Mortgage Muscle

Sydney Morning Herald

Wednesday October 28, 1992

PETER FREEMAN

AUSTRALIAN Home Loans Ltd (AHL), launched almost nine months ago in an unexpected blaze of publicity, is beginning to establish itself as a potentially important real estate lender, having arranged total loans so far of just over $100 million.

Although small compared with the lending of the major banks, this success has provided a warning to all lending institutions that they face the risk of losing an increasing share of a vital area of their business - property investment loans.

For while AHL badges its mortgages under the label of Aussie Homes Loans, its most competitive products are not, in fact, home loans - which are competitive with, but no better than, those of most of the main lenders - but rather its property investment mortgages.

To date, almost 60 per cent of its lending has been for investment loans secured by first mortgages against Sydney residential real estate. Of this, the bulk consists of relatively small advances (most are $100,000 or less)structured so that the principal and interest are repaid over the term of the loan, in precisely the same way as most home loans.

This can be contrasted with the loans taken out by most large property investors who usually opt for fixed rate loans which allow then to lock in the rate so as to more accurately match expected cash flow with ongoing costs.

Borrowers from AHL, as well as many of the small investors who use banks and building society facilities, tend to be looking at buying just one or two modestly priced home units with the aim of paying them off over the longer term, in the process building up retirement assets.

The likelihood of this trend developing further has been increased by the confusion and uncertainty surrounding superannuation, and so its reduced appeal as a long-term savings vehicle.

Mr John Symond, the founder and managing director of AHL, says the popularity of his company's investment loans reflects a range of factors, including a lower rate than those charged by most lenders (at present the rate is 7.95 per cent for the first six months, then rising to 9.95 per cent).

The rates being charged on investment property loans are shown in the accompanying table, which covers all loans where the principal and interest are repaid over a set period (usually 20 to 25 years). Most home loans are structured this way.

With two exceptions the table does not cover either fixed-rate investment mortgages or so-called flexible mortgages, both of which can be suitable for investors. The rates charged on these loans are given in the Money and Markets table which appear each week in Executive Money.

As a general rule, flexible mortgages, which allow money to be drawn down and repaid at any time, are useful for businesses and more sophisticated investors who want a line of credit to meet ongoing, but fluctuating, investment needs.

Not that these are used only by investors. For example, GIO's Asset Accumulator Account, whose low rate has attracted a lot of business, apparently has been used by a significant number of home buyers.

In the case of fixed-rate property loans, these are a sensible option when certainty is essential in order to match financing costs with expected cash flow. However, they require refinancing at the end of the term and can result in heavy costs if repaid early.

One of the loans included in the table which has a fixed rate is Citibank's. This mortgage, which is available to both home buyers and investors at the same rates, is included because it provides the option of fixing every six months and repaying principal and interest over as much as 30 years. This is a very close approximation to how the other loans in the table are structured. Given its low rate the mortgage is a very competitive option for investors.

The other fixed rate loan in the table is provided by FAI First Mortgage, which currently charges 10.9 per cent. This operates in a similar way to Citibank's but has longer fixed rate periods. At present the rate is fixed at 10.9 per cent until April 1995, and then reset every three years at the prevailing rate. There are no upfront fees if the loan is held for the full term but there are a range of early payout penalties.

In the case of AHL's principal-and-interest investment loans, one of the major attractions is the fact the interest rate charged never can exceed the average rate charged on home (repeat, home, not investment) loans by the four major banks - ANZ, Commonwealth, National and Westpac. At present, this is 9.95 per cent - much lower than the investment loan rates charged by the banks.

Mr Symond also places significant importance on the way the AHL investment property loans give lenders a bigger borrowing capacity.

This is because, when calculating a person's borrowing ability, AHL first deducts from the monthly debt servicing cost 75 per cent of the expected rental income. Only after doing this does it apply the usual rule of allowing a borrower to take a loan where the servicing represents no more than 30 per cent of gross family income.

This can be contrasted with the approach of most other lenders. This involves adding around 80 per cent of the rental income to a family's gross income and then apply the 30 per cent debt servicing rule to that amount.

For example, an $180,000 investment unit generating rent of $9,000 a year could be bought with a loan of $150,000, under the AHL arrangement, by someone having a pre-tax family income (after deducting other debt servicing obligations, such as those on a car or home loan) of just $27,500.

This is because interest on the loan, assuming a rate of 10 per cent, would be $15,000 a year, from which is deducted $6,750 (that is, 75 per cent of the gross rental income).

This leaves $8,250 which has to be met by the investor, which is equal to 30 per cent of $27,500.

In contrast, someone with this income would be able to borrow only $104,000 using the approach where the 30 per cent rule is applied not only to the pre-tax family income but also to the rental income (in this case $7,200, that is, 80 per cent of $9,000).

