Borrowing based on an assumption of consistent future income is not exactly foolproof either. People lose jobs, have babies, get sick or injured. The chances of one of these things happening over the course of a 30 year loan is pretty high.
Louise
NAB - No more Low Docs
- Thread starter Fundamental
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Borrowing based on an assumption of consistent future income is not exactly foolproof either. People lose jobs, have babies, get sick or injured. The chances of one of these things happening over the course of a 30 year loan is pretty high.
Louise
Ed Chan's Response
Hi Everyone.
Ed Responds as follows:
It has come to my attention that AIMJOY has misrepresented what I said in a seminar and I would like to take this opportunity to correct this with what was actually said.
Cleary the ATO treats Capital Gain and Income differently. Capital Gains, if held for more than 12 months will entitle the taxpayer to a 50% exemption from tax. Income has no such exemption. As Accountants we are dealing with this on a daily basis and is an area of constant battle with the ATO.
I was asked how does one reconcile the difference between what was declared in a low doc loan application as “Income” to that which was declared in a tax return as “income”.
I explained that in the low doc application, clients often included capital gain, wages, rental, as “Income”. The dictionary definition of “income” clearly does not include capital gain however what the Low Doc Lenders are interested in is how you are going to service the loan. They generally accept what money “comes in” and what money “goes out”, in your ability to service the loan. “Income” is a clumsy request for “serviceability” because clearly many people use debt to service debt.
The idea behind using a portion of capital gain, (in the form of a line of credit against the increased equity of your property) to service your loan is not a new concept. Some call it debt servicing debt.
With a rental yield of 4% and capital gain of 8% (average over a 10 year period) giving a total return of 12% can easily service an interest rate of say 7% or 8%. The net effect is using debt as a tool, one can effectively increase their NET wealth.
Whether you agree with this or not is entirely ones own business. In my book called “Wealth for Life through Property Investing” I have provided some calculations and financial modelling to prove the theory at least works.
Secondly I also explained that a few client were sent letters by the ATO to “please explain” the difference between the “Income” they declared in their tax returns to that declared in their Lo Doc Application. When it was explained that “income” in their Lo Doc Loan Application included “capital gain” we did not hear back from them again.
TOKEN FUNDER wrote:
The Tax Act very specifically differentiates between the notion of ordinary income and capital gains.
In any case, it is irrelevant and intellectually dishonest to suggest that the capital appreciation in an illiquid asset is the same as income. It's a form of self-delusion, the main reason why I see Lo Doc borrowers fall over and given the changing environment around Lo Doc lending is a recipe for disaster.
Ed should pull his head in.
Ed Responds:
Capital appreciation in an asset such as property is not illiquid and this has been demonstrated time and time again when someone refinances their home due to the increased equity and either purchases another property or uses the Line of Credit to fund other debt. If you are using the dictionary definition of “Income” than you are correct but a line of credit can supply cash flow and to some that is “income” though not in the traditional dictionary definition.
Just depends on which hymn book you are singing from. Neither, in my opinion is wrong.
For your information Lo Doc Loan borrowers had a very low degree of default. We have a Finance arm to our business and there has been very few, if any Lo Doc Loan defaults, no more or less than full docs, which explains the explosion of Lo Doc loans in Australia. The problem was lending money to people with no assets at all which is what happened in America. This did not happen here in Australia.
The reason why the Lo Doc loans have dried up was due to the money supply around the world drying up. This of course was caused by the Sub Prime Mortgages in the US. Australia’s Finance industry is highly Regulated unlike that of the U.S. If Lo Doc borrowers were defaulting than Australian Regulators would have ceased this type of lending a long time ago.
In fact we are now starting to see some non bank lenders re entering this market as the track record in Australia warrants them venturing back into this market. The problem as I said earlier was the money supply had dried up and whenever demand is more than supply, either the cost of funds goes up or the lending criteria tightens up. Tightening up ones lending criteria also helps the banks credit rating so when money supply is tight, the banks do both.
This is quite different to the viability of Lo Doc Loans. People tend to confuse the problems in the U.S. with Lo Doc Loans which are two completely different problems.
In my seminars and in my book I also talk about Investing is a concept of “Buying Time” and not buying “Real Estate”. So the more time you can “buy” the safer the investment. The longer you can service the loan, the longer you can weather the storm, the safer your investment.
