How Lenders Assess Property Investment Applications
What do lenders look for when assessing an investment or development application? While lending policies can vary from institution to institution and change with shifts in the economic environment, the so-called ‘4 C’s’ of credit will tend to apply to any type of loan. In this article, we look at what the classic ‘character’, ‘collateral’, ‘capacity’, and ‘capital’ mean when it comes to investment loan applications.
What lenders may refer to as character is really an indication that the borrower will be able to meet their obligations under the loan. Lenders tend to look to past behaviour to assess this factor. They’re looking for affirmation that the borrower will have the capacity to repay the loan.
Lenders will typically refer to the lender’s credit history as a predictor of future behaviour. Stability and consistency are two of the most positive indicators to lenders. An investor or developer’s credit history may be broadly framed to cover the following areas:
- Previous loans applied for and/or approved for
- Repayment period for previous loans
- Any previous defaults
- Number of credit enquiries made in the past
- Employment or business history
- Credit rating
Applicants who have their own business may need to provide at least two years of paperwork for their business, with balance sheet, cash flow statements, notices of assessment, tax returns, as well as paperwork on the project’s development feasibility.
Any persons (or entities) who have applied for any type of finance in the past will have a credit file in their name held by credit rating agencies. These loans can involve anything from mobile phone accounts, personal loans, other investment loans, or home loans. All of these factors may be used by the lender to form an overall lending ‘character’.
The second ‘C’ is capacity, which is closely related to ‘character’. Capacity directly refers to the borrower’s ability to repay the loan. Lenders will usually look at the following to determine repayment capacity:
- Employment or business income, such as salary or rental income.
- Living expenses.
- Credit card limits – in the eyes of some lenders, the higher total credit limits, the less capacity borrowers may have to make repayments.
Lenders are mainly concerned with historical income when determining capacity, not the potential income in the future. Though using tools such as property valuation software to conduct a thorough feasibility of the investment or development is crucial in gaining finance, the forecasted income they report is speculative and is usually discounted to take into consideration external factors and make it more conservative.
The third ‘C’ refers to capital. Capital means the amount the borrower has offered as a deposit for the loan. The higher your deposit, the easier obtaining the loan will tend to be, with all other things being equal.
Many lenders will not approve applications where the loan to value ratio is more than 80 per cent, or where the deposit is less than 20 per cent. For development loans, the deposit may need to be larger.
The second ‘C’ is collateral, or the security the investor or developer is offering the lender for their loan. Usually this is in the form of equity in property, but could also be a term deposit or equity in a business. It almost goes without saying that lenders are interesting in a good amount of security relative to the borrowing amount.
Investment or development loans may be structured to provide anywhere from 65 to 80 per cent of the project cost (development project) or property value (investment property), know as the ‘Loan to Value Ratio’ or LVR. The amount and type of collateral that the investor or developer is putting forward, will influence the LVR that the lender will be willing to offer.