CertIVFMB LearningGuideV2 Mod2 S1-2

FNS40811 Certificate IV in Finance & Mortgage Broking

Section 1

Lenders and loan types Learning outcomes Upon completion of this section you will be able to: 

identify various types of lending institutions and the similarities and differences between them



understand their various roles in the industry



identify the different types of loan types available in the market



analyse the loan requirement of your client.

From the inception of the mortgage broking industry in the late eighties, there were very few lenders that were enticed into the third party operation. These days there has been a great shift from the majority of lenders towards the mortgage broking introduction of loan applications. There are now many lenders from various sectors of the financial services industry that are effectively utilising the broker market to promote their products. To gather funds for mortgage and credit facilities, the lenders will generally operate as one of the following: 

Deposit taking institutions (DTI’s)



Securitisers



Private mortgage funders

Deposit taking institutions raise their funds by utilising deposits from their clients or members. These are known as Authorised DTI’s. These corporations are authorised under the Banking Act (1959) to operate in their current manner. These entities include banks, building societies and credit unions. Australian Prudential Regulatory Authority (APRA) sets, maintains and enforces the standards under which these lenders operate. APRA plays an important role to ensure that the rules, regulations & standards are maintained within the lending institutions that the brokers operate and submit loan applications. Securitisers and Private Mortgage Funders will be discussed later in the section.

Module 2 Learning guide V2

© AAMC Training Group

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Types of lenders Let us now look at the different types of lenders in the market in which the Finance/Mortgage Brokers operate.

Banks Banks fund most of our residential mortgage loans in Australia. Individual banks determine their own fee structures and policy guidelines for their many different products. The state of the economy and market conditions determines the interest rates although the banks can load their own margins at their discretion. With competition high, most banks have the same interest rates or there is very little difference between them. Banks gain their funds from depositors and shareholders. Brokers have contracts with most banks – some with up to 40 Banks. This should be checked with your company. Some of the major bank lenders in Australia are: 

Bendigo Bank



ANZ Bank



Bankwest



Westpac



Citibank



Commonwealth/Colonial Commonwealth/Colonial Bank

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Homeside Lending – subsidiary of NAB



National Australia Bank



ING Bank

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St George Bank



Suncorp Bank

Credit Unions Credit Unions are one of a number of non-bank lenders. Credit Unions tend to target specific employment groups as specified by their names e.g. Police and Nurses Credit Union. They are not restricted to these groups in most cases. To gain a loan with a credit union you must become a member of that Credit Union by paying a nominal shareholding of approximately $2– $2 –$10. When the account is closed the shareholding is repurchased for the amount paid. Credit Unions are supervised by the Australian Financial Institutions Commission (AFIC). Their lending criteria tend to be similar to that of a bank although their policies in some circumstances may lead to more flexible lending conditions than those of the banks.

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Types of lenders Let us now look at the different types of lenders in the market in which the Finance/Mortgage Brokers operate.

Banks Banks fund most of our residential mortgage loans in Australia. Individual banks determine their own fee structures and policy guidelines for their many different products. The state of the economy and market conditions determines the interest rates although the banks can load their own margins at their discretion. With competition high, most banks have the same interest rates or there is very little difference between them. Banks gain their funds from depositors and shareholders. Brokers have contracts with most banks – some with up to 40 Banks. This should be checked with your company. Some of the major bank lenders in Australia are: 

Bendigo Bank



ANZ Bank



Bankwest



Westpac



Citibank



Commonwealth/Colonial Commonwealth/Colonial Bank



Homeside Lending – subsidiary of NAB



National Australia Bank



ING Bank



St George Bank



Suncorp Bank

Credit Unions Credit Unions are one of a number of non-bank lenders. Credit Unions tend to target specific employment groups as specified by their names e.g. Police and Nurses Credit Union. They are not restricted to these groups in most cases. To gain a loan with a credit union you must become a member of that Credit Union by paying a nominal shareholding of approximately $2– $2 –$10. When the account is closed the shareholding is repurchased for the amount paid. Credit Unions are supervised by the Australian Financial Institutions Commission (AFIC). Their lending criteria tend to be similar to that of a bank although their policies in some circumstances may lead to more flexible lending conditions than those of the banks.

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Credit Unions gain their funds from depositors and shareholders. Interest on the members’ deposits is the largest income producing area for the Credit Unions. The Credit Unions return much of the extra income generated, after expenses are paid, to members by way of added benefits such as lower interest rates on lending products, higher interest rates on deposit products and one of the biggest single attractions of Credit Unions is that most offer fee free banking to members. There are over 180 Credit Unions operating in Australia with only a limited number of them involved in origination. In May 2007 the National Credit Union Association and its members joined Abacus, creating a single, united voice for all credit unions and mutual building societies in Australia.

