This article about why you may be looking into refinancing your home loan, plus the hurdles you may face, has been provided by Marcelle Van Der Merwe, Capita Finance Solutions.
Are unit owners at greater risk of getting locked into an expensive mortgage?
Banks tend to subsidise special offers to new borrowers by charging existing clients more for their mortgages. Investors were the first to be affected by an interest rate premium. Borrowers with interest-only loans were next to share the burden. Now owner-occupied borrowers have become the target of interest rate rises. Most of the majors have increased existing client mortgage rates by 0.15% in September this year. Analysts expect rates would need to increase by 0.5% to maintain bank margins based on higher costs associated with current bank funding.
Interest Rates creeping up
Banks maintain profits by charging existing clients more than new to bank clients for their mortgages. Loyal customers effectively end up subsidising special offers to new bank clients. You could be paying significantly more than someone in a similar position with the same bank who happen to get their mortgage more recently.
Cash Flow being squeezed
Making interest only payments attracts a large interest rate premium with most lenders.. Interest only borrowing restrictions especially apply to loans with higher loan to property value ratios.
Interest only terms may also be difficult to roll over or extend as banks would need to complete a full affordability assessment over the remaining loan term after an interest-only period. It would be especially difficult for those with shorter remaining loan terms to extend an interest only term.
Is it time to make a change: refinancing your home loan?
Renegotiating or switching your loan product with your existing bank is a good first step. It could be the only step required to save a bundle and improve your cash flow. When negotiations with your current lender fail to result in a competitive offer and switching to another product does not meet your requirements, it’s time to consider refinancing your home loan.
If you haven’t changed banks in a while, you may find things are a bit different this time. Greater scrutiny brought about by the Royal Commission into the Financial Services Industry has resulted in the rejection of more than a third of refinancing applications during the first quarter of this financial year.
While regulations have not changed, the way regulations are implemented has. Regulators are monitoring lenders closely in an effort to improve consumer protection and improve consumer outcomes. A side effect is that obtaining finance or refinancing your home loan is getting more and more challenging. This can be overcome by knowing what to expect and how to mitigate potential concerns.
Four factors that could make refinancing your home loan more difficult:
- Credit History and conduct
- Exit strategies for loan terms extending past retirement age
- Valuations and risks associated with future values
- Lower borrowing capacity
Credit Score and Account Conduct
Comprehensive (Positive) Credit Reporting (CCR) is Australia’s new credit reporting system aimed at making it easier for lenders to form comprehensive and balanced assessments of an applicant’s credit history.
Your credit report now includes information about current accounts held, what accounts have been opened and closed, the date default notices were paid and whether repayments were met on time. Banks will have access to more comprehensive profiles of consumers and their credit-related behaviour. A missed or late payment more than 60 days overdue will reflect for all credit, phone or energy accounts for up to 5 years on your credit record.
Over-lending for several years, while regulations were loosely enforced, has resulted in many struggling to maintain commitments as outgoings increase. Even so, it’s more important than ever to maintain a faultless credit history.
Mainstream banks have not adjusted lending practices to accommodate current credit reporting which can lead to rejections for minor infringements. Transactions and loan account statements (now a standard requirement) will also be reviewed in detail and any anomalies questioned.
Greater Emphasis on Retirement Planning
Borrowers that apply for a loan term that extends beyond their anticipated or planned retirement age would need to outline a comprehensive exit strategy. Essentially, a detailed plan of how debts will be either cleared or repayments sustained after retirement.
If an exit strategy is not considered viable by a selected lender an application may be refused or a shorter loan term may be offered, reducing borrowing capacity and increasing repayments. As consumers near retirement, a greater emphasis is placed on an exit strategy, exacerbated by declining property values and stricter regulatory oversight.
The goal is to have a strategy to pay out debts before or at retirement while retaining sufficient retirement savings to maintain one’s lifestyle.
Valuations, Current and Future Value of Units
A market downturn has a greater effect on units due to similar features. A lack of differentiation between units in the same building or in similar buildings in the same location, means unit prices tend to move in concert. Forced sales at discounted prices or oversupply of similar units can have a significant impact on your unit’s perceived value, at least as far as valuation agents and banks are concerned.
Mainstream banks generally restrict borrowing to 95% of a property value with most inclined not to refinance debts that exceed 90% of the property value. Loans which attract a Lenders Mortgage Insurance (LMI) premium could be costly to refinance as an additional LMI premium would be payable, normally loans exceeding 80% of the property value. In some cases, it may not be worth moving as LMI costs could easily exceed any benefit over a short term.
Banks also tend to limit acceptance of risky assets in a slow market, especially if they have significant exposure to similar properties. Valuation agents consider a range of risk factors that could affect the future value of a property or make it difficult to sell in a reasonable time-frame.
Some properties are considered too risky for specific banks to provide credit with entire postcodes and property types restricted at higher loan to value ratios. Bank valuations tend to vary significantly on the same property. Getting more than one valuation done and getting some advice on which banks to approach can improve the outcome when refinancing your home loan.
Lower Borrowing Capacity
Borrowing capacity has decreased by up to 40% over the last couple of years. That means the same income, with the same commitments, would now result in a much lower loan amount available from the same bank.
What factors are reducing how much you can borrow when you look at refinancing your home loan?
The National Consumer Credit Protection Act 2009 (NCCP) requires lenders to take reasonable steps in determining whether borrowers can afford commitments without substantial hardship. A recent interpretation of the act has led to lower borrowing capacity due to three dominant factors.
Higher living expenses. A Household Expenditure Measure (HEM) is used as a proxy for living expenses whenever declared living expenses are lower than the relevant HEM figure.
A greater emphasis is being placed on estimating actual living expenses by providing a breakdown of monthly expenses in various categories which takes discretionary spending, fixed outgoings and occasional spending into account. Payments like strata levies and anticipated future lump sums or ongoing cost may also need to be factored in.
Sensitised repayments based on an assessment or buffer rate (currently 7.2%) over the loan term or remaining loan term after any interest only term. Previously banks would apply a sensitised repayment to the loan being applied for but could work of actual repayments made on other debts. Current practice is to apply an assessment rate to all debts, even those with other banks.
Investors will find that rental income is discounted by 20% to 30% to anticipate vacancies. Property management costs and other property expenses and rates would be factored into living expenses while negative gearing benefits are mostly ignored. Previously using 80% of rental income assumed all costs and vacancies associated with a property.
What can you do?
Once you’ve established changes are required and you decide on refinancing your home loan, taking action as soon as possible is key as lending criteria is bound to get tighter in the coming years. Having an experienced adviser in your corner could make the process smoother and save you some time.
If you choose to DIY, be ready to approach more than one bank. Extensive research and financial product knowledge can be useful however it is bank policies that could prove a hurdle to clear. Regardless of your approach, you’d benefit from having:
- a detailed budget,
- access to recent detailed account statements (car loans, transactions, credit cards miscellaneous commitments),
- a clear exit strategy or retirement plan,
- good account conduct and a well-maintained credit history
This post appears in Strata News #211.
Marcelle Van Der Merwe
Capita Finance Solutions
M: 0410 311 889
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