Your 'income' is more important than your 'security'

Personal Finance

David Chaston explains what really motivates banks when you apply for a mortgage, and why they react as they do when you get into financial strife

29th Jul 16, 5:49am by David Chaston

It is a common misconception by borrowers that bank lenders should be ‘happy’ to let a loan run if the borrower gets into temporary strife on the basis that there is ‘plenty of equity’ in the property.

But banks are not ‘asset lenders’. Essentially they are lending to the borrower personally and their principal reliance is on the borrower’s income to service the loan.

Banks are ‘income’ lenders at heart. Serviceability is their key requirement.

Yes, they do want the security of a sensible LVR (loan-to-value ratio) but that is only so they are protected if a meltdown happens. That is only a backstop for them.

When you understand this core motivation you will have a better chance at understanding why they want the disclosures they do.

Banks will say ‘income’ and ‘security’ are both equally important. But it is your ability to service your loan that really motivates them. As you can imagine, what they want is you paying them interest for 25 or 30 years. It’s the basis of their business. Selling you up using the security your property provides just imposes hassle and cost on them, both things they will work hard to avoid.

All the talk in the media these days is about LVRs (loan to value ratios). And that gives an outsized impression this is what home loan lending is all about.

Later this year, this media talk may well turn to “house-price-to-income” ratios. Such talk originates from regulators however, not banks.

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Knowing that your income is key helps you understand a few things.

Firstly, you can’t just walk away from a home loan. It is personal; if you get into strife and the bank sell your property the full amount outstanding is still due from you personally – even if they have sold the house and used the net proceeds to pay down the loan. If the sale didn’t cover all their costs (lawyers, real estate agents, etc.), they will still pursue you for any balance and keep adding interest to the amounts unpaid.

Secondly, even if they don’t require it, you should protect your income with some sort of income protection insurance. A bump in your life’s journey (illness?, and accident?, a family crisis?) can put you in a very tough position which could end up with a bank calling in its loan. And you might still be up-to-date on the payments, and there seems “plenty of equity” in your property.

A large number of mortgage brokers are qualified to help you with such insurance cover.

And thirdly, if you do see an issue coming up, being proactive with your lender usually helps a lot. What it signals is that you are actively planning to overcome those difficulties and banks like that in a borrower. Not fronting early sends the opposite message. Banks like a plan, don’t like borrowers who wing it or don’t think things through. Again, a professional and qualified mortgage broker can help with such planning. A professional mortgage broker will stand with you through the good and the bad. That is when you really know you have a ‘keeper’ as a broker.

This article was written for the Global Finance (GFS) website and newsletter and is here with permission.

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32 Comments

by Zachary Smith | 29th Jul 16, 7:39am 1469734747

I have often wondered about this. A lot of property investors rely on salaries so what happens if a salary suddenly disappears?
I imagine most landlords have a revolving credit facility to enable them to keep the wheels rolling but what does the bank do if they don't see a large chunk of monthly income coming in?
Would it make sense to drain the revolving credit facility by shifting money from it to another bank and use that to mimic your salary while you take action to get another salary or sell up property? Of course this would cost you more in interest but probably not a large amount and if it took the heat off for a year it would seem to be a good strategy.
Would the bank consider that to be a bit shifty? Are you obliged to tell the bank immediately about a change of income or do they give you six months or something? What if you get a generous amount of redundancy pay or if you have an emergency reserve of cash (6 months pay)? Do you need to inform the bank after six months or immediately that you have lost your job?
I guess these are questions the bank could answer but I know the answer would be to tell your manager everything immediately.

by KH | 29th Jul 16, 4:04pm 1469765041

Oh Dear Zach. It is shifty and the bank knows from long experience that after shifty, bankruptcy soon comes marching along.
I am amazed at the edges of the 'investors' industry how much advice is offered about how to manipulate borrowing as much as possible. To me that seems just a way to manipulate yourself off a cliff.