Building Societies Like the Credit Unions, Building Societies are also supervised by the Australian Financial Institutions Commission (AFIC). Building Societies were first introduced into the market mainly to lend funds for housing. Building Societies, like Credit Unions, raise their funds predominantly on individual deposits and investments from their customers. Their lending criteria are also similar to that of Credit Unions. With the deregulation of banking, a number of the Building Societies became banks hence diminishing the number of Building Societies in existence. A number of Finance/Mortgage Brokers use Building Societies more particularly for the first homebuyers. Commonly used Building Societies in Broking in Australia include: 

B&E Limited

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IMB

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The Rock

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Newcastle Permanent

Securitised lenders In the early 1980’s the process of securitisation was developed in the United States. Australia adopted the technique a few years later. Securitisation is the process of packaging similar assets and selling Securities (Bonds) against them. The selling of these bonds raises more funds, which are then lent out by way of mortgages and the cash flow gained from this are then repackaged and then sold as bonds again. The cycle repeats itself over and over again. Mortgages are the most popular area of securitisation however; any asset that generates an income stream can be securitised such as car loans and credit card receivables. A special purpose vehicle, either a trust or a corporate structure often appears on the mortgage



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documentation associated with a securitised home loan as the mortgagor rather than the name of the ‘originator’ from whom the product was purchased. Special note of this should be made and borrowers informed. Securitised lenders, as distinct from banks, do not have to have 10% capital requirement lodged with the Reserve Bank. However, because of this they have stronger auditing requirements. All securitised loans must be approved by and have Lender’s Mortgage Insurance. Most securitised lenders will not charge the borrower this premium until the borrowing exceeds a loan to value ratio (LVR) of 80%. Some Securitised lenders used in Australia include: 

Advantedge

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First Mac



Macquarie Bank

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Non-conforming lenders

Most of the Banks also raise funds in this manner and finance some of their own products as well as products of other lenders and brokers.

Non-conforming lenders Non-conforming lenders raise their funds mainly by securitisation and as their name suggests, they lend money to people who do not qualify for loans from the traditional lending sources or do not conform to the usual lending criteria. There is usually a higher interest rate charged to reflect the perceived risk in this type of lending. The interest rate is usually determined by the LVR. As a rule non-conforming lenders had only accepted loans from people who did not qualify for loans through traditional sources because of things such credit impairment, savings history, financials not completed, recent employment history, debt consolidation, etc. The reason for this was that under the former UCCC it may have been considered unconscionable conduct to place someone into a loan with a higher interest rate than they may have qualified for at a traditional bank. However with the introduction of the National Consumer Credit Protection Act (2009) (NCCP) the onus fits squarely on the shoulders of the Authorised Credit Representative, the Credit Licence Holder to ensure the loan offered is not unsuitable for the clients. Non-conforming loans are generally not covered by Lender’s Mortgage Insurance.

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A number of non-conforming lenders will charge deferred establishment fees. This means that if a loan is paid out within a certain period of time, usually within the first three years, a fee will be charged. This fee is usually highest in the first year and lessens throughout the term. These amounts can be quite substantial but are stated in the contract. This type of finance is usually only short term as the borrower will often seek traditional funding once they have increased their equity in the home, proven their ability to repay a loan, stability in their employment can be confirmed etc. Some of the more prominent non-conforming lenders are: 

Liberty



LaTrobe



Pepper



Resimac

The availability of non-conforming home loans may include the following categories: 

Credit impaired



Self-employed for less than two years

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Start-up businesses

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Inability to confirm stable income



Retired or elderly borrower

Private mortgage lenders Private mortgage companies are not used as much as they were prior to the introduction of a number of new non-bank lenders and onerous legislation introduced in most states to control the industry. Private mortgages are non-regulated loans. Most of these loans are arranged by accountants and solicitors and specialised Finance/ Mortgage Brokers. The funds raised for Private Mortgage Lending are gained from individual investors making the funds available and a registered first mortgage is taken by this investor over residential properties. The maximum LVR generally is no greater than 66.6%. The interest rate charged for these types of loans is generally quite high—approximately 2%–3% higher than the standard variable rate. The applicants who this type of lending attracts are: 

Borrowers that are unable to secure bank or standard loans



Short term borrowers



Those requiring a speedy process




Those who wish to have the ability to roll funds from one project to the next, such as property developers


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Types of loans There are many types of finance products offered through banking and non-banking institutions these days. The following are the more commonly used types of finance. Some you will need to know intimately, while others you will need to only be aware of. 

Residential Owner Occupied



Residential Investment

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Bridging

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Residential Business



Commercial



Personal

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Commercial Hire Purchase



Consumer/Chattel Mortgage



Financial Lease

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Novated Lease

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Operating Lease

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Rental Finance



Commercial Property/Industrial finance

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Factoring

These loans may be classed in two categories according to the National Consumer Credit Protection Act (NCCP): 1.

Regulated (i.e. covered by the NCCP)

2.

Non-regulated (i.e. not covered by the NCCP)

This is further outlined in the section pertaining to legislation.

Residential mortgages A residential loan is the most common type of loan that we will deal with. There are three core products: 1. Standard variable rate loans As the name implies the interest rate charged on these loans may move up and down. The rates usually move in line with the Reserve Bank official interest rates. The Reserve Bank board meets on a monthly basis and determines the need to move the interest rate up or down, which is dependent on the performance of the economy. 2. Fixed rate loans As the name implies the interest rate charged on these loans is fixed for the term of the contractual period. This is usually set from one year to 10 years. The borrower will nominate the fixed rate period at the beginning of the contract and if they should break the contract

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period they will usually be charged a fee. At the end of the fixed rate period, the borrower will have the option for refixing a new term (at the discretion of the lender) or the outstanding balance would be transferred to a standard variable rate. 3. Lines of credit This type of credit facility works in the same manner as an overdraft. We will now look at the varying types of residential mortgages: 

Owner occupier loans



Residential investment loans



Bridging finance



Reverse mortgages



Personal loans

Real estate residential owner occupier mortgage Purpose of loan

1. Purchase existing residential owner/occupied property 2. Construction of a residential owner/occupied property 3. Refinance a current residential mortgage 4. Debt consolidation or Home Improvements 5. Holiday 6. Personal requirements


Loan to value ratio (LVR).

