Investment properties: 4 things every lender looks for
If you’re borrowing to purchase an investment property or add to your property portfolio, it’s critical you consider if the property you’re purchasing is acceptable to the lender. Almost all residential investment loans are secured by residential property, and lenders will decline an application if they deem the property unsuitable.
In cold hard terms, if things go pear shaped and you cannot make the repayments on your investment loan, the lender may sell the property to recoup their money. When that decision is made, the lender wants to know they can sell the property quickly, and that it will sell for enough to cover the outstanding loan and costs.
Lenders do not like risk, so they will look very closely at the property you are purchasing. The following list outlines their main points of focus.
Loan-to-valuation ratio (LVR)
LVR stands for loan-to-valuation ratio. This is the amount of the loan measured against the value of the property expressed as a percentage. For example, if a borrower purchases a property for $500,000 and obtains a loan of $400,000, the LVR is 80%. If they borrow $300,000, the LVR is 60%. This ratio is critical because it will determine how much that can be borrowed, and often, what interest rate the loan will attract.
Obviously, the lower the ratio, the less risky the loan is for the lender. Lenders will not lend more than the property is worth and the highest LVR is usually 95%. The most common LVR number is usually 80%. When the LVR is higher than 80%, the interest rate is usually higher and the loan will attract Lenders Mortgage Insurance, which is another cost passed on to the borrower. Furthermore, the lenders and mortgage insurers will scrutinise the application more thoroughly to ensure their risk is minimised. This makes the loan more expensive and more difficult to obtain approval for.
Location, Location, Location. We’ve all heard real estate agents use this phrase. The more desirable the location, the easier it is to sell the property and the more likely it is to retain or increase in value. In other words, the location of the property is a positive that reduces the risk to the lender.
For that reason, a property in a blue chip suburb in Sydney or Melbourne is considered more favourably than one in a small regional town where the market is less active. As many investors are also finding to their detriment, locations reliant upon a single industry such as mining are also considered risky. If the industry goes into decline or fails, the property will also decline in value. Therefore, lenders may have a lower LVR in certain towns or locations or may not lend in those locations at all. Another example is high-density apartments in our capital cities. As more apartments are completed, supply is rising and prices are coming under pressure. As a result, lenders will commonly only consider applications for those properties with an LVR of 70% or less. Given these projects are commonly located close together, the postcodes in which they are located will have a lower maximum LVR. So do your homework. Look at the supply of properties, the economic features and the long-term market activity of the location. Even if you don’t, the lender will.
Lenders are wary of what they classify as ‘specialist’ property types. These include properties such as studio apartments under 50m2, mixed zoning properties, titles with multiple dwellings, Off The Plan properties, student accommodation, etc. Why? These types of properties are seen to have a smaller market and consequently, lower demand. That means they may take longer to sell, or may need to be sold at a heavily discounted price to attract a buyer. That raises the risk for a lender, so again, they may limit the LVR, or consider the property unacceptable and decline to fund the purchase. If in doubt, ask your lender before you go to the auction or enter into the contract – it may save you tens of thousands of dollars.
The final item to consider is if the property is negatively impacted by any external features. Lenders will decline applications for properties if they think an external feature may extend the selling period, or lower the value of the property. This may include close proximity to high-voltage power lines, land slip areas, flood zones, bushfire zones, old mine areas, etc. Again, it comes down to doing your research.
Property can deliver investors with terrific yield, but if the lender looks unfavourably on the property after assessing these four key areas, they may decline your application. So do your research and if in doubt, ask your financial adviser or the team at Switzer Home Loans.
Adrian Sheahan is the manager of lending operations at Switzer Home Loans. Contact him today for a free loan health check.