by Zachary Smith | 29th Jul 16, 4:19pm 1469765962

I guess there is no real need to be so paranoid and pay yourself from borrowings but it would seem to make sense to have funds in another bank in order to be less dependent on the whim of one bank. In my hypothetical scenario I am sure the bank would first rely on you doing all you can to manage the situation. I would sell my own mortgage free home and rent if absolutely necessary. I'm just wondering how effective revolving credit is as a means of giving one breathing space in the event of a major loss of income. After all they say it takes a month of searching for every 10k of salary so it could take a while to get another good paying job. Does anyone have any experience of this?

by keywest | 29th Jul 16, 9:01pm 1469782860

Better yet would be to have 2 banks on equal footing with say 1 or 2 investment properties each, both with revolving credit, then for a few months you could mask your unemployment, but really would only last maybe 3 months to 6 months before some one cottonend on, but the two bank policy, one with say 50k makes good sense so you could float your portfolio for a year or so

by Kakapo | 29th Jul 16, 7:54am 1469735645

Anecdotally, I know of quite a few mortgages approved on fraudulent income information - misrepresentation short-term substitute job as a full-time job so that the payslip could be used to borrow up large for rentals, take a gamble on no vacancies to cover, that kind of thing. How much non-existent mortgage-servicing income do the banks have lurking on the books undetected?

by JetLiner | 29th Jul 16, 8:05am 1469736338

Interesting article in the AFR about what constitutes 'acceptable' income, or 'non-genuine' income on mortgage applications (http://www.afr.com/real-estate/lenders-blacklist-nongenuine-savings-in-…).

Australian mortgage providers are tightening things up to reduce risk exposure, but of course they have some signs of stress in their housing market -- just look at Melbourne apartments and what's happening there.

by murray86 | 29th Jul 16, 8:23am 1469737432

Excellent article David. Says it all quite succinctly and details why First home Buyers are highly vulnerable in the current climate. Their debt level when buying in major centers must make them have a few sleepless nights if they are not in high paying, highly qualified jobs. It also details why through failing to regulate the market, successive Governments have fundamentally failed their constituents.

I continue to argue for the need for balanced Government regulation in all areas of accommodation and housing. This market economy is failing the ordinary people of the country (and most of the world) to the benefit of a few. There are too many vested interests and people hiding behind fancy qualifications who are too much of extremists advising and lobbying the Government to maintain the status quo. None of the major parties seem to have any idea, and only Meteria Turei has the courage to suggest that house prices need to fall.

by DaveB1978 | 29th Jul 16, 3:58pm 1469764698

So the solution for those people that saved and managed to scrap their way into a house they call their own is to screw them over so someone else can own it? Sounds like a great plan. Any first home buyers that have bought in the last year watch out. Meteria wants you to give your deposit and then some to someone else.

by xelnaga | 30th Jul 16, 6:32am 1469817120

Please don't use recent recent first home buyers as human shields.

They were screwed by the prices going up in the first place. Key already stole their deposit and then some.

by dictator | 29th Jul 16, 8:35am 1469738142

Your job is your credit? I've heard this somewhere before.
https://www.youtube.com/watch?v=sg8fZicILio

Finance it all the way.

by notaneconomist | 29th Jul 16, 8:43am 1469738601

Of course it is the ability to pay and always has been. I have to admit I am somewhat surprised that you feel this article is necessary so I can only assume that you feel people need educating on this matter.......One therefore has to ask the obvious question - What percentage of NZ'ers are financially illiterate?