These may vary from lender to lender. You will need to check with each particular institution.

NCCP coverage

As this loan is purely for domestic purposes, it is covered under the National Consumer Credit Protection Act (NCCP) (i.e. it is a regulated loan.)

Security

Registered Mortgage over a property. The contract for this type of loan is an accepted letter of offer and executed mortgage documents. This means that the client has given the lender security by means of an encumbrance on his property. If the client defaults on the contract, the lender is entitled to sell the property to regain the money still owing. Properties suitable for mortgage security would be residential homes, residential home and land packages, strata titled units.

Term of loan

The loan term may vary from one year to a maximum of 40 years (subject to lenders’ criteria).

Interest Calculated on the daily outstanding balance

The interest can be calculated as either: • Fixed rate (i.e. it remains constant, along with the repayment amount, for the fixed term of the loan). Fixed rates are usually for terms of one to five years. • Variable (i.e. the rate may be reviewed on a regular basis and adjusted according to the banks current rates).

Repayments

Repayments can usually be made weekly, fortnightly or monthly. There are products available that make interest only payments available.

Redraw

Available on most loan products except fixed rate products.

Early payout

Allowed, although there may be some fees. Fixed rate loans may attract additional fees due to the original cost of funds.


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Real estate residential investment mortgage This loan is the same as the residential mortgage only that it is used for investment purposes and is now consi dered a regulated loan under the NCCP. Purpose of loan

1. Purchase existing real estate residential property for investment 2. Construction of a real estate residential investment property 3. Refinance a current real estate residential investment mortgage 4. Personal debt consolidation or improvements to real estate residential investment property

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NCCP coverage

Regulatory changes from July 1st 2010 now include Real Estate residential property investment loans as regulated and therefore mortgagors and guarantors have protection under the NCCP Act (2009)

Security

Registered mortgage over a property. The contract for this type of loan is a signed accepted letter of offer and executed mortgage documents. This means that the client has given the lender security by means of an encumbrance on his property. If the client defaults on the contract, the lender is entitled to sell the property to regain the money still owing. Properties suitable for mortgage security would be investment or residential homes, including house and land packages and strata titled units.

Term of loan

The loan term may vary from one year to a maximum of 30 years (subject to lenders criteria).


The interest can be calculated as either: • Fixed rate (i.e. it remains constant, along with the repayment amount, for the fixed term of the loan). Fixed rates are usually for terms of one to five years. Interest only repayments can be negotiated on most fixed rate contracts. • Variable (i.e. the rate can be reviewed on a regular basis and adjusted according to the banks current rates).

Repayments


Redraw

Available on most loan products, except fixed rate products.

Early payout





Bridging finance This loan is the same as the residential mortgage only that it is used as a short-term solution to enable the borrower to purchase or construct a new home before the settlement takes place on his current home. They are often referred to as a ‘home to home’ loan. This type of loan is usually sought by borrowers who are purchasing a new home or building a home, to enable them to stay in their current property until the new one has settled or been constructed. The borrower then usually sells their current property and pays out the bridging finance amount leaving an end debt. Let us look at an example: Current property value Current mortgage New property value

= = =

$350,000 $150,000 $450,000

The client in this case will want to borrow $450,000 to purchase the new property while he sells his current p roperty, or in the case of construction, while it is being built. Total property values

=

$800,000

Loan required = $150,000 (existing loan) & $450,000 (new loan) plus fees, let’ s say $15,000 Total loan LVR

= =

$615,000 76.9%

The bridging finance amount would be $450,000 plus the fees of $15,000 = $465,000. The original loan would remain the same as it is now. When the current house is sold, the amount of $350,000 or thereabouts (value of current house), would be paid off the bridging loan and an end debt of $265,000 would remain.



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Purpose of loan

1. Purchase existing residential owner occupied/investment property 2. Construction of a residential owner occupied/investment property

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NCCP coverage

The purpose of the loan would determine if the loan was to be regulated or non-regulated.

Security

Registered Mortgage over a property. The contract for this type of loan is a signed accepted letter of offer and executed mortgage documents. This means that the client has given the lender security by means of an encumbrance on his property. If the client defaults on the contract, the lender is entitled to sell the property to regain the money still owing to them. Properties suitable for mortgage security would be investment or residential homes, including house and land packages and strata titled units.

Term of loan

The loan term may vary from lender to lender, but it is usually to a maximum of one year. At the end of this period, the lender will review the status.


The interest is calculated at a variable rate on the daily outstanding balance.

Repayments

The payments (interest only) are usually added to the loan balance (capitalised) if there is enough equity in the property. It is usually a stipulation of loan approval that there is enough equity in the two properties to cover capitalised interest for at least six months. If the borrower wishes to make repayments, these may usually be made weekly, fortnightly or monthly.




Residential business loan This loan is the same as the residential mortgage only that it is used for business purposes. The business operator is able to utilise the equity in the residential property for expansion or to purchase a new business. Purpose of loan

1. Purchase equipment or an investment 2. Purchase a new business 3. Expand an existing business 4. Inject funds into the cash flow of an existing business 5. Purchase shares or other investment



NCCP coverage

As this loan is purely for business purposes, it is not covered under the National Consumer Credit Protection Act (NCCP) (i.e. it is a non-regulated loan).

