When to diversify borrowing?

[Choc]

Hello everyone,

I?ve been a selective reader of the forum for the most part of the past two years and would like to start by saying ?thank you!? to all of those who have been very generous in sharing their knowledge. I have relied mostly on the ?search? function and never really had to register as a member as most of the questions that I had were already covered in various topics.

I am very new to the investment game and lately, I am trying to figure at what stage/loan amount do I need to start diversifying my borrowings in order to spread my risk?

We paid off our PPOR in 2013 and after what seemed like an eternity of agonizing over ?should we, shouldn?t we?; finally took a plunge and purchased our first IP in May last year. I am keen to pick up another IP around the 500k mark and remember reading amongst the threads that it is better to diversify borrowings rather than sticking with one bank.

The current IP was purchased for $465k ? with a total loan size of 500k. Of this, $128k was pegged to the PPOR. We also applied for a 200k loan (untouched) that we intended to use as down payment if we find another PPOR that we like.

I am trying to find out what the major limitations are if I continue to stick with the one bank and how this would impact on my future financing?

I am currently with CBA and have found having multiple offset accounts to be a good feature plus they seem easy with IO loans with IP. We were previously on 4.84% and got a slight reduction (to 4.74%) recently by completing a desktop valuation on the IP and taking on an additional 20k loan ? pretty much sorted out in 1 phone call. I am not that familiar with the other banks so I am wondering if this ?convenience? is fairly standard.

 

[Redom]

Hello everyone,

I?ve been a selective reader of the forum for the most part of the past two years and would like to start by saying ?thank you!? to all of those who have been very generous in sharing their knowledge. I have relied mostly on the ?search? function and never really had to register as a member as most of the questions that I had were already covered in various topics.

I am very new to the investment game and lately, I am trying to figure at what stage/loan amount do I need to start diversifying my borrowings in order to spread my risk?

We paid off our PPOR in 2013 and after what seemed like an eternity of agonizing over ?should we, shouldn?t we?; finally took a plunge and purchased our first IP in May last year. I am keen to pick up another IP around the 500k mark and remember reading amongst the threads that it is better to diversify borrowings rather than sticking with one bank.

The current IP was purchased for $465k ? with a total loan size of 500k. Of this, $128k was pegged to the PPOR. We also applied for a 200k loan (untouched) that we intended to use as down payment if we find another PPOR that we like.

I am trying to find out what the major limitations are if I continue to stick with the one bank and how this would impact on my future financing?

I am currently with CBA and have found having multiple offset accounts to be a good feature plus they seem easy with IO loans with IP. We were previously on 4.84% and got a slight reduction (to 4.74%) recently by completing a desktop valuation on the IP and taking on an additional 20k loan ? pretty much sorted out in 1 phone call. I am not that familiar with the other banks so I am wondering if this ?convenience? is fairly standard.

There may be no need to diversify your borrowings after 1 loan unless you have serviceability issues. CBA will treat your existing debt with them harsher than other lenders, meaning you can borrow less with CBA compared to most other lenders.

Although you'll need to consider what another investment loan with CBA will do to your future borrowing with CBA - as you may need to cash out your PPOR/IP's again in future. You want enough breathing room to move forward (three steps ahead, instead of just the next transaction).

Separately, if I read correctly, your loans may be crossed. No need for that at all, i'd uncross while your going through the lending process again.

CBA cash outs pretty good and their valuation systems are very useful. In terms of service, they are up there and will be hard to beat.

Cheers,
Redom

 

[Terry_w]

If you had banks and things started to go bad you would be able to stall things longer giving you a chance to start selling.

e.g you could keep paying the loan on one property and sacrifice the other. This would give you a chance to sell the property you are paying on time. You could then control the release of funds from the sale and use these as you please.

If you are with one bank they would know you are in trouble and possibly take control of your properties and any proceeds from the sale may be used to pay down any remaining and existing loans.

But having a PPOR fully paid off means the chances of something going back cashflow wise is very low, lower than normal.

 

[Choc]

There may be no need to diversify your borrowings after 1 loan unless you have serviceability issues. CBA will treat your existing debt with them harsher than other lenders, meaning you can borrow less with CBA compared to most other lenders.

Cheers Redom. If I understand you correctly, I shouldn't need to consider someone else until I hit a brick wall?

Separately, if I read correctly, your loans may be crossed. No need for that at all, i'd uncross while your going through the lending process again.

Loans are separate; 80% pegged to IP, remaining 20% plus purchase costs pegged to PPOR. Banks did tell me that it is a good idea to cross-securitise them both in the one loan

 

[Rolf Latham]

I am trying to figure at what stage/loan amount do I need to start diversifying my borrowings in order to spread my risk?

much of that will come down to what your future goals are both with property investing and other possible risk ventures such as business,and what your personal risk profile is.

concentration risk is really a very specific thing and will depend very much on the above.


Generally 1 to 1.5 mill with the one lender at 80 % lvr if all else fits is a reasonable compromise,

at > 80 % we would like to see it at 750 to 900 depending on the lender.


ta
rolf

 

[Choc]

If you had banks and things started to go bad you would be able to stall things longer giving you a chance to start selling.

Good advice Terry. Certainly something to consider. I think that with my loan sizes and overall reluctance to have to manage multiple loans with different banks; I'll probably stick with CBA until I try to buy a third IP.

 

[Choc]

much of that will come down to what your future goals are both with property investing and other possible risk ventures such as business,and what your personal risk profile is.