House prices are more a reflection of the ability to service a mortgage rather than fundamentals. This is why some people place the label "mortgage slave" on those paying over the top prices and then having to service that over the top price for the next 25 to 30 years or whatever duration the mortgagor chooses.

by murray86 | 29th Jul 16, 9:32am 1469741526

20 - 30 years ago mortgages, mine included, were for 20 - 25 year terms and affordable. Today i understand 50+ years is the norm to keep them affordable. So there you go, mortgage slavery to the bank is alive and well. And it is well acknowledged that financial literacy is generally poor. Most don't learn until they try to get into it, and can't be bothered with the detail (where the devil is), and worst of all, blithely blunder through life believing that "bad shit" only happens to others. Thus they are unprepared for the pitfalls that life can throw up. I must admit I was probably pretty bad at that too when I was young. Nothing like the wisdom of experience.

by David Chaston | 29th Jul 16, 10:23am 1469744604

No-one has 50+ yr mortgages in New Zealand. In fact, I doubt anyone can get mortgage terms longer than 30 yrs.

I personally think 30 yrs is too long, but most new home loans are now that length. Combined with unnaturally low interest rates, that allows borrowers to "afford the payments" as they bid up house prices. What most don't realise is just how much more interest they pay over the extended term, despite the "low rate". It is now so distorted, it opens up the opportunity for savvy mortgage brokers to show how you can "save huge amounts" of interest by paying the loan off faster. It is just a pity the starting point has been extended out so far to open up that option.

Find a mortgage calculator and do the math. (see sidebar)

by DaveB1978 | 29th Jul 16, 10:50am 1469746220

The average length of a mortgage is much less than 30 years. It might say 30 years on the loan documents but in reality most people don't stay in one house with one bank for 30 years.

by rjn1 | 29th Jul 16, 1:53pm 1469757230

That's beside the point. The reason the term is important is that it indicates the payment amount with respect to the total loan value and the general proportion of interest you're paying compared to principle. I wouldn't feel comfortable entering into a homeloan if I could only afford to service it based on a 30 year term, and the fact that this is the norm for many new borrowers is indeed quite scary!

When most people move houses, they are not downsizing, so the remaining term of their homeloan is unlikely to decrease.

by DaveB1978 | 29th Jul 16, 3:46pm 1469763975

Agreed, but some will do what I did. Sign for 30 years pay as if it was 20 years. If I need to I can revert to 30 year level payments without any negotiation.

by linklater01 | 29th Jul 16, 4:30pm 1469766607

When I entered the mortgage market in 1969 in Scotland, things were very simple. The maximum was 3 times my income,the term was 25 years and the mortgage was either based on monthly Capital and Interest payments, or interest only but with a full Endowment With Profits policy assigned to the Building Society(no banks were in the market).
It was a long time before I realised that other countries offered more flexibility, but even when things started to change in the UK, I was happy to stick with the original plan and was able to be mortgage free by 53. I can still remember the pleasure I got in getting my hands on the title deeds and vowing never to be in debt again. Nearly 20 years on, i remain debt free. If all that sounds rather smug and self-satisfied, I am well aware of how lucky I have been in life. Good parents,good education,good health etc.
I feel truly sorry for all those struggling to get a foot on the housing ladder. This is very bad for the social fabric of the country.

by Stephen Hulme | 29th Jul 16, 9:37am 1469741849

What percentage of NZ'ers are financially illiterate?

More than you think and this number includes people who have jobs that they should be disqualified from holding given their lack of any formal education in what really constitutes money in a credit based reserve currency system. Even our regulators act as though they are redirecting the flow of coins.

The methods, operations, and appearances of the eurodollar/wholesale system may seem unrecognizable to the traditional banking format of the 1920’s and 1930’s, but in reality money is money and will act like it in whatever form because it is human tool. While the global “dollar short” is the modern, often confusing incarnation, it is really not much different than the deposit fraction. Every bank that issued a passbook balance for customer deposits was in every way (synthetically) “short” the dollar just as wholesale banks are now. The difference is the place in which that short originated and was/is sustained; interbank (now) vs. depositors (then). Read more

by kane02 | 29th Jul 16, 4:41pm 1469767318

20% as a guesstimate?

by dictator | 29th Jul 16, 4:56pm 1469768160

Financial literacy is a rare thing in any western country. Marketing consumerism combined with easy credit leads to a lot of bad decisions. Many people manage their money on a payments basis, such as how many hire-purchase of loan payments they can afford.

