The type of property you want to buy can directly affect whether a lender approves or denies your loan application, so find out what their red flags are.
Lenders and banks will always try to limit their exposure to risk, which is why they demand security for many loans. This ensures they have an asset to sell off in case a borrower defaults on their loan and gives them at least some possibility of getting their money back.
If we put ourselves in the lenders shoes and take this idea one step forward, it makes sense that in the event that they need to sell a borrower’s property it needs to be easy to sell.
This is partly why they are so conservative in terms of the property types they are willing to accept. Their objective is to recover their money as fast as possible, which is why some lenders are less flexible than others in terms of the type of property development they are willing to finance.
When a lender is assessing the property type being proposed as security against a home loan, they are analysing it from a marketability and saleability viewpoint. The more attractive a property is to the market and the higher the demand for it is, the happier they will be to finance this property.
Read on to find out the factors evaluated by most lenders to determine whether a certain property is suitable for finance or not.
Loan to value ratio (LVR)
LVR refers to the loan amount you wish to borrow as a percentage of the purchase price of a property. If you have a deposit of $50,000 and wish to buy a property worth $500,000 your LVR is 90%. This is found by subtracting the deposit from the purchase price of the property, dividing it again by the deposit size and multiplying it by 100 to get a percentage.
Loan amount ($450,000) / value of property ($500,000) = 0.90
0.90 x 100 = 90%
The higher your proposed LVR, the greater the risk and the more money the lender will have to recover if you default on the property loan. Therefore, if the property type you are trying to finance isn’t a standard property development, you can expect the acceptable LVR to be lower than the 80% accepted by most lenders.
Commercial properties are a magnet for lower LVRs because they are seen as a high risk purchase. This is because unlike a residential property, a commercial property’s sale value is directly linked to its tenant status. If you’re buying a commercial property most lenders will set a maximum LVR of 70%.
Even if you’re able to borrow over 80%, lenders will usually make it a condition that you also take out lender’s mortgage insurance (LMI). LMI won’t cover you in any way, but compensates your lender if you default on your mortgage and they lose out when they sell your property. LMI comes with a fee which the borrower must pay and varies depending on the size of your loan and deposit, as well as other factors.
When you seek a loan from a lender they’ll value the security being offered up for the loan. In the majority of purchases this will be the property you’re purchasing. The valuation doesn’t determine the market price of the property, but rather what the bank can hope to recoup if they need to sell it in future.
It’s little surprise that this includes factors such as:
- Location. The proximity of your property to schools, restaurants, transport and other features likely to add value.
- Building structure, condition and faults. The valuer will measure the property and note how many rooms it has, along with checking for issues which may lower its value such as structural damage.
- Presentation and facilities. The overall appearance of the property will be valued, including the fixtures and fittings. Any facilities the property has including pools or gyms are also favourably looked at.
- Access. This includes how many car spaces or garage spaces the property has.
- Planning restrictions and zoning. A valuer also takes into account what a property’s highest potential use is, so this will be determined in relation to any restrictions and zoning issues specific to the area.
Some of the factors above may require expert or insider knowledge to discover, but if you want to evaluate your property’s location, you can easily do it with walkscore.com.
To get a good idea of how appealing your property is from a location perspective jump onto walkscore.com and plug in your address. You’ll be given a score which takes into account the schools, restaurants, cafes and recreation locations within walking distance to your property.
Walkscore.com doesn’t add points to your score for other positive location features such as waterviews or distance from the CBD, so while it can give you a rough idea, the bank valuation will take much more into account.
Another type of difficulty you can run into when you sell a property is it’s title. A bank isn’t immune to this, so any difficulty could affect their decision to finance you. Any property type with an unusual certificate of title, such as company title units, present a higher level of risk to the bank as they could take longer to sell. A higher exposure to risk for the lender translates into stricter lending conditions for the borrower.
- Garth Brown is the Principal at Brown & Brown Conveyancers
- Garth is the Strata Secretary - Owners Corporation at Strata Partners
- Garth specialises in property laq and is a Certified Conveyancing specialist
there are a number of titles which can present obstacles to a lender’s decision when you apply for a home loan.
What you need to know on property titles
Company titled units. With Company Titled units the company owns the whole building. You as the owner only have the right to occupy the building via a share certificate, as opposed to a title where you own airspace.
There is also a risk the other company shareholders could vote you out of the company, therefore you lose your right to occupy and the shares are allocated to someone else.
Company Titled units also generally interview incoming tenants and they decide if they are suitable to rent your apartment. There's really a potential loss of control of the asset and this is the reason why banks generally limit their exposure to risk on company title.
Tenants in common apartment blocks. All owners are listed as co-owners of the total property via a schedule attached to one title - there are no individual titles. These are rare and most have been converted to strata title, creating 'common property' - all owners are a co-owner of the common areas plus their own individual title to their apartments.
Old System title. This is where new ownership is written on the back of a very old title document. The title is not guaranteed by the state. Although these are becoming very rare they're quite common around the Balmain and Glebe areas of Sydney.
Limited title and qualified title. Limited title means the boundaries of the property cannot be guaranteed and have not been investigated by Land and Property Information.
