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Case study: the implications of poor loan structuring

Thursday, 28th Feb 2019

When investors think about finding the best loan for their situation, the majority will often interpret this as finding the lending solution with the lowest rates, the best features and the right repayment plan to suit their cash flow needs. These are all fundamental elements that come into play when organising property finance. However, there’s another critical factor that is too commonly overlooked by investors – the importance of loan structure.

The right loan structure not only plays an important role in helping investors maximise their interest savings and pay down their debt more effectively, it serves as the essential foundation to help them build and expand their property portfolio in future. Getting it wrong can therefore have a number of unwanted implications for investors, leading to reduced flexibility and putting them in far greater financial risk.

Unfortunately, loan structure is a factor that is often misunderstood, and not always by investors themselves. Even finance professionals can get it wrong if they don’t have the right knowledge to understand and support their clients’ needs – and frequently, it’s not until further down the line that many investors discover this.

Case study

Cross-collateralisation: a loan structuring issue whereby more than one property is used to secure another or multiple other loans.

Before

After completing the development of two apartments to add to his existing property portfolio, which already included another two properties, a client had approached a bank directly to secure a lower interest rate across his loans. However, rather than organising standalone loans for each of the four properties, the lender cross-collateralised the investor’s portfolio by setting up three loans across the four assets, with the two apartments used as security for all of the remaining properties.

Whilst the investor was able to marginally improve his interest rates, this posed a number of unwanted issues for the client. With the developed properties used as security for the subsequent loans, the investor was running the unnecessary risk of the properties being repossessed should he find himself unable to meet his mortgage repayments for the other assets. Additionally, when the client returned to the bank to borrow more money, they informed him he was unable to do so due to the lack of remaining equity available as security.

In this specific situation, the client was looking to sell the recently developed properties. However, despite the fact he had built a significant amount equity in the apartments, he was unable to proceed with his initial plans due to the complex structure of his portfolio. With the titles of the apartments now used as security for the other loans, the client would have to pay the majority of his proceeds into the remaining two loan accounts to reduce the debt of his overall portfolio before the titles of the properties could be released, which would in turn leave him with a significantly lower profit margin.

After

With the investor now unable to borrow more money and achieve the result he had desired from the sale, the client approached Momentum Wealth for a solution that would provide him with more flexibility. After reviewing his situation, our mortgage broker recommended that we restructure the investor’s portfolio. By refinancing, we were able to uncross the client’s lending portfolio and diversify his loans to reduce his exposure to the fluctuations of each bank’s rates and serviceability metrics. In doing so, we successfully reduced the investor’s overall monthly repayments by $278 per month and were able to mitigate a significant amount of risk.

Knowing that existing debt was another concern for the client, we also recommended that he converted one of his loans to principal and interest, which is now helping him reduce the debt across his overall portfolio. We also created a loan split against one of the new apartments, which enabled the investor to release equity that was then used to reduce the debt of another asset. As well as improving the investor’s overall financial situation, this has provided the investor with significantly more flexibility should he wish to proceed with his initial plans to sell the apartments, as he will only have to reduce the debt linked to those specific loans in order to do so.

Getting the right loan structure in place as you start to build and expand your portfolio can be fundamental to your long-term success as an investor. As we’ve seen above, building a multi-property portfolio comes with complex financial needs. In order to meet those needs, it’s vitally important that you find a professional who understands how to serve and support your investment goals.

If you are concerned with your current lending solution or would like more advice on the topic discussed, our property finance specialists would be happy to discuss your needs in an obligation-free consultation.