money, paying their shareholders a healthy dividend and ideally deriving a profit from you with as little effort as possible.
I’m not saying any of this to be cynical, but to ensure that you are going into this process with your eyes wide open. Your bank may act like they have your best interests at heart, but they ultimately view you as an opportunity to make money. The only way to ensure you are getting the best possible deal on your mortgage is to use a qualified, independent mortgage broker who can survey dozens of products in the market to find you the ideal fit for your needs.
Mistake #4: Diving straight into a principal and interest loan
I am a big fan of using interest-only loans loans for the first five years of every investment property purchase – and it’s for one very compelling reason.
Put simply, it improves your cash flow by minimising your cash outflow and maximising your tax-claimable mortgage interest. This in turn improves your borrowing power and allows you to proceed with additional property purchases more quickly, allowing you to fast-track your property investing goals.
One thing that investors fail to consider in this scenario is that an interest-only loan doesn’t mean you have to pay only interest. If you’re uncomfortable with the idea that you’re making no progress on your loan principal, there is nothing stopping you from paying additional amounts off the principal if you wish. The benefit you have is that your financial obligation is set to its minimal level – which provides you with plenty of options, rather than restricting your journey.
Mistake #5: Keeping all of your accounts with one bank
By spreading your accounts among a number of different banks, you can effectively spread your risk and ensure that no single financial institution has too much power over your situation.
You need to look no further for evidence of this than what has been happening recently to investors, following the APRA-led move to restrict investor lending. In response, some banks have lifted investor rates by up to 0.30% (on existing and new loans), while others have restricted their risk appetite to 80% LVR. Others haven’t changed their policies; RAMS, for instance, are still lending investors up to 95%.
If you have all of your loans with one bank and that bank happens to adopt a more conservative policy, your investing goals and your present financial situation could be severely impacted. As a property investor, diversity in your lender portfolio can truly be your biggest ally.
Mistake #6: Hitting the financial brick wall
I wish I had known how to avoid the financial brick wall sooner, because by the time my husband Ed and I almost smashed into it, it really knocked us for six.
The fact is, banks will lend you money to finance your property investments – up to a point. After a handful of negatively geared properties, they begin viewing you as a high risk, at which point they put the brakes on your borrowing capacity. This threshold is the bank’s internal risk rating.
I didn’t understand about this threshold (which I call ‘the financial brick wall’) and what impact it could have, until I learnt the hard way – as in, we were all lined up to finance our next deal and the bank suddenly said “no”. This experience taught us the value of having a balanced portfolio, which paved the way for us creating the 10 in 10 mentoring program, but it’s a lesson I would have far rather learnt through education rather than experience.
To learn from our mistakes and avoid hitting the financial brick wall yourself, ensure you have a balanced cash flow in your investment portfolio. Remember that cash flow is king in any business, including the business of property investing.
As well as the six issues outlined in this article, there are many other mistakes investors routinely make when applying for property finance – all of which can be costly and time-consuming to bounce back from.
To ensure you’re putting your best foot forward and investing in such a way that you maximise your opportunities and minimise your risks, make sure you consult a qualified mortgage broker who has experience dealing with investors. Having this type of expert on your dream team will go a long way towards helping you achieve your wealth creation goals, sooner rather than later.
Till next time, happy investing!