There's also a hilarious number of accountants that are unable to manage their personal finances.

Until you have actually helped people with financial problems you have no idea how bad financial literacy is. These days whenever I see someone drive by in an expensive car I speculate how large their debt is.

by scarfie | 29th Jul 16, 9:42am 1469742167

House prices are more a reflection of the ability to service a mortgage rather than fundamentals.

Gee who would have thought that house prices were all about a transfer of wealth.

by Uninterested | 29th Jul 16, 9:36am 1469741781

I guess that the equivalent of salary income of owner occupiers would be rental income for rental investors.

by scarfie | 29th Jul 16, 9:39am 1469741952

In a crisis, as in a downturn where lots of mortgagees lose their income, what is to stop the banks simply loaning your more money to tide people over until a recovery? There is no real cost to the banks by this action, and is probably about how dairy is being managed.

Not a problem, as long as there is a recovery.

by Stephen Hulme | 29th Jul 16, 9:51am 1469742701

Exactly.

by Zachary Smith | 29th Jul 16, 9:52am 1469742761

Is this what revolving credit facilities are for?

by Stephen Hulme | 29th Jul 16, 10:15am 1469744158

Accommodation of some sort, that's for sure.

Witness: Silicon Valley Elites Get Home Loans With No Money Down

Even insurance companies act as though recovery is around the corner regardless of the fact bonds are confirming the exact opposite.

The largest U.S. banks are constrained by post-2008 rules that make it tougher for them to extend loans. So companies such as MetLife Inc. and American International Group Inc. are grasping more market share. While many insurers have been in the commercial real-estate market for decades, the industry is branching out into home mortgages, small-business lending, car loans, renewable-energy financing and student debt. Read more

by rjn1 | 29th Jul 16, 2:07pm 1469758039

This is essentially what happens up to a point. Of course its not in a bank's interests to call-in loans unnecessarily and cause a domino effect, but at the same time, they have to manage their credit risk just like any other business with receivables, and there will come a point where they are better off to cut their losses and hand the account to a debt collector, so to speak. I would think of it like the bank is marking its lending assets to market - if the level of impairment gets too high we all know what happens - regardless of any expected recovery, the bank needs to manage their balance sheet at that point in time.

by notaneconomist | 29th Jul 16, 2:50pm 1469760619

Are you drinking Scarfie?

by scarfie | 30th Jul 16, 12:42pm 1469839321

Lol. What could be, what should be, and what will be are sometimes very different things. Pays to keep a clear head about that. So as while a brewer of fine ales it would be tempting to imbibe at that time of the morning, whiskey would be more appropriate for the hour.

by kane02 | 29th Jul 16, 4:39pm 1469767153

All financial institutions are income lenders.

They have to be because of the new responsible lending code.

It’s just that in the case of a property the counterparty has more skin in the game, and therefore the potential loss is that much greater than if someone was purchasing say a car. The difference between the two is that one is for 30 years and the value doesn't typically depreciate, the latter is for say 4 years and is worth nothing (generally) at the end of the term.

Either way individuals require both to go around their daily business.

by keywest | 29th Jul 16, 9:06pm 1469783174

To be cash flow positive is the aim I guess, hence why paying principal is so important as an insurance against bad times, I have always paid off about 2 to 5 percent of my outstanding loans every year to keep things ticking over, means my portfolio is not maxed to the limit but at least is secure, I am cash flow positive on interest only, but choose to pay P&I, the bank likes me I hope...

by Macadder | 29th Jul 16, 10:33pm 1469788432

Another perspective:
https://www.theguardian.com/commentisfree/2016/jul/29/stephen-hawking-b…