A common strategy used by property investors around Australia to amass large portfolios of real estate is potentially very risky, experts warn.
More than half of all property investors are using equity in their homes or other investments as a way to pay for a deposit on another property, with lenders allowing them to tap into house price growth seen during the property boom.
While this strategy is popular with property investors as it doesn’t require them to cough up any savings, some commentators are raising the alarm, including LF Economics co-founder Lindsay David, whose newly published report The Big Rort points to significant risks for investors and the housing market generally.
Mr David claims that investors’ high level of borrowing through accessing equity – which in many cases allows them to borrow more than the value of the property itself – puts them at a higher risk of default.
It may have also helped to keep houses prices higher by allowing people to borrow on top of any wealth made during the boom.
“The Australian house of cards has ballooned through the use of issuing new loans against the unrealised capital gains of other properties in a portfolio,” the report said.
He said households were “creaking under the strain of servicing an immense stock of mortgage debt which still continues to grow”.
Mr David’s research indicates that those with an “officially listed [loan to value ratio] in the 50 per cent to 70 per cent bracket” – common to those who have borrowed using equity – are more likely to be close to default than those with a loan size at 90 per cent or larger.
In many cases, these investor loans are interest-only and “when house prices have fallen in a local market, many borrowers were unable to service the principal on their mortgages when the interest only period expires or are unable to roll over the interest-only period”, the report warns.
Usually, when someone buys a home they have to stump up a 20 per cent deposit or pay lender’s mortgage insurance. For instance, in the case of a $500,000 home, a 20 per cent deposit would be $100,000 and they would be given an 80 per cent loan of $400,000.
If they have another property also worth $500,000, they could borrow 20 per cent of the value of the property they’re hoping to buy, by using the value that is already in the property they own – known as pulling out equity – which usually involves refinancing.
Of course, the owner would need to have enough value in the home – either from repayments or from value growth – to be able to do this.
Mortgage Choice’s 2017 Investor Survey found more than half of Australian property investors surveyed relied on equity to build their portfolio, either by funding full deposits or part-deposits.
But Mortgage Choice chief executive John Flavell said investors were still required to prove they could manage the loan commitment.
“You can minimise risk by looking to acquire an investment property that is mid-range in the purchase price, located in a well-established metropolitan area, where demand for rental properties is high, this provides an income outside of wages to service the debt,” Mr Flavell said.
Property Investment Professionals of Australia chair and Empower Wealth founder Ben Kingsley said it was more important to consider serviceability than equity when it came to this method of financing property.
“You won’t be lent a lot of money just because you have a lot of money in your family home,” he said.
He also urged people to consider keeping loans separate rather than cross-collateralising – for instance, by taking the deposit proportion out of the borrower’s home from an offset account and then having the rest borrowed against the investment property.
Cross-collateralising has many consequences for the borrower. This includes less control over buying and selling, complexities around future use of equity and increased difficulty switching loans.
He warned that those who invest are able to use the borrowed funds to maximise the outcome. But it “magnifies risk as well as reward”, he warned.
“There are horror stories out there with people with negative equity in Dysart, Moranbah, Mackay and Gladstone. Evidence of prices lower than what people originally paid.”
Dream Financial mortgage broker Paul Bevan said investors should remember the equity they have accessed is secured by the owner-occupier property, not the investment.
“If you cannot meet your repayments on the new higher loan amount and default, then you could be at risk of losing your owner-occupied property,” he said.
“Similarly, if you are relying on rental income to service your investment property loan of $320,000 and your property remains vacant for an extended period of time and you are unable to meet your loan repayments and eventually default, then you are at risk of having your lender repossess your investment property.”