Hi all,
I am trying to do some rough future projections with regard to buying investment properties, and wondered if someone could give me a hand with some calculations please.
DSR – I know each lender will calculate slightly differently, but just to try and get a rough idea I'm using the model (30% of salary + 80% of rental income) / loan repayments. If I have a large sum of money in an offset account, thus reducing my mortgage repayments significantly, will a lender take this into account since it's the actual amount I'm repaying, or will they use the 'standard' monthly figure that assumes I have no offset account? The difference between the two figures is about $1k/mth, so will obviously have a massive impact on my affordability calculations!
LVR – Say I have a PPoR with $300k loan balance & $500k value, then I take out a $100k LOC to fund the deposit for a $500k IP, leaving a new $400k loan to service. Leaving purchases costs aside just now for simplicity, would my new total LVR be inclusive or exclusive of the LOC loan? If included, it would be ($300k + $100k + $400k) / ($500k + $500k) = 80%. If excluded, it would be ($300k + $400k) / ($500k + $500k) = 70%. Which is correct? I assume the first, but just want to be sure please!
LOC – Is there a standard 'term' for LOC loans? Does it match your mortgage term, or do you set it independently? Just trying to get a feel for what the monthly minimum repayments would be on an LOC loan, and obviously term plays a big part in working that out…
LOC – Do LOC repayments form part of DSR calculations when calculating affordability, ie should they be included in the overall 'monthly loan repayments' element?
Cheers!
HI YU,
Not a broker so i'll leave the DSR question to those more qualified than I.
LVR – LOCs are included in your overall LVR. So in your example your LVR is 80% secured by PPOR. Your LVR secured by IP is also 80%. Gives you an overall LVT of 80%. I find it best to work LVR based on your security position – this lets you know if you have any spare equity to release.
LOCs – have also seen them referred to as equity loans.
LOC Repayments – when calculating DSR banks will use the LOC limit and not just what you have drawn. A bit like a credit card banks are risk averse and will assume you blow the lot when calculating DSR.
Cheers
Hey Derek,
Thanks for replying!
1 – No worries hopefully someone else can advise on the DSR question.
2 – Cool thanks, I thought that'd be the case.
3 – Sorry by 'term' I meant length of the loan rather than another name for it!!! As in, is there a standard length of time you take a LOC loan over, so I can work out what the minimum I/O repayments would be?
4 – Surely it'd be the monthly repayments towards the loan they'd take into account for DSR purposes, not the actual LOC limit…? I thought affordability was eg (30% of monthly salary + 80% of monthly rental income) divided by monthly loan repayments? If you use the whole amount of the LOC (eg $60k) rather than the monthly repayments (eg $1,500) then you'd never be able to service that debt according to the calculation… Or am I getting that wrong?
Cheers!
With respect to DSR and the offset account, no it isn't taken into account, as the lenders view is that it can be withdrawn at any time to be used on something else.
DSR is really old school. Lenders typically use the NSR method in calculating serviceability. Different guidelines between lenders may mean that there might be situations that with one lender you might not meet serviceability whereas with another it will.
LOC's are generally revolving with no set term and are calculated at interest only, and lenders will calculate on the maximum limit (as Derek has mentioned).
Cheers
Tom
Hi Tom,
Thanks for that. Dammit I thought that may be the answer re DSR & offset, for the exact reason you mention – lenders would probably assume you're going to spend the lot on something else…
Hmmm ok, didn't know DSR was old school sorry – my starting point for this journey was a book my dad gave me recently, I don't think it's very old, but all it ever talks about is DSR – no mention of NSR… I will google now and check out what that is
Ah, I see now what you and Derek mean about the LOC and lenders using the limit rather than the monthly repayments – I was mistakenly calculating affordability at the monthly level (eg using monthly salary, rental income, loan repayments etc). When you calculate at an annual level, this makes more sense.
Thanks for the confirmation though re no term for an LOC…
I will investigate NSR now for calculating affordability!
Thanks both
Cheers
Hi Tom,
Sorry to labour the point here, but as a novice trying to work some stuff out I just can't get my head around what you and Derek have mentioned regarding the way LOC loans are regarded in terms of affordability calculations. I hope you can stick with me a little longer and help me out again please…!
