26 Giffard Street
Williamstown 3016
Ph. 03 9397 7275
Fax. 03 9397 1734
Mobile. 0428 310 165
Email. reidcont@tpg.com.au
ABN: 65 111 801 079
www.reidconsultants.com.au

This newsletter discusses what self-employed means in terms of the effect it has on lending. Lending, whether it is the Big 4 or 5 banks or the non-traditional lenders, is based on two basic premises, what is the underlying asset value and can the borrower make repayments. In the current economic cycle, the value of the primary asset is all important.

As far as a lender is concerned, they want to know whether they will be repaid in the normal course of business and if the borrower cannot make the repayments, will the sale price of the asset be sufficient to meet their debt. It is simple economics for them, they are in the business to lend money and like any other business, they want to ‘sell' their products, being loans. As all business people know, a 'sale' is only completed when you receive the money. Same for small business as it is with banks, if you cannot get paid, you are behind.

Pricing for banks is similar again to small business, the larger customers get better pricing as do the better customers. If a small business has a loyal customer who pays 30 days without chasing, you look after them and give them better service and/or better pricing. It is about risk and return. The lower the risk of a transaction, then the lower return you will accept. This is the crux of the matter. If a lender can verify you have been in employment for a number of years with steady income and the property you want to purchase stacks up via valuation, you can get 100% loans (or more) at very competitive rates. The income verification is an important element in lowering the perceived risk of a loan default.

Often self-employed folk cannot easily provide the same degree of proof of level of income or choose not to. This may be due to the ability to minimise taxable income, via splitting incomes, obtaining tax deductions for expenses not readily available for PAYG earners, using different tax vehicles to defer income or just out and out not declare some income, i.e. cash transactions. While this is against the tax law, it happens. The GST legislation has failed in its attempt to suppress the black economy. The issue becomes when you want to borrow money to purchase a property, you cannot (or choose not to) provide proof of income levels sufficient to show you can service the loan levels you want. This is especially true for the new self-employed person who does not yet have a 2 year plus history of tax returns. If you have the previous tax returns and have a sufficient deposit not to require LMI (see below) then a full documentation loan will probably be the right loan for you.

The table on the left shows an income level per year with a range of borrowing limits, minimum to maximum from a range of lenders. This is a single person with no dependents or other debts. An income of $50,000 gross can borrow up to $440,000 to purchase or refinance a property. For a self-employed person who takes about $500 a week in cash and does not declare it on a tax return, their ‘real' income is about $75,000, meaning they could borrow up to $636,000. Take out $1,000 in cash per week, the effects on borrowing are very large

Income and Borrowing Amounts Shown as $'000 Income Min $ Max $ 50 260 440 75 425 636 100 568 802

This is the dilemma faced by lenders, self-employed who want to borrow large sums of money yet cannot easily provide proof of repayments based on tax returns etc. yet the lenders ‘know' they can service the loan or are able to make the repayments. This has given rise to the popular low-doc or even no-doc loans. These are normal loans except, instead of providing proof of income, the borrower signs a declaration stating they have capacity to pay. Different lenders require different forms, some require certification of income (an issue if the Tax Office decides to audit these types of loans) and some just require a declaration that you can service the loan. In a lot of cases, these are self-certifications, however some require an accountant's letter.

The two things lenders do to offset their potential risk is:

1. to limit the range of products and borrowing limits and,
2. the majority of lenders will require Lenders Mortgage Insurance (LMI) to be paid.

LMI is normally in the form of an upfront payment (some lenders may capitalise). The amount of LMI depends upon the level of borrowings to valuation, being the Loan to Value Ratio (LVR). You may also pay a higher interest rate and higher fees compared to a full documentation loan. The following is an example of the differences between a full-doc loan and a low-doc loan.

As you can see above, even though the interest rate is the same, the application fee and amount you can borrow before incurring LMI are the two areas of difference and additional cost. In previous years, there were also higher interest rates charged for low-doc loans, however due to competition between lenders, this has mostly disappeared.

Give me a call to find out whether this type of product would work for you and what could you borrow based on available cash flow and value of your property. We will work with your accountant or advisor to structure a solution that suits your needs and circumstances. We take the approach of looking at your long term goals and working to find a solution through finance for you. This appointment is no-cost and is obligation free, call - 9397 7275

Helping People through Finance