Under this formula someone with a gross income of $27,500 (remember, this is after all other debt servicing obligations have been deducted) would have a total income of $34,700 for the purposes of the loan test, 30 per cent of which is $10,410 - enough to service a $104,000 loan at a rate of 10 per cent

None of this means that it is necessarily sensible to borrow as much as AHL is willing to lend. Whether or not this makes sense will depend mainly on what happens to rental returns and property prices over the long term and to your own income in the shorter term. If, for example, property prices remain stagnant over the longer term it may prove difficult to make sufficient gain to compensate for the after-tax interest costs incurred in holding the property.

As for which property investment loan is most suitable, while AHL currently has a lead over most of its rivals, it is not without its drawbacks. As the table shows, its upfront costs are towards the high end of the range (even after a recent reduction) and it imposes a one-month interest penalty if you pay out the loan early (most lenders apply a payout fee only to fixed rate mortgages).

As well, like building societies and most of the smaller banks, AHL requires borrowers to pay mortgage insurance when the loan-to-valuation ratio exceeds 75 per cent. This is a once-only upfront payment which protects the lender against the borrower failing to repay the loan.

The cost in the case of AHL is slightly higher than that imposed by most lenders since it also requires insurance cover to meet 12 months' interest payments. On a $100,000 loan which represents 80 per cent of the valuation of the property the total cost of mortgage insurance would be $500, whereas standard mortgage insurance would cost $400. Most banks don't require such insurance unless the loan-to-valuation ratio exceeds 80 per cent.

For some people, another concern will be the relative obscurity of AHL. Here two points are relevant. First, with almost 900 loans already approved it is likely any traps would have been revealed by now given that each loan should have been checked by the borrowers' solicitors.

Second, AHL itself doesn't provide the loan funds. It is merely the manager of the loans whose role is to bring together borrowers and lenders. At present the latter are three banks which don't lend directly to real estate purchasers, either at all or, in NSW, to any significant extent.

These banks provide a pool of funds which is channelled through the Permanent Trustee Company, acting as mortgagee, and AHL, as the administrator of the loans. AHL's operation, which is based at Parramatta, mainly works through a network of area managers who come to a potential borrower's home, although a number of branches (including one at Chatswood and another at Bondi Junction) are planned.

 THE RATES
 WHAT YOU GET %
 Savings/Cheque Accounts
 For $1,000 deposit:
 Banks                     2-5
 Building societies      3-4.5
 Credit unions           3.5-4
 For $5,000 deposit:
 Banks                 2.25-5.5
 Building societies     3.5-5.5
 Credit unions              4-5
 Other deposit rates
 3-yr fin co debs      7.2-7.65
 Cash mgt trusts      4.40-5.18
 Common funds         4.72-5.57
 Five-year govt sec   8.03-8.88
 WHAT YOU PAY %
 Home loan (variable)
 Banks                  9.75-10
 Building soc            9.5-10
 Credit unions        9.75-10.5
 Home loan (fixed)
 Banks               9.95-11.75
 Building soc        10.25-11.5
 Credit unions             10.5
 Personal loans
 Banks                    14-17
 Building soc           14-16.5
 Credit unions        13.5-16.5
 Credit cards
 Banks                  15.5-22
 Building soc             17-18
 Credit unions            16-18
 PROPERTY INVESTMENT LOANS: WHAT'S ON OFFER*
         Usual term           Upfront  Min
 Lender    (years)    % pa     fee* *  $  loan $
 Advance    20-25     11.25    1,100    15,000
 ANZ        15-20     11.0     750      50,000
 Aust Home
 Loans      15 or 25  9.5-10   1,200    50,000
 Bank
 of Melb    25         11.25     750    50,000
 Barclays   20            11     900   100,000
 BNZ        25          9.74     930    50,000
 Challenge  20         11.70     500     None
 Citibank   20-30        8.5   1,475    41,000
 Common-
 wealth     15-20     11-12.25   1,230    None
 FAI        24 10.9      None   30,000  250,000
 Greater
 Newcastle  25             11    1,100    None
 IMB        25           11.4     1350    None
 Metway     20-30        11.5      900   10,000
 National   20-25     From 11      600   10,000
 Newcastle
 B Soc      25          11.25      750    1,000
 State      15          11.15    1,195   50,000
 St George  25          11.45    1,200     None
 Westpac    20             11      750   25,000
           Max       Max. loan   Early payout
          loan $     val. %      penalty
          None        90         Month's interest
          None        90         None
          500,000     85         Month's interest
          None        90         Month's interest
          None        90         None
          750,000     90         None
          500,000     85         Month's interest
        3,500,000     95         Varies
          None        70         None
          250,000     85         Up to 3 months
        1,000,000     90         Month's interest
          None        90         None
          None        90         0.5%
          None        80         None
        Negotiable    90         Up to 2 months
          None        90         None
          500,000     90         Month's interest
          500,000     95         None
*  Table covers loans where principal and interest
 are repaid over the term of the loan (P&I loans).
 GIO, MLC and NatWest do not have P&I loans for
 property investors.
*  *  Approximate fees on a $100,000
 loan for $130,000 property.
 Includes ALL of the lender's fees,
 including legal costs.

© 1992 Sydney Morning Herald

Back to News Index | Back to Home