It's likely I didn't word my original question on this point very well, so let me try again with an example…
Let's assume this is the situation prior to buying my first IP:
- PPoR value = $500k
- PPoR loan balance = $300k
- Annual repayment on PPoR loan (12 x $2,100) = $25,200
- Annual salary = $150k
At this stage I thought my affordability (via DSR, I know you said lenders use NSR now but I would like to understand this scenario first before I change!) when calculated annually would be:
(annual loan repayments) / ((annual salary x 30%) + (annual rental income x 80%))
$25,200 / $50,000 = 50.4% DSR
Ok so, in preparation for buying my first (of many hopefully!) IP, what I'm trying to work out now is my affordability in future.
I thought I could take out a LoC loan against my PPoR, given the $200k equity and 50.4% DSR – but if I understand your explanation correctly, then there's no way I could…
Proposed IP:
- IP value = $500k
- IP deposit = $100k (funded by LoC on PPoR)
- IP loan balance $400k (forget purchase costs just now for simplicity)
- Annual repayment on PPoR loan (12 x $2,000) = $24,000
- Annual rental income (12 x $2,000) = $24,000
In order to achieve this, there are two steps – first get the LoC, second get the IP mortgage.
To get the LoC, I'm sure the lender will check affordability as well as LVR. So prior to the LoC my LVR is 60% (300 / 500), and after the LoC it's 80% LVR (300+100 / 500). All good there.
But if I use what you and Derek suggested (and I'm sure this is where I've misunderstood you), I wouldn't even be able to get that LoC loan, let alone the new IP, due to affordability. Using the same method as above, it would be:
(annual loan repayments + LoC limit) / ((annual salary x 30%) + (annual rental income x 80%))
($25,200 + $100,000) / $50,000 = 250.4% DSR
If you take the proposed rental income & loan repayments into account from the new IP, it would come down slightly:
($25,200 + $100,000 + $24,000) / ($50,000 + $19,200) = 215.6% DSR
But either way, both DSRs come out way beyond 100% and the application would obviously be rejected. Surely this is not correct?!?
I would've thought that rather than the whole $100k facility being taken into account, it would just be the annual repayments that would be factored in (if anything, and that's what I was trying to ask initially).
For example, if the annual repayments are around $6k per annum ($100k LoC loan at 6% I/O), wouldn't the calculation be:
(annual loan/LoC repayments) / ((annual salary x 30%) + (annual rental income x 80%))
($25,200 + $6,000 + $24,000) / ($50,000 + $19,200) = 79.8% DSR
This is what I was trying to get at in my first question – essentially I was wondering if the $6k of annual LoC repayments should be included in this equation or not.
Apologies if it wasn't clear – and sorry for the very long worked example, but I hope it helps someone understand better what I'm asking…
Many thanks for taking the time to respond, and hopefully clear this up for me!
Cheers!
TYU,
I think you have misunderstood what we were trying to say. When taking into account the LOC, the lender will use the worst case scenario and calculate repayments on the total limit amount of the LOC for servicing despite what you are thinking of withdrawing.
i.e. you take out a LOC for $100K at interest rate of 6%, and despite only intending to initially use say $50K of it, the lender wont care and will use the $100K at 6% for calculating repayments. So your last example is correct in the way you worked out your repayments. The $100K figure is not the repayment itself.
Though I don't know why you are using the annual salary x 30% for your calculations?
Cheers
Tom
HI YU,
When calculating your capacity to borrow money the bank looks at you from two aspects. What your security level is and whether or not you can service the loan.
LOCs have a number of advantages but there is also a disadvantage to them.
When looking at your serviceability the bank will consider your LOC fully drawn and if your annual interest bill (assumption being LOC is fully drawn) is $10K then this added to your loan commitments. Doesn't really matter if the LOC is sitting there untouched.
At the same time the bank will consider your LOC limit when assessing your toal debt levels. If you have a $200K LOC then the bank will use this figure when looking at your overall debt levels. Once again it doesn't matter if you haven't drawn anything from your LOC.
Lets assume for one minute you are buying an investment property worth $400K.
When assessing your situation the bank will factor in some rental income (which helps your serviceability).
When you set up a LOC the debt is entirely carried by your existing income. In effect you have increased your debt level but there is no commensurate increase in rental income – this in turn has a negative effect on your overall serviceability.
This is the challenge of setting up LOCs – create a very large LOC and you blow your serviceability and LVR out the window. Setting up & extending LOCs is something that needs to be approached strategically. Get the balance wrong and you hold yourself back.