Security

Registered mortgage over a property. The contract for this type of loan is an accepted letter of offer and executed mortgage documents. This means that the client has given the lender security by means of an encumbrance on his property. If the client defaults on the contract, the lender is entitled to sell the property to regain the money still owing to them. Properties suitable for mortgage security would be residential homes, residential home and land packages, strata titled units.

Term of loan

The loan term may vary from one year to a maximum of 40 years (subject to lenders criteria).


The interest can be calculated as either: • Fixed rate (i.e. it remains constant, along with the repayment amount, for the fixed term of the loan). Fixed rates are usually for terms of one to five years. • Variable (i.e. the rate may be reviewed on a regular basis and adjusted according to the banks current rates).

Repayments


Redraw

Available on most loan products, except fixed rate products.

Early payout


Reverse mortgages From the last available figures, reverse mortgage out standings grew to $2 billion between 2005 and 2007. Growth in this area will continue to flourish as more and more cash poor retirees seek alternative funding for their retirement income. Lending via this type of funding has already proven very successful in the UK and USA and is currently experiencing growth in Australia. These loans are designed for the retirees who own their own home, who are cash flow poor and have not adequately funded their retirement needs. Retirees use the equity in their homes and are not restricted on the use of the funds. A reverse mortgage requires no repayments to be made by the retirees but they or their beneficiaries can meet the full repayments or interest



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only payments if they wish to keep the debt at the amount borrowed. The loan will be paid out when the borrower sells the property; either or both partners wish to move to an aged care facility or passes away. All fees, charges and interest are added to the loan. Disbursements of the funds are either via a bulk payment or monthly income streams and it’s very important that the clients seek expert advice to ensure their pensions or other payments are not affected. Lenders provide calculators to enable the broker to give clients a printout that shows all things remaining constant, such as what the debt will be along with the future projected value of the property. There are some restrictions on these loans incl uding the LVR that is dependent on the borrower’s age. The borrower’s age is also taken into consideration when determining the loan amount available. If there are joint borrowers then the lender will take into consideration the age of the younger borrower when assessing the maximum lending amount. There has been much discussion on the appropriateness of the reverse mortgage. ASIC has issued a warning to lenders and brokers that they should take extreme care when considering whether a reverse mortgage is suitable and appropriate for their clients. You will find that this area will fall under ASIC regulation in due course to ensure the borrowers’ interests are looked after at all times. There are obvious areas of consideration to be questioned and the main area of discussion and argument has been in the inheritance factor. The retirees borrow funds against the value of their home and inevitably the equity in the home may decrease. This needs to be considered due to the inheritance planning of the funds prior to taking out the loan. It is advisable for the borrower to seek the advice of an accountant and/or a lawyer before making a decision of taking a reverse mortgage. There are more and more lenders now entering this market as they can see it is a much-needed product by their aging clients and the large growth being experienced in this area.

Home reversion scheme These types of schemes operate in two different ways: 1.

The borrowers sell their home to the lender and lease it back

2.

The borrowers sell their home to the lender and retain possession of the house. The lender then places a caveat on the property to protect their interest.

The funds under this scheme are dispersed in the same way as the reverse Mortgage Scheme above in that the clients either receive a lump sum or a monthly income stream.

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Shared appreciation mortgage The borrowers give up right to part of the future growth in the security property in return for a discounted interest rate. This type of lending is not well used compared to the Reverse Mortgage lending products.

The National Rental Affordability Scheme (NRAS) The National Rental Affordability Scheme (NRAS) is a long-term commitment by the Australian Government in partnership with the states and territories, to invest in affordable rental housing. The Scheme, which commenced in 2008, aims to address the shortage of affordable rental housing by offering financial incentives to the business sector and community organisations to build and rent dwellings to low and moderate-income households at a rate that is at least 20 per cent below the prevailing market rates. NRAS aims to: 

increase the supply of new affordable rental housing



reduce rental costs for low and moderate income households



encourage large-scale investment and innovative delivery of affordable housing.

The Australian Government is committed to stimulating the construction of 50,000 high quality homes and apartments, providing affordable private rental properties for Australians and their families. The National Rental Affordability Scheme (NRAS) is an Australian Government initiative to stimulate the supply of 50,000 new affordable rental dwellings. Successful NRAS applicants are eligible to receive an Incentive for each approved dwelling where they are rented to eligible low and moderate-income households at a rate that is at least 20 per cent below the prevailing market rate. Potential investors in investment vehicles involving the NRAS should note that the allocation or reserved allocation of NRAS Incentives does not constitute Government endorsement of the development proposal as an investment opportunity.

Background Governments, the business sector and community organisations recognise that housing affordability is an issue of significant community concern. The growing cost of housing i s having a serious impact on the ability of many Australians to meet their financial commitments.



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Under NRAS, the Australian Government is providing Incentives to: 

increase the supply of affordable rental dwellings;



reduce rental costs for low to moderate income households; and



encourage large-scale investment and innovative delivery of affordable housing.

The Scheme offers annual Incentives for ten years. The two key elements of the Incentive are: 





A Commonwealth Government Incentive currently of $7,143 per dwelling per year as a refundable tax offset or payment; and A State or Territory Government Incentive currently of $2,381 per dwelling per year in direct or in kind financial support. So potentially this could equate to $9,524 (CPI Indexed) Tax Free Incentive per property, per year.

NRAS is designed to pool significant resources from a range of participants including financial institutions, non-profit organisations and developers which, when combined with the Incentives from the Scheme, will increase the supply of lower-rent housing. These resources could include loans; equity investments; capital grants by Commonwealth, State and Territory or Local Governments; donations by charities; free or discounted land by churches; or contributions by developers in accordance with planning requirements. The tenant eligibility criteria ensure the Scheme is open to a range of household types on low and moderate incomes.

