Learn the important information you need to know if you are considering using your existing property as security
When you borrow money to buy a home, you'll probably be borrowing a very large sum of money. All regular home loans require security as collateral for the loan. This is done to protect your lender against your default. It would be a pretty reckless lender who lent money without any guarantees that the money will be regathered at some point. Most people choose to use their property as security for the loan. This is because the property will usually be worth at least as much as the loan.
What is property security?
Property security is a way for people to secure a loan. It's what the lender uses as protection in the event you can't repay the debt. Without any security, in theory you could default, disappear and they would have lost their money completely.
By making borrowers put up a security against the loan, if you can't repay your debt, or fall into severe financial difficulties they can take possession of the asset you secured the loan with (most likely your own property) and sell it to recover their costs — and at times still make a profit. So to break it down...
- Security: Security is an item or sum of money that is used to protect the loan. The security will have to be something that, if sold, will be able to cover the cost of the loan and any money that they spend selling the item. The security can be a number of things, but will generally be in the form of property or money.
- Property security: Property security is simply security in the form of property. The property security may be the property in which the loan is used to buy, or it may be another property - it's not unheard of for a parent to use the family home to secure against a child's loan - but obviously, any agreement with a 3rd party security must be consensual and agreed upon in writing.
How does property security work?
The property security is used as a safeguard for the lender. If you pay off your loan as asked the property security won't be used. However, if you fail to pay the loan as agreed, the property security may eventually be used to pay off the money the lender has given you.
Repay your loan as required and you won't have to worry about this. Commonly, a home loan will involve the lender holding the deed of the property until the loan is repaid and this is the basis of security for the property.
The value of the security is assessed by a professional valuer. This is called a bank valuation. A bank valuation will determine the approximate price of the property and will be used to work out the loan size and subsequently, the loan to value ratio. 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 can not 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.
There are few lenders willing to risk financing a studio apartment, since they are considered to be in low-demand due to their size. In fact, most lenders won't even look at an application for a home loan on a property that is smaller than 40 square metres. Unfortunately, most studio flats are between 25 and 40 square metres, making things difficult. However, there are one or two lenders willing to consider properties with a surface area smaller than 40 square metres as loan security, but you might want to consider contacting a professional mortgage broker for help as such applications can be difficult to get through.
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, in the first place don't expect to be able to get more than 60% of the value of the property, especially on a low doc home loan. An inner city flat is considered to be a high density unit, located in buildings that have more stories or that have more than 30 flats.
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 and they aren't interested in having to deal with properties that won't sell quickly if you default on your home loan.
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 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, you will find that you can only borrow 60% of the value of a property that exceeds $3,000,000. 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 repayments?
According to the Australian Securities and Investment Commission (ASIC), this is what happens when a mortgage default is enforced:
A lender can sell the primary security on a loan to cover their costs if: a borrower's payments fall into default and if the payment default is not corrected after the lender gives notice.
Lenders will be required to submit a letter of demand or requirement notice if payments fall into default, although it is stated that this is not mandatory. If the borrower fails to make a payment as set out in the letter of demand, the borrower must then send a default notice. This notice explains how to rectify the situation and gives the borrower 30 days to do so.
Once the lender has served the appropriate notices and provided that the borrower has not requested a hardship service, the lender has the power to obtain a court order allowing them to enter the property, from here it can be sold to recoup their costs. A borrower has the option of defending against this action. They must file a Notice of Appearance within 10 days and a Notice of Defence within 30 days after that. If this does not happen, the court will order that the lender has the power to take possession of the property, but not the goods inside.
The property can be sold at auction or by private sale.
What happens if the lender goes bankrupt?
If the lender goes bankrupt you'll not be liable to pay any money. However, if the lender goes bankrupt your loan and the security property may be switched to another lender. According to Phil Naylor, CEO of Mortgage & Finance Association of Australia, this will rarely negatively impact consumers in terms of the interest rates they pay on their loans.
Using property as security is one of the most reliable ways to secure loans for large amounts of money. It's common to use the property you have bought as security. Just remember your home is at risk if you fall behind with repayments and should you fall into real trouble you could lose your home altogether. This is why it's so important to budget correctly and to never borrow more than you can realistically afford to repay. What's the point borrowing that little bit too much to buy a more expensive property, if you're only going to lose it further down the line?
Remember, the security is there for the lenders, not for us consumers. It's a necessary step to secure your home loan and work your way towards full home ownership. Use the calculator to calculate how much you could potentially borrow before making the commitment to a home loan.
It's important to remember that using your home as security is more beneficial for the lender, not the borrower. So 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.