As an aside banks, as a rule of thumb, are reluctant to set up large LOCs without due reason. This is something you'll need to discuss with your broker.
The rate you are going you'll soon be able to set yourself up as a broker.
Hi Derek,
Many thanks for this very comprehensive explanation – I really appreciate it!
I understand now exactly what you mean. The way you've described it here is pretty much what I thought was the case initially, I think I just worded my initial question badly then misunderstood your responses… This is excellent, thanks again for replying.
We have a meeting coming up with our broker soon to discuss & set in place our structure and future strategy, but a big part of that meeting for me is going to be 'is this broker the one we want to trust with our future??'. A couple of the responses I got to my last post were along the lines of 'a good broker would have explained that to you' – but for me a massive question is how do you know if your broker is good, if you go and see him with no knowledge of what you're asking him to help you get into? Do everything he says blindly now, and find out in twenty years he wasn't that good after all?? Not me – I need to have a good grasp of the basics now so I'm able to readily understand what he's saying – that way I can make a better judgement now as to how good he is, and move on if I don't feel confident he's right for us.
Thanks again Derek.
Cheers!
Hi Tom,
Thanks for sticking with me and replying again! Between yours and Derek's responses, I've got it now – as mentioned above, this is pretty much what I thought initially, I just didn't word it very well… I always assumed that lenders would use the LoC limit rather than the drawn-down amount when used in any calculations, I just wasn't as clear whether LoC's should be factored into LVR/DSR calculations or not…
The rationale for salary x 30% was from the book I mentioned previously – the thinking is, around a third of your wages go on tax, a third on living expenses, and a third is left over for servicing debt. Just a rough figure and could obviously vary considerably from this, but the book reckoned it was a reasonable rule of thumb… Similarly for the rental income, they reckoned you should write off about 20% of the income to rental expenses, because lenders will too, hence the 80%. Again, a very general rule of thumb and not to be taken as gospel, but good enough to start with I thought…
Thanks again Tom, really appreciate it!
Cheers
Fair enough. I would say the biggest downfall in using DSR is living expenses don't take into account marital status, number of dependents, which not only varies between lenders, but with some by huge amounts.
Hence why they use NSR. I suppose us brokers have got it easy with all the serviceability calculators lenders give us to use to determine this.
Cheers
Tom
Hi Tom,
Thanks for this – yeah now I've got an understanding of how DSR is calculated thanks to you guys, I will try to work out NSR and use that instead. A quick google shows there are a few NSR calculators available to download – I will check them out.
Just as an aside though, when you mention DSR doesn't take into account marital status – we're going to be putting the first IP solely in my name for the best negative gearing benefit since I'm the higher earner – I was of the understanding that the lender wouldn't even consider my wife's income/expenditure when calculating affordability, regardless of the method used. I thought they looked at my income & expenditure only… Have I got that wrong?
Cheers!
Hi TYU,
All lenders have a default living expense when they assess loans as part of their NSR. Despite the title and loan being in your name only, they will still consider you as married and will treat living expenses as such (which is obviously a higher figure than that of a single person).
Cheers
Tom
Hi Tom,
Yeah I downloaded an Excel calculator and kind of worked out that it seems to be a default living expense based on single/couple and number of dependents – cheers for confirming though.
Given they would assume our expenses are per couple then, do they also use my wife's income to assess affordability even if the title and mortgage is to be in my name only?
Cheers
edit – I meant to ask also, what is the highest acceptable percentage for NSR currently, do you know? The calculator I've got says 95% or less is an automatic pass, and 95% or greater would be referred for consideration – but that calculator is from 2007… Does the same still hold true just now would you say, and either way does it vary from lender to lender at all or an industry standard? Thanks!
TYU,
If you pass servicing without the need of your wife's income then it is fine. If you don't pass then you have the option of using her income for servicing purposes.
Technically, as long as you have any net surplus within a lenders guideline, it will count. In saying that serviceability is only one part of the overall picture from a lenders point of view, with other things taken into account to determine your risk rating.
Cheers
Tom
Hi Tom,
Thanks once again for clarifying that – and for all your input on this thread!
Absolutely, I understand that serviceability is only one part of the overall assessment – but I'm also glad I understand now how that works at least.
Cheers
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