Implementation and administration of NRAS The Department of Families, Housing, Community Services and Indigenous Affairs (FaHCSIA) is responsible for the management of NRAS, in consultation with the Australi an Taxation Office. The Commonwealth is working with State and Territory Governments, investors and not-for-profit housing providers in the ongoing management of NRAS, which commenced on 1 July 2008.

Legislation, regulations & guidelines The legislative framework for the Scheme is provided through the National Rental Affordability Scheme Act 2008, the National Rental Affordability Scheme (Consequential Amendments) Act 2008 and the National Rental Affordability Scheme Regulations. 





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National Rental Affordability Scheme Act 2008 National Rental Affordability Scheme (Consequential Amendments Bill) Act 2008 National Rental Affordability Scheme Regulations




Policy Guidelines These guidelines provide details of the administration of the National Rental Affordability Scheme to complement the Legislative and Regulatory Framework. If there is any inconsistency between the guidelines and the above-mentioned legislation, the legislation prevails to the extent of the inconsistency. 

National Rental Affordability Scheme Policy Guidelines (source from http://www.fahcsia.gov.au/sa/housing/)

Participation by charities Charitable organisations can become involved in the Scheme in a range of different capacities. They may: 

be contracted by investors to provide tenancy and property management services for participating NRAS dwellings;





team up with other partners in joint ventures or consortia arrangements to construct and manage new dwellings; or apply for NRAS incentives to help construct and manage dwellings themselves.

The Australian Government's Department of the Treasury has advised the High Court Word Investments decision determined that where an organisation raised funds exclusively for a charitable purpose, the fact that it did so through a commercial enterprise did not preclude it from being a charity. The Department has been advised that the High Court Word Investments decision now provides further certainty for charitable organisations participating in NRAS. Treasury has c onfirmed that the Word Investments decision replaces the need for an extension of the temporary safety net that was put in place to provide certainty that charitable Community Housing Organisations will retain their charitable status if participating in NRAS. The Australian Taxation Office can provide i nformation and clarification on your charitable status in relation to NRAS. For more information visit theAustralian Tax Office website.

Taxation enquiries Interested parties with general taxation enquiries about the tax implications of their involvement in NRAS should visit the ATO website or contact the Australian Taxation Office on 13 28 66. This call centre operates from 8am-6pm weekdays (AEST). If a potential applicant or participant would like specific advice on the tax implications of the NRAS arrangement they are entering into, they can seek advice from the Tax Office. Binding advice can be sought in the form of a Private Binding Ruling or a Product Ruling. The links will provide you with further information to determine which type of advice is appropriate for your Source: (http://www.fahcsia.gov.au/sa/housing) needs.



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Self -Managed Super Funds Traditionally Finance Brokers have funded their clients’ borrowings for Properties (Residential and/or Commercial) for Investment or Business purposes via stand-alone or structured lending. Whilst this has assisted many investors and business owners in obtaining their respective properties, the way of funding and structuring these types of loans has changed. Self-Managed Superannuation Funds are now able to borrow to assist with the purchase of these properties. At this stage of the journey it would be just pure folly for Finance Brokers to ignore this type of funding arrangements. It should be mentioned to all clients that there are other ways of funding such purchases, because to ignore may see legal action being instigated against the Finance Broker. Why, you may be asking yourself? The simple fact is there may be many more investment benefits and taxation strategies for the clients to fund via their current or yet to be formed Self-Managed Super fund. Whilst this type of lending strategy may sound exciting there are also pitfalls that have to be observed and hence you must ensure that the clients are referred to a qualified advisor who operates in this area. AAMC Training Group offers the full training course for this subject matter so we will now look at some of the benefits and pitfalls worth noting, notwithstanding it is just a few and not extensive.. According to the latest ATO statistics for SMSFs, real property makes up 15% of the sector’s assets. This is twice the property weighting for regular super funds where only about 7% is invested into real property. With residential property already making up one quarter of SMSF real property assets, the ATO said trustees should avoid transferring residential property to a fund unless it is income generating and effectively a business asset with proper arms’ length arrangements in place. The only real estate you can transfer into your SMSF is business real property. You cannot transfer a residential investment into your SMSF. You also cannot transfer a property that has both business and nonbusiness uses. Before you transfer a business real property into your SMSF, make sure you understand and comply with the super laws concerning the property transfer, both before and after the event. The real estate must be business real property both at the time and after it is transferred into the SMSF,”

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According to the ATO, transfers become complicated if the property transfer is done off-market as the onus is on the trustee to ensure the arrangement is on commercial terms. “You must have a legally binding lease between your SMSF and your business. If you do not have a lease in place you will be breaching the super laws. The lease must be on arm’s length terms at market rent,” For example, if the rent is below market it could be viewed that the SMSF is giving an advantage to the tenant at the expense of the fund members but if it is above the market it could be viewed as being an attempt to circumvent the excess contributions tax, they explained. Illustrating the ATO’s concern about property investments into SMSFs, they expressly cautioned that capital improvements should not be done. There are also heavy penalties for those trustees that make contributions in excess of the allowable yearly contributions amounts and sadly this is one major area of the breaches and has been a very expensive lesson for many. There may be taxation advantages when the client reaches age 60 in regard to capital gains tax and also other benefits from: 



having the rentals paid direct from the business or renter into the SMSF, and Then the loan repayments being taken directly from the fund.