Thanks Rolf - I consider myself to be risk adverse and I am unlikely to be venturing beyond property investing. Having said that, I never really considered property investments until fairly recently.

My future views may change but I am more likely to forgo an "attractive" investment if it means that I'll have to pay LMI - If my equity doesn't allow it, I will rather walk to keep the LVR at 80% or below.

 

[Redom]

Cheers Redom. If I understand you correctly, I shouldn't need to consider someone else until I hit a brick wall?

Best to dig a little deeper than hitting serviceability wall with CBA on your next property, will also need to consider impacts on future cash outs.

For example, you may need to withdraw equity to fund IP3. You'd want to make sure you have the breathing room with CBA available to you to go ahead and do that.

One way to do a quick check, when you go and see how much you can borrow next, get an overall upper limit from CBA. This should give you a guide for how much breathing room you have. If the upper limit is close to the actual loan required for the next purchase, it may be hard to release equity in future. Note that this should be considered in the context of assumptions around future income/expenses.

Cheers,
Redom

 

[Colin Rice]

My future views may change but I am more likely to forgo an "attractive" investment if it means that I'll have to pay LMI - If my equity doesn't allow it, I will rather walk to keep the LVR at 80% or below.

LMI is a leveraging tool allowing you to not only buy more properties with less money down but also and just as important (in many cases) withhold funds as a buffer in case things go pear shaped.

It is largely about cash flow so if you did hit hard times the bank wont know nor care if you are still making your interest payments. If you put the full 20% in to avoid LMI and end up with no cash reserves and as a result cant make payments the bank will be concerned.

It helps to look at LMI from a cash-flow perspective rather than 10k extra borrowings. It equates to less than $10/week and less once you factor in depreciation over 5 years plus the interest is tax deductible for the life of the loan.

 

[Peter_Tersteeg]

Generally 1 to 1.5 mill with the one lender at 80 % lvr if all else fits is a reasonable compromise,

at > 80 % we would like to see it at 750 to 900 depending on the lender.

It does depend on the individual circumstances and goals, but the parameters Rolf has outlined tends to fit fairly well to most scenarios from the perspective of lender policy.

If your serviceability is somewhat limited, then it may be necessary to diversify sooner.

 

[Choc]

It helps to look at LMI from a cash-flow perspective rather than 10k extra borrowings. It equates to less than $10/week and less once you factor in depreciation over 5 years plus the interest is tax deductible for the life of the loan.

Very valid and sensible point Colin, thank you for pointing that out. Incurring LMI does however impact on interest rates and whilst all these costs are tax deductible; the flow on effect is probably larger than I can grasp right now. I probably need more time to understand more and to change my current mindset on having to pay LMI.

If your serviceability is somewhat limited, then it may be necessary to diversify sooner.

Thanks for pointing that out

 

[Terry_w]

Good advice Terry. Certainly something to consider. I think that with my loan sizes and overall reluctance to have to manage multiple loans with different banks; I'll probably stick with CBA until I try to buy a third IP.

I have clients with 2 or 3mil with one lender. I think if the client is stable with a strong income and not self employed there is a very low chance things can start to go bad. The people that I have seen fall over seem to have done so because they hang on and don't try to sell until the very end- and all of these people have been self employed.

 

[Choc]

I thought a lot about LMI last night and in going through my previous postings; I realised a fundamental flaw about my decision making process. I am making decisions on buying an IP as if I was buying a PPOR. Thanks again to Colin for pointing out the very obvious.

In addition to limiting cashflow, I am also losing out on opportunity cost. Admitting to this openly makes me look really stupid but hopefully helps someone else. Why buy a 500k IP with an 20% downpayment when you can buy 2 or more with a 10% contribution for each

I have clients with 2 or 3mil with one lender. I think if the client is stable with a strong income and not self employed there is a very low chance things can start to go bad. The people that I have seen fall over seem to have done so because they hang on and don't try to sell until the very end- and all of these people have been self employed.

I have seen that myself - not only with properties but other investments as well and I guess it explains why I tend to be overly cautious (almost to my own detriment).

 

[Colin Rice]

Hi Choc,

Your welcome.

Love love love it when the penny drops

 

[Rolf Latham]

I have clients with 2 or 3mil with one lender..

I also have that sort of one lender exposure with some clients.

Esp those with a single security, and those with larger portfolios, where its impractical to spread lending across 12 lenders or the like.

Small risk or not, there is usually very little borrower upside. aside from the McDonalds benefit.

If there is no logical benefit to retain or create the risk, dont go there.

I have had more than one PAYG get into issues due to avoidable risk.

I guess it comes down to what peops want to value convenience at, and thats an individual decision.

Surviveability is key in my view.

ta
rolf

 

[Choc]

Hi Choc,

Your welcome.

Love love love it when the penny drops

Cheers Colin, raised this with the bank and the LMI like you said is around the 10k mark - I am rather on board with the idea until....
the bank told me that the difference in interest rate equates to .30%

The plus side is I retain equity but the downside is having to pay almost $4000 more in interest alone (based on the higher interest rate). That said, the option is to pay down 20% to lock in the reduced interest rate for now. If and when I need to access that equity, I can then pay LMI to withdraw that amount but still enjoy the guaranteed rate.

Seems more logical to do it this way?

 

[ericproperty]

Surviveability is key in my view.

completely agree, high surviveability => longer holding period => better CG potential

invest safe!