I have said over and over, your strategy has to be safe. The best way to make it safe is to create a “Buffer” and the use of a Line of Credit against increased Equity as a Buffer to service the Negative Gearing for say 10 years allows you the time to weather the storm and your investments to grow in value. The markets will always ebb and flow in the short term but trend upwards over the longer term.
Nothing has changed and its not rocket science. The best things are always the simplest.
Clearly this is not for everyone and its best to keep within ones own comfort zone.
Regards
Bianca on behalf of Chan & Naylor
www.chan-naylor.com.au
Hi Everyone.
Ed Responds as follows:
It has come to my attention that AIMJOY has misrepresented what I said in a seminar and I would like to take this opportunity to correct this with what was actually said.
Cleary the ATO treats Capital Gain and Income differently. Capital Gains, if held for more than 12 months will entitle the taxpayer to a 50% exemption from tax. Income has no such exemption. As Accountants we are dealing with this on a daily basis and is an area of constant battle with the ATO.
I was asked how does one reconcile the difference between what was declared in a low doc loan application as “Income” to that which was declared in a tax return as “income”.
I explained that in the low doc application, clients often included capital gain, wages, rental, as “Income”. The dictionary definition of “income” clearly does not include capital gain however what the Low Doc Lenders are interested in is how you are going to service the loan. They generally accept what money “comes in” and what money “goes out”, in your ability to service the loan. “Income” is a clumsy request for “serviceability” because clearly many people use debt to service debt.
The idea behind using a portion of capital gain, (in the form of a line of credit against the increased equity of your property) to service your loan is not a new concept. Some call it debt servicing debt.
With a rental yield of 4% and capital gain of 8% (average over a 10 year period) giving a total return of 12% can easily service an interest rate of say 7% or 8%. The net effect is using debt as a tool, one can effectively increase their NET wealth.
Whether you agree with this or not is entirely ones own business. In my book called “Wealth for Life through Property Investing” I have provided some calculations and financial modelling to prove the theory at least works.
Secondly I also explained that a few client were sent letters by the ATO to “please explain” the difference between the “Income” they declared in their tax returns to that declared in their Lo Doc Application. When it was explained that “income” in their Lo Doc Loan Application included “capital gain” we did not hear back from them again.
TOKEN FUNDER wrote:
The Tax Act very specifically differentiates between the notion of ordinary income and capital gains.
In any case, it is irrelevant and intellectually dishonest to suggest that the capital appreciation in an illiquid asset is the same as income. It's a form of self-delusion, the main reason why I see Lo Doc borrowers fall over and given the changing environment around Lo Doc lending is a recipe for disaster.
Ed should pull his head in.
Ed Responds:
Capital appreciation in an asset such as property is not illiquid and this has been demonstrated time and time again when someone refinances their home due to the increased equity and either purchases another property or uses the Line of Credit to fund other debt. If you are using the dictionary definition of “Income” than you are correct but a line of credit can supply cash flow and to some that is “income” though not in the traditional dictionary definition.
Just depends on which hymn book you are singing from. Neither, in my opinion is wrong.
For your information Lo Doc Loan borrowers had a very low degree of default. We have a Finance arm to our business and there has been very few, if any Lo Doc Loan defaults, no more or less than full docs, which explains the explosion of Lo Doc loans in Australia. The problem was lending money to people with no assets at all which is what happened in America. This did not happen here in Australia.
The reason why the Lo Doc loans have dried up was due to the money supply around the world drying up. This of course was caused by the Sub Prime Mortgages in the US. Australia’s Finance industry is highly Regulated unlike that of the U.S. If Lo Doc borrowers were defaulting than Australian Regulators would have ceased this type of lending a long time ago.
In fact we are now starting to see some non bank lenders re entering this market as the track record in Australia warrants them venturing back into this market. The problem as I said earlier was the money supply had dried up and whenever demand is more than supply, either the cost of funds goes up or the lending criteria tightens up. Tightening up ones lending criteria also helps the banks credit rating so when money supply is tight, the banks do both.
This is quite different to the viability of Lo Doc Loans. People tend to confuse the problems in the U.S. with Lo Doc Loans which are two completely different problems.
In my seminars and in my book I also talk about Investing is a concept of “Buying Time” and not buying “Real Estate”. So the more time you can “buy” the safer the investment. The longer you can service the loan, the longer you can weather the storm, the safer your investment.
I have said over and over, your strategy has to be safe. The best way to make it safe is to create a “Buffer” and the use of a Line of Credit against increased Equity as a Buffer to service the Negative Gearing for say 10 years allows you the time to weather the storm and your investments to grow in value. The markets will always ebb and flow in the short term but trend upwards over the longer term.