At this stage we believe there are a few lenders playing in this space with more considering entering this area due to the large growth and take-up of the SMSF. The latest data released states there are around 460,000 Self-Managed Super Funds in Australia with approximately 1.8 trustees per fund, which by my reckoning is one very big opportunity awaiting those that choose to increase their skills, knowledge and qualifications in this area. In addition, it is noted that only 30% of the 16000 financial planners have the SMSF qualifications and of those only 10% are actually active in this area, so once again large opportunities exists for the qualified advisor. As you would appreciate, funding these types of purchases varies from lender to lender that play in this space so let us look at one particular lender’s view, guidelines and structures and documentation.



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Residential property Product

Investment Property Loan

Minimum Loan Amount

$200,000

Interest Rate

7.46% pa variable

Term

Maximum 30 years with up to 10 years interest only available

Application Fee

$1,500 flat fee

Monthly Service Fee

$8

Loan to value ratio

80% with corporate trustee or 72% with personal trustees

Estimated solicitors costs to prepare loan documentation

$1,430 inc GST

Commercial property Product

Bank Bill Business Loan

Minimum Loan Amount

$250,000

Interest Rate

8.25% pa variable Indicative - fixed rates available upon request

Term

Maximum 15 years with up to 10 years interest only available

Application Fee

$1,600 flat fee

Monthly Service Fee

$35

Loan to value ratio

65% with corporate trustee or 58.5% with personal trustees

Estimated solicitors costs to prepare loan documentation

$2,200 inc GST

Serviceability is calculated at 1.5 times interest cover using the rental income from the subject property and past / future contributions. If serviceability is not met from these sources then we can look at the customer’s whole situation. In order to proceed with an application for SMSF lending, the customer is required to provide the following documentation: 

Application form

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Undertaking to pay solicitor's cost





Offer & Acceptance

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Superannuation Trust Deed



Company searches for both Property Trustee and Super Trustee



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Security Deed between the Super Trustee and Property Trustee (Bare Trust)

A statement of advice from a financial planner or a written advice from an accountant is required from an RG146 accredited financial planner/accountant, which will certify that the appropriate strategy of the SMSF is to invest in the purchase of the property.




Please note the important different lending requirements for Corporate Trustees and Personal Trustees. It would be fair to say that a lender would consider a Corporate Trustee (Qualified Investment Advisor) has more business and investment acumen than a Personal Trustee (normally Mum and Dad), so therefore the greater the loan. Should a fund have a personal trustee and your clients are seeking a higher LVR, then they will need to consult with their accountant or another authorised trusted advisor who will get the paper work undertaken via the respective professional. Hopefully the above overviews has been of assistance for you in gaining a brief knowledge and understanding of the funding channels where clients can avail themselves of the benefits of utilising their SMSF to their own advantage. Please also note that none of this material can be considered as advice so you must consult a qualified professional and/or inform your clients to do the same. This material is stated for general information only as we do not know your personal circumstances and none of the above information can be relied upon as advice.

Non-resident lending (FIRB) Housing loan applicants do not have to be citizens of Australia, however to purchase residential property in Australia there are certain guidelines that have to be met. The government’s approach to the Foreign Investment Policy is to encourage investment consistent with community interests. In recognition of the contribution that foreign investment has made and continues to make to the development of Australia, the general stance of policy is to welcome foreign investment. The government recognises community concerns about foreign ownership of Australian assets. One of the objectives of the government’s foreign investment policy is to balance these concerns against the strong economic benefits to Australia that arise from foreign investment. The foreign investment policy provides for government scrutiny of many proposed foreign purchases of Australian Business and properties. The Government has the power under the Foreign Acquisitions and Takeovers Act 1975 (the Act) to block proposals that are determined to be contrary to the national interest. The Act also provides legislative backing for ensuring compliance with the policy.



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By far the largest number of foreign investment proposals involves the purchase of real estate. The government seeks to ensure that foreign investment in residential real estate increases the supply of residences and is not speculative in nature. The government’s foreign investment policy, therefore, seeks to channel foreign investment in the housing sector into activity that directly increases the supply of new housing (i.e. new developments – house and land, home units, town houses, etc.) and brings benefits to the local building industry and their suppliers. In short the Foreign Investment Review Board will approve applications for real estate purchases as detailed below: Foreign non-residents or short term visa holders can invest in Australian real estate only if that investment adds to the housing stock. This generally occurs by acquiring new dwellings, off-the-plan properties under construction or yet to be built, or vacant land for development.

Established (Second-Hand) Dwellings Non-resident foreign persons cannot buy established dwellings as investment properties or as homes. Foreign companies with a substantial Australian business, acquiring second-hand dwellings for the purpose of providing housing for their Australian-based staff normally meet with no objections subject to the condition, the company undertakes to sell the property if it is expected to remain vacant for six months or more. In remote and rural locations foreign companies may rent out dwellings acquired under this category only where they are unable to sell the property. Whether a company is eligible, and the number of properties it may acquire under this category, will depend upon the scope of the foreign company's operations and assets in Australia. Foreign companies would not be eligible under this category where the property would represent a significant proportion of its Australian assets.

New Dwellings Non-resident foreign persons need to apply to buy new dwellings in Australia. Such proposals are normally approved without conditions.

Vacant Land Non-resident foreign persons need to apply to buy vacant land for residential development. These proposals are normally approved subject to conditions (such as, that ongoing construction begins within 24 months).

