The future of credit - price of mortgages

The future of credit - price of mortgages

As most people are now aware, there is fierce competition amongst the banks in Australia who are all striving to build their mortgage books through more generous than ever discounts to their standard variable home loan and investment loan rates. The question for consumers is, how long will this last and how are the banks going to price loans in the future to maintain their profitability and margins for their shareholders? If we take a look at the market today and how it has evolved in the past few years, it will give us an insight as to where the banks are heading with their future pricing models for home and investment loans.

How are loans Currently Priced?

Mortgage Discounting

Pro-Packs were introduced by the banks to give borrowers who borrow larger amounts bigger discounts on the standard variable base rates loans are priced at. They also include features within the loan that have become popular with borrowers over the past 5 years such as offset accounts and credit card facilities. An example of how this would look for an investment loan is illustrated below (assuming the standard variable rate is 5.50% p.a.:

Loans of Over $250,000 and under $500,000 – An additional 0.70% discount to the Basic Rate

Loans of over $500,000 and under $1million – An additional 0.85% discount to the Basic Rate

Loans of over $1million – An additional 1% discount to the basic rate

In essence, depending on what borrowing category you fall into, your loan package would look this way:

Loans of Over $250,000 and under $500,000 – An additional 0.70% discount to the Basic Rate or 1.20% discount less a 0.25% Investment loan premium for a rate of 4.55% p.a.

Loans of over $500,000 and under $1million – An additional 0.85% discount to the Basic Rate or 1.35% discount less a 0.25% Investment loan premium for a rate of 4.40% p.a.

Loans of over $1million – An additional 1% discount to the basic rate or 1.40% discount less a 0.25% Investment loan premium for a rate of 4.25% p.a.

Power Pack Diagram

As you can see, nearly all loans will attract a discount of between 1.2% – 1.4% p.a. on the standard variable loan rate and due to the competition within the loan market, all lenders are now doing this. This in conjunction with borrower’s willingness to switch banks for a better deal (following the governments abolition of refinancing fees from 1 July 2011) is making it increasingly challenging for lenders to retain customers and maintain a suitable margin for the shareholders. The question is then, what is the future of lending likely to look like for us as investors and consumers?

Introducing Personal Risk Profiling and Pricing

Banks have recently introduced personal risk profiling and pricing within the personal loan market. This is where the bank uses as much information they can access on the individual borrower to assess their risk to the bank in order to come up with individual rate pricing for the borrower. The higher the risk the borrower is within the eyes of the bank, the higher their loan rate will be. 

Big data analysis is being incorporated into many more industries around the country to assist in making complex decisions available at the click of a button. Given the challenge banks are currently facing in having to offer discounts to borrowers across the board in a one size fits all approach, this is going to become a standard way of operating for banks in the mortgage space in the next 18-36 months. The way a borrower will be assessed based on their personal situation will look something like this:

Credit Scoring – What is the borrowers historical credit scoring like based on:

  • Historical Loan/Credit Repayment History – Does the borrower have a solid history of making loan and credit repayments on time? 
  • Individual Borrower Loan Activity (Churn Rates) – Is the borrower one that moves to better deals on a consistent basis, always looking for the best deal? If so, the bank is less likely to want this borrower as a client and will price any loan offers accordingly

Property Risk – What is the banks view on the property put up as security from a risk perspective to their loan book portfolio. These items will be considered:

  • Property Location – How does the location of the property rate from a risk perspective to the bank? For example, does the suburb have one or two major industries that employ the majority of workers in that area? Has the bank got enough exposure to mortgages within that suburb already? 
  • Property Type – Is the property being purchased in an area that is likely to become oversupplied in the short term, becoming more difficult to lease? 
  • Property Purpose – As is already the case, borrowers purchasing an investment property are being subjected to a higher loan rate for their purchase vs a home owner buying a property in the same suburb with the same loan amount. This will become more heavily scrutinized and assessed as we approach the new age of lending where property types such as short stay, student accommodation and holiday letting properties will attract a premium based on the risk it represents to the lender. 

Employment Risk – How does the borrower stack up from an employment risk perspective. The lender will consider these variables to assess employment risk:

  • What industry is the lender working within? What is the economic outlook on that industry in the short and medium term? What has been the employment trend of that industry over the past 15 years?
  • How often has the borrower changed jobs in the past 10 years? The less stable a borrower is with their employment, the pricier the loan is likely to be.
  • What are the industry income forecasts in the short and medium term? 

 

Loan to Value Ratio on the security Property – What percentage of the property purchase price is the borrower borrowing for the purchase? At present as borrowers borrow beyond 80% of the valuated purchase price, lenders mortgage insurance is charged to the borrower to protect the bank from a mortgage default situation where they are unable to sell the security property for enough to cover the outstanding mortgage amount. With the introduction of personal risk profiling, banks will still charge the lenders mortgage insurance, but will also factor that risk into their loan assessment and ultimate price to the borrower. 

What Does all of This Mean to Property Investors?

With these changes on the horizon, it is essential for property investors who are looking to build themselves wealth through property investment to be aware of the impact these changes could have on their ability to borrow money for more investment properties. Ensuring your personal finances are in order, your loans are paid on time and all your bills such as mobile phones, electricity, credit cards and personal loans are managed well is going to become really important if you want to get access to ongoing credit in order to build a large property portfolio and get the most competitive loan mortgage rates on offer in the market.  

Of course this type of assessment isn’t entirely fair, but like all businesses in the commercial world, technology is becoming an integral part of a business’s arsenal to assess risk and make more complex decisions easy. 

Now so, more than ever for aspiring property investors, getting your financial dealings in order is essential for those investors who are hoping to continue accessing the best loan rates from the mortgage market into the future.

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