Qualified title is a conversion from Old System to Torrens Title. It bears a notation on the title that stays on the title until 12 years have passed, to allow any claims on the land to take place.
Superannuation trust funds. Companies linked to trust funds for superannuation also come under the microscope, as well as what is contained in the documents for self-managed super funds.
What types of properties can be financed?
There are a wide range of properties that can be financed. However, the secret is matching the right property type to the right lender, which is why the advice of a professional mortgage broker can be invaluable. Whether you want to purchase a warehouse conversion, a heritage listed property, an inner city unit or vacant land, you will generally be able to find a lender willing to help you finance any type of property development.
Many home loans are taken out to finance the purchase of a home, whether that be a house or apartment. Some of these loans come with conditions which differ to an investment property, such as higher LVRs.
Approximately 1.19 million Australians own an investment property. Loans for investment properties generally have the same characteristics as a loan for a home, although they may have lower LVRs or shorter interest-only options available.
Vacant land and construction
Many lenders offer loans which can be used to purchase land and/or construct a property, whether it’s to sell off later as an investment or to enjoy as a home. These loans allow you to drawdown funds as your builder requires them, so you only pay interest on the amounts you’ve used. Some of these loans will come with extra restrictions which may include lower maximum LVRs or increased fees.
Commercial properties include a large number of different property types, such as warehouses, factories, retail spaces, hotels, offices, parking spaces, farming land and medical properties.
Buying a commercial property to conduct your business from or to rent out as an investment has it’s own set of separate conditions. As mentioned above this can include a low LVR, because they’re higher risk than regular residential loans. They may also have shorter maximum terms, higher minimum redraws and higher interest rates compared to residential loans.
Some lenders will also limit what types of commercial property they’ll finance, which means finding finance could prove difficult, or may require a professional mortgage broker.
What types of loans are available
Many of the loans offered today are very flexible with what purposes they can used for, so there's no hard and fast rule about what loan suits or is available for what type of property. Still, there are some generalisations that can be applied to the different types of property you can buy:
Residential loans can be used to finance homes, investment properties, vacant land and construction. Some can even be used for business purposes, although as mentioned this could bring with it a lower maximum LVR. These can be taken out with a standard variable rate, fixed rate or split rate and the loans can come with many different features such as an offset account. You can also use these loans to purchase vacant land and construct a property on it.
Commercial loans can differ from residential loans in that many lenders will charge borrowers business rates rather than regular interest rates. These can sometimes be high and as mentioned the maximum LVR may be lower at approximately 70%. Some lenders will extend this if you have a particularly strong income as this will see you be able to borrow up to 85% of the purchase price of the property.
In addition, commercial loans typically have lower terms. A regular home loan may be offered with a maximum term of 30 years, while a commercial property may be offered with a maximum principal and interest term of 15 years. If you want to switch your repayments to interest-only, this may be even further reduced.
Other conditions such as high minimum redraws may also be present in a commercial property mortgage.
Malcolm has almost paid off his whole home loan and is looking for a new investment property to buy. He’s currently deciding between purchasing a two bedroom unit in Sydney’s northern districts, or a warehouse in Sydney’s south west. Both properties will cost him approximately $420,000.
If Malcolm purchases the unit he’ll be able to take out a residential loan. He chooses the RAMs Investor Home Loan with an interest rate of 5.8% p.a.. This allows him to borrow up to 80% of the purchase price of the property, meaning Malcolm needs a deposit of at least $84,000 (possibly more once he takes into account stamp duty and legal fees).
It has features such as:
- Split loan option
- Additional repayments with no minimum amount
- Interest-only repayments for up to 10 years
- Redraw with no minimum amount
- 100% offset account
- No maximum loan size
- Maximum term of 30 years
It also has an application fee of $595, monthly account fees totalling $20 a year and a settlement fee of $275.
If Malcolm chooses to purchase the warehouse, he’d need a commercial loan. After some deliberation he goes with Citibank’s Commercial Standard Mortgage. This has a maximum LVR of 75%, which means he needs a larger deposit of $105,000 plus stamp duty and other one-off costs.
It has a maximum term of 15 years as opposed to the 30 years allowed by RAMs and limits interest-only payments to 5 years.
In terms of fees, Malcolm would have to pay 0.25% of the loan amount with a minimum of $500, which would cost him $1050 for this loan size.
In terms of comparable features, the Commercial Standard Mortgage offers:
- Split loan options
- Unlimited additional repayments
- Interest-only repayments for up to 5 years
- Maximum loan size of $7.5 million
- Maximum term of 15 years
While the residential loan seems to have lower fees and more features, there are many commercial loans in the market, so if you're interested in buying a commercial property compare a good deal before deciding on one.
Think like a bank before you apply
Even if Malcolm (from the above case study) decides on one type of property and loan, there are also the variables mentioned above including legal issues, saleability and his deposit size that’ll go into the lender’s decision to approve or reject his application for finance.
Ultimately different property types will have a bearing on a lender’s decision. When all is said and done a bank is still a business and like any business, doesn’t want to lose a cent if they don’t have to. This unfortunately extends to borrowers and the types of property they wish to purchase, so if you’re a borrower, think like a bank before you apply for a loan.