When building a property portfolio, most investors will focus on the need to identify properties with high growth potential. However, your property portfolio will be hindered from the outset if you can’t get the funds to finance your investment journey.
Choosing the right financial structures and taking the right steps towards preparing your finances can be critical to achieving your long-term property goals, and failure to do so could severely restrict your ability to move forwards with your investment plans. Here are five common finance mistakes that can limit your borrowing capacity.
Cross-collateralisation
Cross-collateralisation is where a lender uses more than one property as collateral to secure a loan. This is a common practise amongst banks looking to maximise their security; however, unbeknownst to many investors, this set-up can also have critical implications on your future borrowing capacity.
As your debt levels increase with your chosen lender, many banks will restrict your product choice or even stop lending to you altogether due to increased risk. Unfortunately, the likelihood is that you would then also be unable to secure a loan from a different lender due to the lack of property titles available as security, meaning you may then need to refinance your loans to switch lenders.
In addition, crossing your loans could also restrict your ability to leverage equity from your portfolio for future investment purposes. For example, if one of your properties increased in value but the others had decreased, the equity from the first property would be inaccessible due to the value of the portfolio as a whole. To avoid these issues and maximise your potential borrowing capacity, it’s better to take out separate loans for each new property from an established line of credit, using multiple lenders where possible to maximise your product choice.
Choosing the wrong ownership structures
When it comes to applying for a loan, it’s really important to choose an ownership structure that aligns with your property investment plans. Choosing the wrong structure can have vital implications on your ability to achieve your goals, and it can also be an expensive mistake to fix retrospectively.
For instance, whilst buying property via a trust may be useful for asset protection, this ownership structure can also limit your future borrowing capacity due to the tax implications involved, with many lenders not allowing negative gearing claims for loan serviceability. Similarly, a lot of lenders won’t allow you to borrow through a Self-Managed Super Fund. After speaking to your accountant about the best structure to suit your situation, you will need to talk to your mortgage broker about whether you can actually get funding with that ownership structure, ensuring you understand the future implications this could have on your borrowing capacity.
Not understanding joint and several liability loans
Joint loans and several liability loans can be a useful option for borrowers looking to increase their serviceability, but it’s also important to understand the potential implications of these products. When borrowing jointly with another party, you will each be individually responsible for the debt (in most cases, 100% of it), but lenders will only take into account half the rental income when assessing your serviceability in future. This can impact your borrowing capacity should you wish to invest in another property outside of the joint purchase.
However, bear in mind that individual lenders will often assess this differently, and speak to a mortgage broker with a knowledge of property investment to ensure you understand the full implications of your chosen lending product.
Taking on too much debt
When determining your eligibility for a lending product, lenders will calculate your debt-to-income ratio to assess your ability to service the loan. One of the key mistakes that can therefore significantly limit your borrowing capacity as an investor is taking on too much unnecessary debt and expenses.
A key factor that often catches investors out here is their credit card limit. Banks will consider credit card limits as debt, and will take a monthly liability to mitigate their risk in lending to you. This can impact your perceived serviceability, and therefore limit your potential borrowing power.
When taking on additional overheads or applying for a personal loan, make sure you understand how these additional debts and expenses could impact your future eligibility for an investment property loan. If serviceability is becoming a problem, you may need to consider cutting back on unused credit cards and paying down existing debts to improve your potential borrowing power.
Making too many loan enquiries
Another fundamental finance mistake that a lot of investors make is submitting too many credit enquiries. Many borrowers don’t realise that these enquiries will be recorded in their credit report, which can then be viewed negatively by future lenders and adversely impact your eligibility for a further loan.
A lot of banks will often be reluctant to lend money to you if they see you have made multiple credit enquiries in a short time period. If you’re thinking about applying for finance, consider speaking to your mortgage broker first to carry out a pre-approval and assess the likelihood of qualifying for the loan.
Maximising your borrowing potential
With banks tightening their lending criteria in light of recent movements in Australia’s lending environment, it’s never been more important for investors to understand the factors that can impact their borrowing capacity.
Preparing your finances early and seeking the advice of a specialist mortgage broker who understands the structures and steps that support your long-term investment is fundamental for those looking to make the most out of their investment journey.
If you are looking to secure finance for your next property or would like to discuss how recent changes to the lending environment could impact you as an investor, Momentum Wealth’s mortgage brokers would be happy to discuss your situation in an obligation-free consultation.