Interest Rates and Borrowing Capacity: Why Property Investors Aren’t as Stuck as They Think

The banks don't like the fact that the brokers have 80% market share. The system's rigged for you to win. Like, it's literally there, you can do it. If you want what the wealthy have, you do what the wealthy do. People want it, but they don't want to do it.

This is what rich people do, man. 40-year loan terms. Why not? Noodle it! Property Nerds.

The home for data-driven property investors. Where we uncover Australia's hot and cold markets, latest headlines and trends. Welcome to another episode of the Property Nerds podcast, and I'm back with the favourite, Mr Jack Fouracre from Fouracre Financial. Why did you say favourite, mate? Because I reckon I just had two episodes without you here, and I'm wondering if people would have been like, where's Jack at?

I don't know, man. The views speak for themselves on YouTube. The ones that I'm in, they seem to get more of the views, so shout out to the fans. I reckon the algorithms love to, you know, as soon as they see a bit of red in the videos, they're like, oh, we've got to get the algos up, the views up. But now look, Jack's in, and why I say he's also the favourite, man, is we go deep into finance.

And everyone knows, property's a game of finance, right? But the main thing I wanted to shout out to everyone listening in, but if you're not listening in, don't forget to jump, if you are listening in, don't forget to jump into YouTube, because with YouTube, this is where we have videos like this pop up. And last few episodes with Jack, we actually shared a bit of whiteboarding and a bit of drawing, right? That was great. We've got to lobby the team here at SPI to get us a whiteboard in here.

Absolutely, we're going to get that in. I've got to say, this is the first episode I've done walking into the studio. I mean, SPI was, well, it was pretty pivotal for me in my early 20s, like listening to Smart Property Investment Show, that whole network. It really forged the way for me to be here today. So to come in and do an episode now in that studio, it's surreal, man.

Actually, now that you say it. Big smile on my face the whole time walking in. Now that you say it, I think it was my first ever podcast episode in 2018 was on the Smart Property Investment Show. And it was with Phil Tarrant. He's like obviously a superstar in the podcasting world.

It's every property investor's dreams to jump on the mic with Phil Tarrant. So I get you, man, because listening to this podcast going back many years, and for those who don't know, the Property Nerds is hosted as well as part of the Momentum Media Smart Property Investment Network. So we're part of the furniture here now, man, part of history for future. Pinch myself, man. There you go.

Well, man, let's talk finance because whenever you're in, we go deep into finance and next episodes, which is why I'm telling anyone who's listening in, jump onto the YouTube, give us a like and subscribe because then you get notified with the videos like this. But also, we're going to bring the whiteboard in. We're going to get Phil Tarrant's P&L and we're going to attach a whiteboard to his P&L as a deductible expense. We're going to help his gearing and we'll chuck a whiteboard in here so we can start doing it. Plenty of other props in here, man.

I noticed your books aren't up there, so I'm going to bring one in next time. I'll chuck it in. Actually, 100%. Let's plant a few books in here because there's a few books not in there. For those who are watching, you might not be able to see the bookshelves here, but we're not seeing a Driving the Data.

We need to get it back up there. But for those who haven't, actually, that's a good opportunity for a plug. Get a copy of Driving the Data. It's a bestseller on Amazon across three categories. And I'm not collecting any of the profits.

I'm pulling up all the profits. We're opening up the Paliwal Foundation soon. It's nearly, nearly launched. As soon as it's launched, all the profits are going to go into there. We're going to put it to some good causes and you're going to be doing good.

So buy yourself a copy of Driving the Data. Get educated. Bust some myths. Trust the data and then give back to good causes at the same time. But Jack, speaking of finance today, interest rates are the hot topic.

They've been rising. Some are even saying there's more and more to come. But let's talk about the interest rate impact on repayments, on servicing, how do people think about it? Let's talk about it. What are your thoughts on its impact on servicing and repayments?

Yeah, just one increase. It's not really that much to move the needle. For a very small amount of people, it might just shift them to a different lender. That's it. Like for a borrowing capacity, it's about 20 to 30K of loan, which is not a huge amount.

For the most part, that might affect people's ability to do an equity release for slightly less than what they were going to do, like an equity release with a major bank. They were going to go to the purchase with the third tier anyway. It's not really going to change much for them. And then in terms of repayments, you're looking at about 150 to 200 bucks a month. So again, not a huge amount.

And that's pre-gearing if you're an investor. Because after negative gearing, they'll come down at least depending on your tax rates, like $40 to $75. But then you've also got, you know, with pressure on interest rates, it means that the investors are going to be more likely to want to increase their rents. You know, sometimes when, like my parents were the type of landlords that would say, oh, no, they're good, they're loyal, keep them happy, don't up the rent. But that'll change real quick once you start seeing rates going up and people want to, you know, toggle that to increase their rents.