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Temporary residents Established (second-hand) dwellings Temporary residents need to apply if they wish to buy an established dwelling. Temporary residents may acquire one established dwelling only and it must be used as their residence (home) in Australia. Such proposals normally meet with no foreign investment objections subject to conditions (such as, that the temporary resident sells the property when it ceases to be their residence). Temporary residents are not permitted to buy established dwellings as investment properties.

New dwellings A 'new dwelling' is a dwelling, which is being purchased directly from the developer and has not been previously occupied for more than 12 months in total. Temporary residents need to apply to buy new dwellings in Australia. Such proposals are normally approved without conditions.

Vacant land Temporary residents need to apply to buy vacant land for residential development. These applications are normally approved subject to conditions (such as, that ongoing construction begins within 24 months).

Policies Residential Real Estate for redevelopment All foreign non-residents are required to notify of any proposed acquisition of established dwellings for redevelopment (that is, to demolish the existing dwelling and build new dwellings). Proposals for redevelopment are normally approved subject to the following conditions: 



the existing residence, once purchased, cannot be rented out prior to demolition the existing dwelling must be demolished and continuous substantial construction of the new dwelling(s) must commence within 24 months.

Redevelopment, which does not include refurbishing an existing dwelling, can be done in the following two ways: 1.

Replace a habitable dwelling with multiple dwellings A redevelopment proposal is normally approved where an existing habitable dwelling is demolished and replaced with multiple dwellings (that is, more dwellings can be built than will be demolished)

2.


Replace a derelict or uninhabitable dwelling with a new one


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A redevelopment proposal is normally approved where it can be shown that the existing dwelling is at the end of its economic life (that is, derelict or uninhabitable) To demonstrate that the dwelling is derelict or uninhabitable, a valuation of the existing structure(s) by a licensed valuer and/or a builders report is required. Photographs and other forms of evidence, including council development approval, may also be required Once these conditions have been fulfilled, the new dwellings that have been constructed may be rented out, sold to Australian interests or other eligible purchasers, or retained for the foreign investor's own use.

Acquisitions by individual(s) Foreign persons are prohibited from acquiring established dwellings for investment purposes (that is, they cannot be purchased to be used as a rental or holiday property), irrespective of whether they are temporary residents in Australia or not. However temporary residents in Australia can apply to purchase one established dwelling to use as their residenc e in Australia. Approval is usually provided subject to a condition that the temporary resi dent sell the dwelling when it ceases to be their residence.

Acquisitions by companies Proposals by foreign-owned companies to acquire second-hand dwellings for the purpose of providing housing for their Australian-based staff are normally approved subject to the following condition: 

the company undertakes to sell or rent the property if it is expected to remain vacant for six months or more.

Vacant land Proposed acquisitions of vacant land for residential development-are normally approved subject to development condition(s) imposed under the FATA. Acquisitions of single blocks of vacant land (that is, land which is zoned to permit the construction of no more than one residential dwelling per block of land) for the purpose of building a single residential dwelling on each block are normally approved subject to the following condition: 

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continuous substantial construction must commence within 24 months.




Acquisitions of other vacant land (not single blocks) for the purpose of building multiple residential dwellings are normally approved subject to the following conditions: 



continuous substantial construction must commence within 24 months; and at least 50 per cent of the acquisition cost or the current market value of the land (whichever is higher) must be spent on development.

Once these conditions have been fulfilled, properties acquired under this category may be rented out, sold to Australian interests or other eligible purchasers, or retained for the foreign investor's own use.

New dwellings New dwellings acquired 'off the plan' (before constructi on commences or during the construction phase) or after const ruction is complete are normally approved where the dwellings: 

have not previously been sold (that is, they are purchased from the developer); and have not been occupied for more than 12 months.

There are no restrictions on the number of such dwellings in a new development which may be sold to foreign persons, provided that the developer markets the dwellings locally as well as overseas (that is, the dwellings cannot be marketed exclusively overseas). This category includes dwellings that are part of extensively refurbished buildings where the building's use has undergone a change from nonresidential (for example, office or warehouse) to residential. It does not include established residential real estate that has been refurbished or renovated. A property purchased under this category may be rented out, sold to Australian interests or other eligible purchasers, or retained for the foreign investor's own use. Once the property has been purchased, it is second-hand real estate and is subject to the restrictions applying to that category.

Residential Real Estate for redevelopment Established dwellings may be acquired for the purpose of redevelopment (that is, to demolish the existing dwelling and build new dwellings). This does not include refurbishing or renovating the existing dwelling. Proposals for redevelopment are normally approved subject to the following conditions: 




the proposal must provide for an increase in the housing stock, that is, an increase in the number of dwellings the existing residence cannot be rented out prior to demolition and redevelopment


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

the existing dwelling must be demolished and continuous substantial construction of the new dwellings must commence within 24 months.

A redevelopment proposal which does not increase the number of dwellings may be approved where it can be shown that the existing dwelling is at the end of its economic life (that is, derelict or uninhabitable), since constructing a new dwelling would effectively increase the housing stock. To demonstrate that the property is uninhabitable and must be demolished, a valuation of the existing structures by a licensed valuer and/or a builder's report is generally required. Photographs and other forms of evidence may also be required. Approval of such p roposals would be subject to the same conditions outlined above. Once these conditions have been fulfilled, the new dwellings that have been constructed may be rented out, sold to Australian interests or other eligible purchasers, or retained for the foreign investor's own use.

