6. How to Improve Your Finance Application
Reduce or Eliminate Unnecessary Debt
Banks want to lend to investors with a low debt-to-income ratio (e.g. someone with plenty of income to service their existing debts).
The less debt you have, the more money they’ll be willing to lend.
The big one for many people is credit cards.
Banks look at credit cards as high-interest, unsecured personal loans. If you have multiple cards and/or a high credit limit, the first thing you should do is cut back.
We recommend limiting yourself to a single credit card with a lower limit, around $2,500 or so.
Why is that?
Even if you owe nothing on your credit cards, lenders consider your credit limit(s) when assessing your eligibility. This can put a stop to your investment goals before you’ve even started.
In the bank’s eyes, having the potential to rack up debt is the same as having already done so. Similarly, other debts (such as car loans and personal loans) can impact your ability to borrow money.
These types of debts should also be minimised before applying for investment loans. You can do that by paying down the loan, refinancing to secure better interest rates, or by paying off the loan entirely.
Good and Bad Debt in Relation to Finance
Okay, so I need to reduce all my debts, right?
Well, no, not all debts.
There are two sides to debt – good debt and bad debt.
Bad debt is the most obvious and easy to accumulate. It’s tied up in your credit cards, your car loan and other consumer debts that do nothing to improve your financial standing.
Bad debt can be hard to shake, and the banks don’t like it! If you’re not convinced, watch this video about how bad debt can really hold you back.
You should reduce your bad debt as much as possible when applying for an investment loan.
Good debt is debt that helps you purchase wealth-building assets. When it comes to property investment, good debt can be an absolute goldmine.
Debt that can be used to purchase appreciating investment (such as real estate) is a great way to leverage finance and grow your own wealth.
As you start paying off your debt through rental income and tax breaks, you’ll widen the gap between the debt and the value of the property.
This is hugely important because it builds equity and frees up funds that can be used to expand your portfolio further.
You can learn more about developing an equity strategy here.
Good debt should be tax deductible. In the case of property, the interest payments, maintenance costs and depreciation on the property may all be claimed as tax deductions.
The biggest benefit of good debt is that it’ll continue to put money in your pocket, rather than taking it away.
The Bank Loves Savings
Along with reducing bad debt, also look at increasing your savings. Savings are a big win in the eyes of banks.
Having a healthy savings account shows the bank that you are saving money consistently. This demonstrates your ability to manage money and set funds aside on a regular basis. In the bank’s eyes, that means you:
- Have a savings buffer that will allow you to continue repaying your debt, even if something unexpected happens (such as losing your income)
- Are more likely to be able to repay the debt over the long term as interest rates and property values fluctuate
If your savings are haphazard, start making regular payments to your savings account. We recommend setting up an automatic transfer that fits within your weekly budget.
This shows potential lenders that you’re smart with money and helps create the savings buffer they’re looking for.
Bad Credit is a Turnoff
Just like bad debt is undesirable, so is a history of bad credit.
Check your credit file and fix any errors or omissions before applying for a loan. If your credit is less than stellar, that doesn’t automatically mean you’ll be turned down. Every lender is different and has different criteria.
Generally speaking though, lower credit scores mean higher interest rates, which can affect the profitability of your investment portfolio.
Your best option is to meet with a mortgage broker who has experience working with property investors.
Mortgage brokers often have access to specialty loan products that are ideal for investors with average credit scores.
There are plenty of things you can do to improve your credit score. You can boost your credit rating by:
- Repaying credit cards and loans on time
- Paying off your credit card balance in full each month
- Consistently paying bills on time and in full (such as utilities and phone bills)
- Reducing the number of credit applications you make
- Lower your total credit card limits to $2,500 or so
- Minimise any unsecured personal loans
- Avoiding changing jobs frequently
- Avoiding moving home frequently
Employment is an Important Factor to Obtain Finance
Lenders like to see stable employment – e.g. being employed in the same role for 12 months or more.
Even if you’re fairly new to your position, roles that are similar to previous jobs might be enough to satisfy a lender.
If you’re self-employed, you’ll need to prove the income you report. A lender will want to see consistent business income.
At a minimum, you’ll need to provide the two most recent years of tax returns. If there is a large disparity in income between those two years, the lender will typically use the lower figure.
Lenders all have their own criteria when it comes to employment. If you’re new to your role (or industry), or if you’re self-employed, that won’t necessarily stop you from being able to obtain finance.
For the best results, find a good mortgage broker to help navigate different lending institutions to find a product that suits your employment status.
Control Your Loans
It’s not just the banks that can say yea or nay – you can too.
As an investor, it’s important to know your rights and learn how to recognise the best types of investment loans for your strategy.
Before signing off on a loan doc, review your options carefully and consider how they fit into your short and long-term investment goals.
Spread Your Risk
Most banks have clauses in their loan documents that allow them to review any of the loans you hold with their bank at any time.
This clause means the bank is entitled to use the equity in any property (that is held by the same bank) to protect themselves against the changing values of other properties. They can do this even when one property is not specifically attached to the loan in question.
In other words, if you have several properties financed by one lender, the lender can use any of your properties as security against your total debt.
This can severely limit your borrowing capacity and investing future.
The best solution to this problem is to use more than one lender.
Don’t just rely on the bank you’ve been with your whole life – explore loan products from other banks and non-bank lenders.
Spreading your loans between multiple lenders helps to protect investment properties from being used as security against unrelated debts.
We typically recommend using a different lender each time you invest. This is a simple way to control your financial future and minimise the risk of your portfolio.
It’s helpful to work with a mortgage broker – they have access to many non-bank lenders and can minimise your risk as much as possible.
Don’t Hold Anything Back From Your Lender
Above all, disclose anything and everything about your financial situation.
If a lender discovers something you failed to disclose, they could decline your loan application based on non-disclosure.
Even if it’s something you know will have a negative impact on your borrowing ability, it’s better to be honest than to be caught in a lie!
