How the New Lending Restrictions May Affect You

Those my age might remember in 2004 when the NSW Government introduced a Vendor Tax of 2%, applicable on the sales price of all investment properties. It was the straw that broke the camel’s back in a struggling market.

I was working at St George Corporate at the time, funding property developers, and watched property prices dive and lots of borrowers struggle.

It was a reminder that of all the things that affect property prices, artificial Government intervention is certainly one of them.

Property investors took a backward step at the time and if anything bought interstate. To this day, I think 2005 was the best year in memory to buy property; it’s great to buy when nobody else is.

With credit growth and property prices outstripping wages, you may have heard that the regulators have just stepped in; the following changes will take effect:

  1. Banks will need to assume that interest rates are 3% higher than they actually are when determining your Capacity to repay your loans (currently, the stress test is about 2.5 times, so no major change here)
  2. A DTI of 6 will come into play. This means that your debt cannot exceed 6 times your income. If someone earns $200,000 per annum and another $50,000 in rent, they now can’t borrow more than $1.5M.(currently, banks just need to show that your net income is enough to cover repayments & living expenses, by $1)

This DTI requirement will affect investors more than owner-occupiers. Those getting a home loan, who need to service their loan with after-tax dollars, often cap out the affordability test, before even getting to the DTI of 6 times.

Interestingly, not all lenders need to follow these rules, so some of the non-bank lenders might just have a field day until they’re also roped in. Some lenders are able to approve twice as much as the big banks, for investors, albeit at a slightly higher interest rate.

Low-doc lenders might do more also. They allow borrowers to self-declare their estimated income without providing tax returns but are only extended to the self-employed (those with an established GST-registered ABN).

How these changes will affect the market is unclear, particularly after the growth in the last 18 months. The fact is interest rates are low and are going to stay low. A lot of property investments are positively geared, which none of us are used to – so perhaps the market will just thin-out

Consider someone buying a townhouse for $965,000. The interest-only repayment on the $1,000,000 loan @ 2.49% is $24,900 per annum. If the weekly rent of $750 equates to $39,000. Maybe agents’ fees, strata and other costs bring the net rent down to $31,000, but that still gives a $5,100 annual profit!

Some lenders can apply the owner-occupied interest rate when buying an investment property, like AMP. In the example above, if P&I, the interest rate could be 1.84%. The interest component would be $18,400 per annum, giving a $12,600 annual net rental profit!

Yep. AMP is offering a $2,000 rebate and can apply the same cheap rates to both your home and your investment loans.

But most freestanding houses, and more expensive properties, are still loss-making, with investors happy to get an annual tax break and rely on the future Capital Gain.

What will certainly affect property prices is any change to Negative Gearing, which I think is inevitable at some stage.

Negative Gearing is a form of financial leverage where an investor borrows money to buy an investment property and the cost of owning this property exceeds the rent it generates. This loss (which is sometimes built up with depreciation) can be offset against other income.

So, if someone’s on an effective tax rate of 49% and has an investment property that makes an annual loss $10,000, they’ll save $4,900 in tax.

Only 3 Labor governments have ever won power from the Opposition: Whitlam, Hawke and Rudd. None of them got elected with a platform of new or increased taxes—Anthony Albanese knows that too well—so we can safely assume that if Negative Gearing is to be changed at all, it will need to be the Liberals to do so!

Whilst there may be a limit of some kind imposed on us for Negative Gearing, I’ll certainly be lobbying to not have it removed altogether.

Personally, I think we investors pay our fair share.

Stamp Duty of around 4% applies at the time of purchase and a further 20% of the Capital Gain comes back into the public purse when it gets sold. So if someone buys a property for $1M and sells it in 15 years for $2M, tax revenue of $240,000 has been generated. For serious investors, the land tax might be another $12,000 per annum, which adds another $180,000.

So, potentially $420,000 of taxes that have pretty much arisen out of nothing!

My advice to those looking to invest in property remains simple:

– Consider the tax implications, in particular, land tax (what it looks like now and perhaps what it might look like down the track, especially if you’re looking to buy a new home but hang on to your current one)

How you structure your lending is so important, to remain protected and at the same time be as tax-effective as possible

Often, buying in ‘joint names’ is not the best way

Anyway, I’m here for you for these kinds of things. But when it comes to which property to buy, here are some tips:

– Look for something unique, that might still do OK in a soft market

Does the property get excellent natural light?

Properties can be knocked down and rebuilt but you can’t change where the sun comes up and goes down.

– Don’t just visit the property at Open Inspection times. Call past at other times in the day. Chat to the neighbours.

Just take with a grain of salt what’s said by the next-door neighbour, they might be bidding at the auction against you!

Invest with your head, not your heart; don’t just do what your heart says and then use your head to come up with justifications. That’s the wrong way ‘round. Let’s face it, it’s how we all make most make decisions with everything in our lives, right?

– Is there a café within 7-minute walk?

Do they sell smashed avocado? (just joking)

– Is there a train station nearby?

Not that ‘no’ is a deal-breaker. There aren’t train stations at Bronte, Balmain, Bondi or Breakfast Point!

– Will it appeal to someone who works from home; where would they sit?

– Is being on the main road a bad thing?

I honestly don’t know the answer to that. When electric cars take over and noise and pollution is removed from our roads, what will this do? Or will governments around the world insist that these cars are built to make noise, so crossing the road won’t be so dangerous?

When buying in regional areas, the above points are even more crucial. Whilst there are some awesome buys out of town, I do have a concern that some of those who have secured a ‘sea-change’ or ‘tree-change’ may come out of this lockdown missing their old way of life and their social networks, and may in time look to come back to the big smoke.

– Don’t discount commercial property! Particularly those with flexible zoning.

I touch on these kinds of properties in my videos, often combined with SMSF possibilities, and will certainly be making more!

I only have 50 subscribers, that’s a bit embarrassing… perhaps you can help ~ 🙂 (you can click on the image below).

YT iChoice channel

I hope you’re feeling positive and looking forward to the best few months of the year.

C’mon summer!

Jason

Jason C. Khoury, JP, Financial Strategist, iChoice Managing Partner