So it's just what happens. Actually, that's a really good point. Like it doesn't always flow through, which is why, like, they have to keep increasing interest rates more if they want the effect to show. Because when you're increasing the interest rates, rents increase, rents come into the inflation basket. When you're increasing interest rates as well, people have some of it come back to them with gearing.

And then when you're increasing interest rates as well, people are constantly shifting and moving their lending aside because they're looking at ways that they can manage the household. It's not just, I'm going to stop going to the shops because interest rates went up, right? And suddenly magical inflation just falls down. Of course, it helps, obviously. But let's go back to borrowing capacity.

Because with interest rates, you said the 20K in borrowing cap might be impacted, 20 to 30K. But if you go to the biggest bank, say for a couple who might be able to service an 800K property with the biggest bank, and then you go to the smallest, never heard of you, didn't even know you exist bank in the country. Like I'm talking, like, I don't even know if there's a tier six, but we're just going to make one up. We're going to go tier six. What's the difference like from top all the way to end?

It's a lot. It's more than you think. And it depends if you have an existing portfolio or not as well. Like if you're comparing like for like, just a straight up owner-ock purchase, then it's still more because they have a lower assessment rate. Like if you look at the major banks, they've got a 3% stress test rate.

The non-major banks and third tier lenders, some of them don't have any buffer. Some of them have 1%. Some of them now are even allowing you to go to 40-year loan term. So for those reasons, it's not that bad. And the rate, you could probably get it similar, maybe 0.

7% higher, which, you know, it's only, it's not that much difference really when you weigh it up. So, but where that difference gets really, really big is when you've got existing investment portfolios, you've got interest-only loans, because they're taking actual repayments on those interest-only loans, right? All the major banks, they're looking at when it rolls over to the P&I rate over the shorter 25-year term, that's what they're looking at. So they're going to service you. If you've got a 30-year loan term and the repayments are just $1,000 a week, as an example, they will service you on the 25-year loan term if you have a five-year interest only, which means a higher repayment, which means it might be $1,200, $1,300.

Yeah, but they also sensitize that as well. There you go, on top of that 3% assessment rates. So let's just say that's the equivalent of you paying $1,000 a month, but maybe the bank thinking you're paying $1,600 or $1,500 a month. Whereas with that smaller lender, if they see $1,000, they treat it like $1,000. That's why I question sometimes people when they get a bit standoffish with those third-tier lenders, especially at the lower LVRs, because I had a scenario that I was explaining to one of the clients last week, and the difference was 0.

7% in the rate. And they were like, oh, I just don't want to What's the compounding wealth over time of 150k in extra purchase? Then we looked at this 120 per week difference and how on every year ahead that 120 a week gets lower by 10, 20, 30 bucks because the rent increases. So by year four or five, it's like near negligible. It's back to the same.

But then the last thing is loan structure. And what I've seen you do is that I've seen you go and support people with equity releases, not just cross collateral tied loans where people go and tie the loans and try and do a purchase, but equity releases more than what's needed to act as a buffer because they're going through changing periods of interest rates increasing, rainy day money. What if they need some reno funds? Could you talk about how that strategy works for someone who's going, I want to expand my portfolio, but I'm worried about the holding costs. How do many investors who've worked with you and the team go past that?

So it's like a, I'll put it in the debt recycling bucket because like most people know what debt recycling is. You pay down non-deductible debt, cash it back out, invest it. Then there's a negative gearing benefit. I would put this same strategy into the negative gearing bucket because say for example, you cash out 300k, right? You only need to use 250k as a deposit.

That other 50k that's unused, you can't just, I've had people ask me this all the time, you can't just use that to pay off your own occupied debt because that's not an investment expense, right? So what you could do is with that 50k that's sitting in the offset against your investment debt, if it receives the rental income for the asset, it can make the repayments on the cash out loan and the loan against the property. And yeah, it's negatively geared, but it's slowly depleting. That's an investment expense, right? That additional interest that's charged as the cash balance is going down from that buffer, you know, it's just, it's negative gear, it's recycling debt.

You're making repayments with debt. So it's not going to last forever, right? It's not going to, but it's a big five, six years. Like give an example. I remember I had 600k in equity release in 2021.

Off that 600k in equity release, I think I purchased like two and a half to three plus million dollars of real estate at 90% loans, highly leveraged and had 250k offset leftover. It was a couple of K a week of negative cashflow on the additional real estate. And 50 grand will get you two years of negative cashflow. That's right. And so that actually, yeah, it was a hundred grand negative cashflow a year, but then post-tax it came down to 50 or 60 as an estimate.

