If you're looking to purchase an investment property, many lenders will try to refinance your home loan and offer discounted rates and incentives to get you on-board.
If you intend to borrow and use your home as secuirty, and if it's a family home that you intend to live in, using your home as secuirty is not a big issue. But if you intend to build a property investment portfolio, you will need to make sure that your loans are not cross collateralised (also referred to as cross securitisation), otherwise you could put your investments and family home at risk.
Getting the Deposit
The easiest way for most people to come up with a deposit to buy an investment property is to use the equity in their own home.
When you approach a lender to take out a new loan, such as one of Australia's big four banks, they will use their own panel of valuers to estimate the value of your property. Based on this valuation process (known as a bank valuation), the banks will decide how much they will lend to you.
Bank valuations are not based on what you can get if you sell your property, but rather it's a discounted valuation. Bank valuations can be discounted by as much as 10 per cent or more. The reason for the discounted valuation is to ensure that if your property was repossessed and sold, the banks will be able to recoup their money from the sale of your property.
Why Lenders have Buffers and Safety Margins
Lenders such as banks, credit unions and other financial institutions need to operate with buffers and profit margins if they're to stay in business. They make money by charging borrowing costs, fees and interest rates on top of the money they lend out. Bank valuation is one example of a buffer that protects the lender should a property be sold under distressed conditions.
Another buffer used by financial institiutions is to charge LMI (Lenders mortgage insurance) on deposits that is less than 20 per cent of the property's purchase price. Many buyers end up paying the required LMI, which can be very expensive, otherwise they will not get the required funds. Essentially, LMI protects the lender in the event that the borrower defaults on their loan.
How Cross Securitisation Works
When you apply for a loan, your lender will engage the services of a valuer. This valuation is not the market rate, but rather a discounted rate that the bank is willing to lend to you.
When you use your home as security on an investment property, you effectively tie up both investments with the lender. If you're forced to sell your investment property for whatever reason, you may also be required to sell your family home if the sale of the investment property does not cover the cost of the borrowed loan. Another disadvantage of having all of your investment property secured and with the same lender is that it can be difficult to sell, even with just one property.
If on the other hand you have a stand-alone loan, you can take out a line of credit and use that fund to pay for the deposit on a new investment property. You can than take out another loan with a different lender, thus ensuring that you don't cross collateralise your assets.
Why Lenders Prefer a Cross Collateralised Structure
For banks and mortgage brokers, it's in their best interest to cross-secure your home loan. For the banks it means that all of your loans are with them, and because they're cross collateralised, it makes it more difficult and less likely for a borrower to move away to a competitor.
Brokers will still be paid a commission regardless of whether the loan is cross securitised or not, but there's less paper work if the loans are crossed secured against another property. Having a loan in one place also means that the borrower is less likely to move lender.
What are your Options?
It's important to know that when you buy your first investment property, that you don't fall into the trap of securing your loan against any of your properties. You can be sure that the next time you take out an investment loan, you will be asked if you would like to use your family home as security. Just politely, but firmly say "no".
If a bank or broker will not lend to you unless you use your home as security, walk away and find another lender that will offer you a stand-alone home loan.