With so much in the news about the problems in the American sub – prime mortgage market, many Australian property investors are wondering what this means to them.

The fall out is clearly being noticed here with a change in the lending practices of some of our local banks. But first let’s look at the USA situation…

The US sub-prime market is very much an integral part of the US residential lending landscape, not that it is called that over there. “Sub Prime” is a name the media gave to what we know as non conforming loans. Loans given to clients those with either a bad credit rating or those unable to substantiate their income by way of financials or payslips.

In fact some have called these NINJA loan. Loans to people with No Income, No Jobs and No Assets.

It goes back to 2004 and 2005, at the height of the US property boom, when lenders started adopting creative methods to make home ownership more accessible for a population demographic which was previously unable to own their own home.

The lending industry offered very flexible products in order to make monthly repayments affordable for these credit impaired clients and as a result, the following occurred;

• High LVR loans (up to 140% of the property value) were made available on the speculation that property values would keep rising and clients could then re-finance and obtain a lower LVR loan with a lower interest rate.

• Low start, honeymoon or teaser rate loans were introduced – with home loans starting as low as 1% or 2%. It became easy to make repayments even on a very low income, thus further fuelling the US property boom. However interest rates would be re-set after the honeymoon period to the standard variable rate of about 7%. Once this roll-over occurred many sub-prime borrowers were no longer able to meet their repayments and defaulted on their home loans.

• Unscrupulous brokers and lenders used the relaxation in credit policies to sign up clients who would never be able to make the necessary repayments. These clients signed high income declarations to show serviceability (so-called liar or NINJA loans). In fact some institutions paid brokers larger commissions to write these types of loans.

The popularity of this type of loan really took off and about 7 million US property owners took out these types of loans. This represents about 15% of the total lending volume in the US, compared to Australia where these "high risk" loans only make up about 2% of the total lending volume.

A whole generation of new real estate investors got caught up in this sub-prime lending market. Many of these inexperienced investors had only been investing during the last few "good" years of the property cycle and were unaware of the risks they were exposing themselves to. They took advantage of these easy loans and borrowed to the hilt, way above their means.

The crunch time arrived for many of these American investors when the "honeymoon" low interest rate periods came to an end at the same time as property markets crashed.

To compound the situation, some imaginative finance experts packaged these loans with the help of US investment banks and on sold them as AAA securities to institutional and private lenders worldwide with the promise of a high net return, but without disclosing the true risk behind these investments.

As the number of defaults began to increase and property values decreased, these institutions lost the money that they had invested in these securities.

The US sub-prime crisis is now starting to impact negatively upon Australian investors in various ways.

We have already seen interest rates increase for fully documented loans, with even higher increases applied to Low Doc and No Doc loans.

Some lenders have withdrawn all of their products and disappeared from the market altogether, whilst other lenders have had their funding lines cancelled and haven't been able to settle on loans that were previously approved.

The situation has left many investors in the dark about future funding for purchases or access to equity (equity access loans).

We have seen many lenders withdrawing their No Doc products, leaving property investment clients high and dry without access to necessary funds. With the exception of a handful of lenders that have now significantly increased their rates, the availability of No Doc loans has quite dramatically decreased.

Investors who want to implement a Living off Equity strategy are potentially adversely affected since they can no longer easily access cheap money to fund their strategy.

At RJA Financial Services we believe that the worst is yet to come and we are expecting further significant changes in the lending landscape; especially with regard to Low Doc and No Doc products. In recent weeks we have had more Low/No Doc loans declined than throughout the last 5 years combined. It would seem that mortgage insurers are now exercising extreme caution and are not prepared to take on unnecessary risks.

Now, more than ever, it is crucial that investors seeking funds to make that next property purchase seek out professional advice and have a full understanding of all the boxes they must tick before getting that all important nod from their lender.

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in complex structures please click here.

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