And then on top of that, you've got 250 grand leftover in the offset. That's five years of buffer. It's wild. And people don't recognize that in five years on a $3 million asset growing at 5% is 150 in the first and compounding. So you're looking at at least 700k to 800k of equity gain, at least just on the new additions against a 250k of cashflow wipeout.

So it's almost two to three times the return. And you know, all you did scribble with your hand to sign papers or e-sign or, you know, just send a printer and scanner thing across. It's wild. It's just a dream for you to win. Like it's literally there, you can do it.

And it's, yeah, like I guess when people go and buy properties, they think, oh, you know, it's going to be negative cashflow. I've got to be careful here. Okay. But if you do that, then what that means for your personal home loan, for example, you're just paying off more or just building up in more offset against your own occupied property. So you've got all this extra cashflow that you can now just build up your personal cash buffer, knowing that one day, you know, that cash that's making the investment repayments is going to run out.

But in that time, you've known that's coming, you're prepared for it. This is what rich people do, man. Honestly. That's recycling of the investments in that way. And, you know, like it's the importance as well of recognizing, okay, maybe let's just say you can't do that.

You're in your earlier investments and you're trying to manage it. Like, okay, if we go, Arjun, you did that. Do you think I'd do that if I didn't have financial discipline though? You have to have financial discipline too. Like if you're saving $0 a month and you have no income discipline to save into your bank accounts, these strategies won't last.

One day a bank will go, we can't equity release you anymore. You're to the ceiling of your capacity. And then what? Do you want to just sell everything you worked so hard for? Then you got to make sure your finances are right.

And so on that, I've got a formula and this formula has come up over 1600 clients now reviewed. And when I've reviewed their portfolio plans, I figured out this is crazy. Every time a customer does this, they usually have enough to hold on to multiple properties, even without an equity release strategy. It's if you're putting away 25% to 45% of your net income into an offset account each month, you will be able to hold the number of properties you need to achieve passive income to replace a passive income of either one person or two people's income in your household. And the reason why that's so powerful is that you're not saving to save.

You're saving to hold the fort. You know what I mean? So if you have a six to 800K property that's negative geared one to two K per month, one to two K per month in cashflow, what the four K in monthly savings against a 14, 15K or 15, 16K after tax household income, which is what someone is a couple on circa 250 to 300, they have after tax income of 15 to 17 per month. They have 25% saved. It's like four to four and a half a month, roughly.

Then straight away, that means you could hold on to two investment properties personally. One may be in your super fund, depending on your age, if you're in your 30s and 40s. And if you have a PPR, principal place of rents, you could hold that. I literally had the scenario with someone this morning, their home, two investments and their super, super property being sold, two investments being sold. They take the millions of dollars of post sale money, move to a financial planner, and they will get their financial advice to be able to get a return from that.

And they're able to get 125 inflation adjusted passive income, which is what the wife earns. And his goal was to have the wife's income replaced and be living debt free. So he can continue to work or if he doesn't wish to, they could both live on that one income because they're debt free and they own no other debts or properties. And the kids have moved out because the child today is like, I think, eight years old and they're 38 year old couple. So that's like, what, 22 years?

Child's going to be 30, right? So 30 year old might be chilling at home if you're super tight, but you might also move out. But the main thing I'm trying to say here is that, yes, these equity release strategies are great. But at the same time, it's like, if you want to rock solid your financial future, your 25 to 45% net of your income going into your offset, not for the purpose of go save so you can save your way to wealth, you can't, but you can hold the fort of negative cashflow until it turns positive. Such a big piece.

Now, Jack, in terms of right now, we've got interest rate increases. Let's go back in time. And back in time in 2022, we went to the first round of interest rate increases. And what people don't recognize is it got to a peak that's higher than what it is now, meaning even if it increased a couple more times, probably just reach whatever numbers were already at before. You've been lending during that time.

Did you see a slowdown? Did you see that you couldn't get people across the line? Did you see any negative impact to property market prices? Because I saw price still smashing it. So what do people got to avoid to not get caught up in if it's happening again?

Well, initially, it was the banks, the major banks didn't really adjust. But I'd say within six months of those initial increases, we started to see them really loosen up their policy, like in terms of the type of income that that accept, how easy it would be to calculate, or just like a short term amount of non-base income and overtime and bonus and commission. Historically, you'd need to show those types of non-base incomes over a longer amount of time. But when the rates started going up and the borrowing power started just coming down with those major banks, they started to see the market shift towards non-major banks and third tier lenders. So yeah, they were pretty quick to adjust and make those changes so that they could recoup some of that market share.

And I think they have, honestly, they've done a really good job of that. So I have no doubt that if that was to happen again, and they started to see the shift to third tier lenders and all that, it'll happen again. The banks don't like the fact that the brokers have 80% market share. Of all new business written, it's 80% is brokers. They don't like that.