Nothing has changed and its not rocket science. The best things are always the simplest.
Clearly this is not for everyone and its best to keep within ones own comfort zone.
Regards
Bianca on behalf of Chan & Naylor
www.chan-naylor.com.au
A most valuable comment, which many dont understand.
In my seminars and in my book I also talk about Investing is a concept of “Buying Time” and not buying “Real Estate”. So the more time you can “buy” the safer the investment. The longer you can service the loan, the longer you can weather the storm, the safer your investment.
ta
rolf
In my seminars and in my book I also talk about Investing is a concept of “Buying Time” and not buying “Real Estate”. So the more time you can “buy” the safer the investment. The longer you can service the loan, the longer you can weather the storm, the safer your investment.
ta
rolf
depends on your POV, some would argue that the last 40 years is an anomoly and that these excessive gains will drift down over the next 40 years. IF this eventuates, then you are buying a recipe for losses.
agree with Ed's comments re capital / income etc.
agree with Ed's comments re capital / income etc.
Ed,
You're spinning.
Potential capital gains are not income. Not from the Tax Office's perspective, not from a lender's perspective and not from any common understanding of the word.
It.Is.Not.Income.
Ed, here's the test: What do you think would happen if the investors taking your advice wrote to their lenders to say that X% of the income they declared was actually their estimate of the potental capital gain in their property portfolio and that they always intended to pay the loan through borrowing against same?
If Ed is reticent, would the brokers in the room like to hazard a guess??
As an aside, Ed, when you encourage people to "count" prospective but unrealised capital gains as income, do you point out the they should reduce the asset base declared to the lender by the same amount or does the income on page 1show up as equity on page 2?
Secondly, the argument that Lo Doc has a lower rate of default is horse hockey.
Here's some info of performance before the credit crisis really hit rates.
http://www.inassociation.com.au/pdf/BenMcCarthy_ABS2007.pdf
Advice like your own is a not insignificant contributor to those results.
Thirdly, the argument that "if it wasn't as good as Full Doc somebody would stop the bank's doing it" shows you need to beef up your education. APRA capital requirements around Lo Doc are materially higher for Lo Doc because it is recognised as higher risk business.
As lenders allocate funding to Full Doc, away from Lo Doc and investors and others who have based their financial planning around the notion that the relative cost and availability of Lo Doc wouldn't change find their plans in the toilet, they should drop the "equity is income" crowd a note of thanks.
You're spinning.
Potential capital gains are not income. Not from the Tax Office's perspective, not from a lender's perspective and not from any common understanding of the word.
It.Is.Not.Income.
Ed, here's the test: What do you think would happen if the investors taking your advice wrote to their lenders to say that X% of the income they declared was actually their estimate of the potental capital gain in their property portfolio and that they always intended to pay the loan through borrowing against same?
If Ed is reticent, would the brokers in the room like to hazard a guess??
As an aside, Ed, when you encourage people to "count" prospective but unrealised capital gains as income, do you point out the they should reduce the asset base declared to the lender by the same amount or does the income on page 1show up as equity on page 2?
Secondly, the argument that Lo Doc has a lower rate of default is horse hockey.
Here's some info of performance before the credit crisis really hit rates.
http://www.inassociation.com.au/pdf/BenMcCarthy_ABS2007.pdf
Advice like your own is a not insignificant contributor to those results.
Thirdly, the argument that "if it wasn't as good as Full Doc somebody would stop the bank's doing it" shows you need to beef up your education. APRA capital requirements around Lo Doc are materially higher for Lo Doc because it is recognised as higher risk business.
As lenders allocate funding to Full Doc, away from Lo Doc and investors and others who have based their financial planning around the notion that the relative cost and availability of Lo Doc wouldn't change find their plans in the toilet, they should drop the "equity is income" crowd a note of thanks.
Thanks for that Token Funder. It was interesting to observe the difference in defaults between those loans over 70& LVR and those les than. I guess it might show both age of loan, perhaps time expereince of investor and access to equity in general.
It makes sense that some banks are still happy to look at say 60% LVR for lo docs where the risk is much more similar to full docs in terms of defaults with also a safety margin in terms the property sale should a forced sale coem about.
It makes sense that some banks are still happy to look at say 60% LVR for lo docs where the risk is much more similar to full docs in terms of defaults with also a safety margin in terms the property sale should a forced sale coem about.
