I often have clients get in touch who have large residential portfolios with low gearing, and long term bank relationships. They’re on a comfortable income to service their actual commitments, but are really struggling with their bank.

Some aren’t able to secure an extension to their lending to acquire further properties. Some are being told they are no longer allowed to roll their interest-only terms and are facing principal and interest payments that will severely impact their cashflow. Some are being told their interest rates are now going up because they are an investor.

Most of these people are facing a simple dilemma: they have outgrown the retail division of their bank.

In recent years, banks have brought in many criteria under the banner of responsible lending standards that are making borrowing for residential investors difficult. Pertinent to the above, banks are required to assess lending on test rates (up to 7.0%) and all debt must be repaid over the remaining terms of the loans.

What does this mean for you as an investor? You must be able to fully service principal and interest at 7.0% over the term of your loan, as opposed to the actual rate of interest you are on (say 4.0%). In real terms, on a $1,000,000 loan with 25 years to run, that can mean the bank is assessing your cost at circa $85,000 per annum as opposed to circa $63,000 per annum. A difference of $22,000!

Say goodbye to interest-only

It also means that interest-only terms are increasingly hard to come by, despite being prudent practice as an investor. Most people will have heard the quote “debt is cheaper than equity”, a truism which is saying you should hold a level of debt against your portfolio to maximise your returns. Unfortunately, given the bank is required to ensure you have sufficient income (today) to repay your entire debts over the term of your loans, at some point they cut off your access to interest-only.

Taking the example above, if you have a 25 year term remaining on the loan but are seeking five years on interest-only, the bank will reduce the term of your loan to 20 years for assessment purposes (25 years less the five years’ interest-only). This would spike your assessed servicing cost from $85,000 to $93,000 per annum.

On top of all of this, the banks will arbitrarily scale your residential income at 75%. If you are earning $100,000 of income, the banks will reduce this to $75,000 for servicing purposes. You are being stung from both sides!

If you’re tight or can’t meet the servicing criteria, the bank will refuse further extensions of your interest-only, debt increases and possibly dictate you begin principal and interest terms on your debt.

No need to despair however, as there are solutions available. As above, many people have just outgrown retail bank lending. There are areas within banking that provide for large investors who are running into the headwinds above.

Large property investors are able to access funding that will provide greater flexibility. The key areas of focus for these parts of the bank are the loan-tovalue ratio (LVR) – (preferably less than 55% LVR) and interest cover (preferably greater than 1.5 times).

Interest cover ratios are the real win for investors. Again, working on the example we had above with $1,000,000 of debt, the bank will be seeking an interest cover of 1.5 times (net income/ interest expense). This means at a 4.0% fixed rate they will be seeking $60,000 of net income (1.5 times $40,000).

This simple measure adds huge value to investors by firstly taking actual net income (what you actually earn after expenses) which on a larger portfolio tends to be greater than 75% of rental. And secondly, by running on an interest cover basis, putting $20,000 or more back in your pocket and possibly further lending.

Now, there are some drawbacks to this type of lending, and it isn’t for everyone. The banks will want large scale investors (with at least $5,000,000 of debt), low LVRs (below 55%) and the pricing mechanisms are different to retail rates, which rule out access to cash backs or bottom dollar specials. I often find however that overall, the pricing isn’t vastly different and the structure will actually add value to the client.

If you are having trouble with your bank or think that you could be getting more from your portfolio, give Squirrel a call. It costs nothing to sit down and chat through your options.