There has been a lot of commentary in the media about the “credit crunch” that we are in at the moment. Why is the credit crunch going to impact you and your plans? And what can you do about it?
Why has credit tightened?
Over the past year I have written (here and here) about how the government has tightened up lending standards in an effort to cool the property market and reduce the volume of interest only loans. The reason for this is that they didn’t want Australians over-borrowing whilst interest rates were very low, and they didn’t want investors speculating in the property market. They have certainly achieved their aims. The property market has cooled and investor and interest only loans have fallen dramatically.
The RBA is out of touch
The RBA seems to be comfortable with the credit tightening as noted in its most recent minutes:
“They noted that most borrowers took out a loan that was substantially smaller than the maximum loan that lenders were prepared to offer; three-quarters of borrowers had taken out loans that were less than 80 per cent of their maximum borrowing capacity based on serviceability considerations. This suggested that relatively few borrowers would have been constrained by the tightening in lending standards that had reduced maximum loan sizes to date.”
The RBA’s comment is ridiculous because this statistic doesn’t include the fact that many borrowers would have had loans declined. And, of far greater importance, many prospective borrowers would have been told that they would no longer qualify for the borrowings they desire by their mortgage broker or banker and in these cases would never proceeded to a formal application. So, to say that relatively few borrowers have been constrained by the credit tightening shows how out of touch the RBA is and that is a worry!
Anecdotally, I estimate that a least 30% of our clients have been impacted by the credit crunch i.e. they are willing and able to borrow more but cannot do so. Given that our clients almost always have higher than average earnings, the broader market has definitely been significantly impacted.
Applying for a mortgage can be like a criminal forensic investigation
Unfortunately, in many instances, I liken the loan approval process now to a criminal forensic investigation and the applicants are assumed to be guilty until proven innocent. The lender will trawl through your bank and credit card statements and ask questions about where you are spending your money and why. They will want third-party documentation to verify the existence of every asset, liability and commitment (and sometimes they want multiple forms of verification!). These days it can be an intrusive and laborious process.
To me, what is going on feels a lot more severe than just prudential lending standards. I wonder if this is how the banks are repaying the government for introducing the ‘major bank levy’ (tax) and the Royal Commission? Maybe the banks are thinking “we’ll show the government whose boss… we’ll restrict money supply and potentially cause economic problems such as a falling property market, lower confidence, etc.”. Maybe they are using the excuse of “tighter credit” to show how much power they have?
Some stories from our office that will blow your mind
I would like to share with you some stories that demonstrate just how crazily tight credit has become:
- A client invested some monies in a peer-to-peer lending platform (e.g. you deposit money with them and they pay you interest each month). The bank is refusing to treat this as an investment (asset). In fact, they are treating it as a loan (liability) unless the borrower can get a letter from the provider confirming it is an investment. Getting such confirmation from an online/app business is near on impossible.
- Lenders are now asking about Life, TPD and income protection insurance. That is, sometimes they require it to be in place before they approve a loan.
- One client that has a family income of over $250k p.a., total assets of over $7 million (75% are investment assets) with existing loans of approximately $1.2 million with over $1 million of cash in the offset account – so virtually nil net debt. This client wanted to buy another investment property and borrow circa $950k. Their existing bank (who they had an excellent credit history with) asked for copies of nearly every document in their possession together with letters from their accountant and us (as their financial planner) re-confirming the information. The approval process was arduous and drawn-out.
- Most lenders will ask for a copy of a rental property’s lease agreement plus a transaction listing for the past 6-12 months. Lenders will then review this to ascertain the consistency of income.
- A lender identified a regular monthly fee of $70 and asked why it wasn’t separately disclosed in the applicant’s budget – oh, I forgot to mention, you must include a budget of your living expenses in the loan application.
- A colleague told me that a lender queried a $20 monthly payment in an applicant’s bank account. The applicant repaid a small layby purchase. The bank asked the applicant to get a letter from the vendor confirming what this $20 charge related to and that the debt has been fully repaid.
Everyone is treated the same. It doesn’t matter whether you are a first home buyer with a very small deposit or an established family with a net worth of several million dollars and six-figure incomes. Both parties will have to jump through the same hoops. It’s almost as if the bank employees are too scared to approve a loan unless the evidence is overwhelming that it’s a strong application.
What can you do?
Successful investing is as much about finding solutions to (potential) problems as anything else. That is, you must look for the opportunities. The silver lining. You must expect there to be bumps in the road. Some challenges here and there. Don’t be dissuaded by them. Understand that its all part of the journey. Today’s credit crunch is no different. Here are a few adjustments you can make:
1. Realise things have changed
The first thing you probably need to do is adjust your expectations. Of course, not all applications are a nightmare. But you must expect to provide a lot more supporting documentation, answer lots of questions and the whole process to take longer. Some loans are approved relatively simply and quickly. However, just don’t expect it. Expect it to be difficult and that way you leave room to be pleasantly surprised if everything turns out to be relatively smooth.
2. Understand the far-reaching consequences of what you do day-to-day
What you do today could impact on your ability to borrow in one or two (or more) years’ time. The reason for this is twofold. Firstly, lenders are closely reviewing your transactional and financial history with a fine-tooth comb. Secondly, the new comprehensive credit reporting regime (in place since July 2018) will mean that a lot more credit history data is being collected. Things like applying too often for credit cards or personal loans, late bill payments and having high credit card balances will negatively impact your credit score and therefore your ability to get a loan.
This means when contemplating a financial transaction, you always must consider whether there will be any negative impact on your borrowing capacity or credit score. This is something new that all Australian’s will need to get used to.
3. Plan ahead… well ahead
Give all these challenges, it is more important than ever before to plan ahead. This gives you an opportunity to position yourself so that you maximise your chance of getting the required lending approved. You must consider the timing and impact of things like changes in employment, income, property valuations and so on. I have always said that the best time to borrow is when you don’t need it so proactively accessing equity (i.e. increasing loan limits to 80%) every few years becomes an event more important and valuable practice.
4. If you sell a property, don’t repay the loan
One of the problems with the credit crunch is that some people wouldn’t be able to qualify for the amount of lending they currently have. This means, if they sell a property and repay any related loans, they might not be able to borrow again to purchase another property. If you fall into this category, one solution to consider is to not repay the loan. Depending on the lender and product, you may be able to secure that loan using another property (or the cash you receive when you sell) so that the loan remains open. You can repay the loan balance such that only a few hundred dollars is outstanding (don’t repay it in full otherwise it will automatically close the loan). This will allow you to redraw the loan if you need the money in the future – and a redraw changes the original tax nature of the debt. Be careful with this – make sure you receive the correct advice.
5. Split out unused loans
For example, if you have a large amount of cash in your home loan offset but do not qualify for additional borrowings, what you might be able to do is split your home loan into two accounts – a used and unused portion. You can then repay and redraw the unused portion (to change its tax nature) and use it for investment purposes.
Its not all bad news
Whilst the credit market is very tight, in most circumstances we are successful in getting our clients loans approved. It’s just that the process is more convoluted, and it takes a lot longer.
But we are in a new credit environment and borrowers must understand that their financial history will have a far greater impact on their borrowing capacity than it did in the past. As such, making sure you work closely with a banker or mortgage broker will help you avoid some of the things that could impair your borrowing capacity and therefore your financial plans.