Property security: how it works with a home loan

Property security (or mortgage security) is the way that banks guarantee an asset against your home loan. It gives the lender confidence to get you a loan, because the money they lend you (say, $600,000) is "secured" against a property asset that is worth more than the loan ($800,000).

This is what the lender uses as protection in the event you can't repay the home loan debt. If the worst happens and you stop paying your home loan payments, the lender knows they can take possession of the asset you secured the loan with, and sell it to recover their costs.

What does using a property as security mean?

• Security: An asset that is used to protect the loan. The security is something that, if sold, can cover the cost of the loan and any money that is spent selling the item. It can be a number of things, but will generally be in the form of property or liquid/accessible cash.
• Property security: Property security is simply security in the form of property. The property security may be the property that the loan is used to buy, or it may be another property. For instance, a parent may offer the family home as security against a loan for their child's property purchase.

The value of the security is assessed by a professional valuer. When the lender requests a valuation, known as a bank valuation, this document determines the approximate current value of the property and will be used to work out the loan size and subsequently, the loan to value ratio (LVR). This also gives the lender an indicative price on how much they can get for the asset if they have to sell it.

Related: Calculate your own LVR

What types of property cannot be used as security?

The easier a property is to sell and the higher the demand for that particular type of property, the better the chances of a lender accepting it as loan security. Below you will find a few property types that lenders tend to shy away from when it comes to low doc loans.

• Studio Flat

  There are few lenders willing to risk financing a studio apartment, since they are considered to be in low-demand due to their size. Many lenders set a minimum floor area for apartments they'll accept as security, and many studio flats fall below it, which makes things difficult. However, some lenders will consider smaller properties as loan security, so check each lender's criteria. You might also want to consider contacting a professional mortgage broker for help as such applications can be difficult to get through.

• Serviced Apartment

  Serviced flats are usually under a management agreement, whereby a number of investors benefit from the profits that a complex of such apartments generates from short-term tenants. Therefore, due to this management agreement, most lenders are unwilling to risk accepting such units as loan security.

• Inner City Flats

  If you are considering an inner city flat, you may be able to borrow less of the property's value than usual, especially on a low doc home loan, because many lenders set lower maximum LVRs for high-density apartments. What counts as high density (such as the number of storeys or units in the building) varies by lender, so check the lender's criteria.

  You will find it even more difficult to use an inner city flat as loan security if it is located in a building where there are still units that haven't been sold. This is because the unsold units give the lender the impression that demand is low for such property types.

• Heritage Listed

  Lenders tend to shy away from properties that are listed on a state or federal heritage protection list because these properties come with a wide range of restrictions and there aren't as many people interested in purchasing such a property. After all, not everyone wants to invest in a property that they can't make changes to as they wish.

  However, this doesn't mean all lenders are unwilling to approve a home loan for a heritage listed property, but it does mean you will have your work cut out for you finding a lender to approve your application.

• High Value Luxury Properties

  When it comes to luxury properties, many lenders set lower maximum LVRs for high-value properties, so you may need a bigger deposit. Check the lender's criteria. Additionally, very few lenders are willing to accept such properties as loan security because their value can fluctuate significantly, depending on market conditions.

What happens if you don't make your mortgage repayments?

A default notice, which is also called a section 88 Notice, is a notice that a bank must give you before they take enforcement action against you, after you have defaulted on your home loan. The bank must give you a default notice before it calls for the repayment of your entire home loan as well.

The bank must give you at least 30 days to fix the default. It's not a lot of time, but gives you enough breathing room to explore options to catch back up on your repayments. This could look like:

• Refinancing to restructure your debts and catch up on missed payments
• Selling other assets to repay your missed repayments
• Selling the property to pay out the entire loan

If you don't fix the default within the period in the notice, the lender can start enforcement proceedings, which can include asking a court for an order to take possession of the property so it can be sold to recover the debt. If you've asked your lender for hardship help, it generally can't start enforcement proceedings until it has told you it won't change your loan contract and 14 days have passed.

A borrower can defend this action in court, but the deadlines for responding to court papers are strict and vary by state and court, so get legal advice straight away. If you don't respond in time, the court can order that the lender may take possession of the property, which can then be sold at auction or by private sale.

The most important things to know about home loan defaults

Can you change your property security?

This is possible with loan portability, which is a feature offered on most variable rate home loans. It allows you to keep your loan when you buy a new property and simply 'port' the loan over to the new security, rather than refinancing your home loan.

A $40,000 mistake: The property security mis-step that could cost you dearly

When you've obtained your loan, ensure that your repayments are made on time. Remember that if you experience financial difficulties and cannot meet your loan obligations, contact your lender first to agree on a solution.

Information if you are struggling to pay your loan

Frequently Asked Questions

• How much can I borrow if I own my house outright?

  If you own your house outright, you may be able to borrow up to 80% of the property's value or even more, if you're prepared to pay lenders mortgage insurance. However, the amount you can borrow will vary depending on the lender's policies and your financial situation. Your current house will be used as collateral against the loan, which means it could be seized by the lender in the event you fail to repay the loan.

• If my loan security is an investment property, does that mean it's always tax deductible?

  The security you have against your loan, doesn't always reflect the intention of the loan. For instance, you might have a $300,000 loan secured against an investment property worth $500,000. But that loan may have been used to fund something entirely unrelated to the property – for instance, you borrowed it to purchase a new car and pay for a major renovation on your own home. This means that even though the loan is secured against an investment property, the purpose of the loan wasn't to fund the investment, so it's not tax deductible. In other words: the way you spend the money is of more interest to the Australian Taxation Office when it comes to allowing tax deductions, than the actual security attached to the loan.

• What happens if the lender goes bankrupt?

  You still owe the money if your lender goes bust, so keep making your repayments under your loan contract. Your loan, and the mortgage over your property, may be sold or transferred to another lender. If that happens, the National Credit Code says you have the same rights under your loan contract and mortgage against the new lender as you had against the original one.

• What assets can be used as collateral to secure a home loan?

  The most common security is property – most banks will want to secure the loan against the property that is being purchased. However you may also be able to secure the loan against other properties (investments or holiday homes) or cars.