More than half of all property investors are using equity in their homes or other investments as a means of paying for a deposit on another property. This is creating significant risks for investors and the broader economy, warns Lindsay David, founder of LF Economics.
“The Australian house of cards has ballooned through the use of issuing new loans against the unrealised capital gains of other properties in a portfolio,” David said in his new report, The Big Rort. “This approach allows lenders to report the cross-collateral security of one property, which is then used as collateral against the total loan size to purchase another property. This approach substitutes as a cash deposit.”
David said this practice places investors at a higher risk of default. His research indicates that those with an “officially listed [loan-to-value ratio] in the 50 per cent to 70 per cent bracket” are more likely to be close to default than those with a loan size that is at least 90% or larger.
The risks are amplified when loans are interest-only. If house prices drop, many borrowers will be unable to service the principal on their mortgages once the interest-only period expires, or may be unable to roll over the interest-only period.
Mortgage Choice’s 2017 Investor Survey found that more than half of investors surveyed admitted they relied on equity to build their portfolios, and used it to fund full deposits or part-deposits.
John Flavell, CEO of Mortgage Choice, said investors are still required to prove they can manage their loan commitments.
“You can minimise risk by looking to acquire an investment property that is mid-range in the purchase price, located in a well-established metropolitan area, [and] where demand for rental properties is high. This provides an income outside of wages to service the debt,” he said.
Ben Kingsley, chair of Property Investment Professionals of Australia (PIPA), said it’s more important to consider serviceability than equity when considering this method of financing property.
“You won’t be lent a lot of money just because you have a lot of money in your family home,” he told the Domain Group.
Kingsley urged investors to consider keeping loans separate rather than cross-collateralising, as the latter creates risks for borrowers, including less control over buying and selling, complexities around future use of equity, and increased difficulty when switching loans.
While those who invest are able to use the borrowed funds to maximise the outcome, it “magnifies risk as well as reward,” Kingsley said.
“There are horror stories out there with people with negative equity in Dysart, Moranbah, Mackay and Gladstone. Evidence of prices lower than what people originally paid.”