Advanced off-the-plan approval for developers Developers of 10 or more dwellings may have previously applied for advance approval to sell up to 50 per cent of new residences to foreign interests. If such pre-approval was granted, the developer is required to provide a copy of their pre-approval letter to each prospective purchaser and to report all sales (that is, Australian and foreign) to FIRB on a 12 monthly basis until all the dwellings in the development have been sold or occupied. As the administrative procedures are streamlined, the current system for developers seeking advance approval to sell new dwellings to foreign persons will be discontinued. Until further notice, the pre-approval arrangements that have been operating for some time will continue to operate on a case-by-case basis. Please contact FIRB for specific advice. All current pre-approvals remain valid. Where such approval has been granted, foreign purchasers should not apply for individual approval. If the developer has not been granted advance approval, then the individual investor must seek approval.

Who should apply? The FATA and the policy apply to certain acquisitions by foreign persons. A foreign person is defined as: 



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a natural person not ordinarily resident in Australia a corporation in which a natural person not ordinarily resident in Australia or a foreign corporation holds a substantial interest






a corporation in which two or more persons, each of whom is either a natural person not ordinarily resident in Australia or a foreign corporation, hold an aggregate substantial interest





the trustee of a trust estate in which a natural person not ordinarily resident in Australia or a foreign corporation holds a substantial interest the trustee of a trust estate in which two or more persons, each of whom is either a natural person not ordinarily resident in Australia or a foreign corporation, hold an aggregate substantial interest.

Application for Foreign Investment Review Board approval The board is unable to give ‘In Principle’ approval to persons wishing to acquire property, so an application for foreign investment approval must specify the particular property to be acquired. Most banks will give ‘Conditional Approval’ of the loan application prior to and subject to FIRB approval. Approval can take some time, so it is important to submit the application for FIRB approval as soon as possible. The real estate agent or developer is responsible for the FIRB submission.

Application to the lenders Loan application forms are to be completed in the same manner as for Australian residents. All details are required to be completed in full along with supporting documentation (see Section 8). Most banks will lend up to 70% LVR for non-r esidents. Mortgage Insurers will not insure these loans. The other lending criteria are the same for all borrowers. 



Most banks require that 100% of rent received from the property will be applied to loan repayment. Some banks require six months loan repayments to be deposited in trust prior to loan settlement.

Remember by doing your own research you leave little room for error.

Personal loans Personal loans are commonly sought by borrowers who are asset rich, income rich but cash flow poor. The uses for personal loan funds may vary. The approval turn-around time for personal loans is usually much shorter making them an attractive form of funding.



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Purpose of loan

1. 2. 3. 4. 5. 6.

Purchase motor vehicles Home Improvements Debt consolidation Holidays Household goods Other general domestic uses

NCCP coverage

As this loan is purely for personal purposes, it is covered under the National Consumer Credit Protection Act (NCCP) (i.e. it is a regulated loan.)

Security

These loans are usually unsecured, but the lender does have the option to use currently owned vehicles, caveats on properties etc. as security.

Term of loan

Up to seven years

Interest

The interest may be calculated as a variable rate or a fixed rate.

Repayments

Repayments can usually be made weekly, fortnightly or monthly.

Equipment finance overview Equipment and motor vehicle financing is one area that most finance brokers avoid as they feel the actual process of financing is too difficult. When in fact it is not and this area of financing can be very lucrative due to the high turnover and quick results. The leasing and equipment finance broker Industry has grown considerably large in some overseas countries and this has been driven by the fact that most large finance companies have reduced their own work forces and rely mostly on Finance Brokers for their business. One could say that the Australian commercial market has started to mirror that of the residential loan market, which is already seeing ever increasing housing mortgages being written by brokers. Lenders have relied more and more on brokers to inc rease their overall mortgage portfolio. However when there is a downturn in the property market due to economic circumstances, opportunities must arise for brokers to increase their income streams. If, as is mooted, lenders from time to time decide to limit any commissions paid, brokers have the opportunity to charge their clients a fee for service. Finance brokers entering the plant, equipment and motor vehicle area normally already have a very good client base that they previously serviced in the mortgage or other financial services areas and hence they are now realising that most of their clients either have business or personal equipment requirements. This type of funding enables businesses to access equipment, vehicles and technology that may not have been available through more traditional forms of finance. It allows them to spread their repayments to match their cash flows.

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Payments of brokerage can range from 1% to 8% or a dollar amount as set by you, but you must remember that this type of financing is very price sensitive and competitive. Brokers in this area of finance have the potential to earn excellent income and, if they service their clients properly, will have an excellent ongoing income stream. The advantage of Leasing/CHP business is the short waiting period to be paid, as most lenders pay the brokerage entitlement to introducers on the settlement of the transaction. The brokerage on a motor vehicle finance deal could well be in the vicinity of $1000 and that is a good return for the work involved as compared to mortgage loans when payment of commission usually takes place in the month following settlement. If a broker was active in the bigger ticket items suc h as Plant and Equipment, the potential brokerage earnings are far greater.

Examples Normal Motor Vehicle Brokerage is between Normal Plant & Equipment Brokerage is between

2.00 – 2.80% 2.50– 3.00%

Suggested earning from a motor vehicle loan Amount financed Term

$57500 4 years

Balloon Payment 40% Brokerage @ say 2.00%

$23000 $1150 (excluding GST)

Suggested earning from a plant & equipment loan Amount financed Term Balloon Payment Brokerage @ say 2.6%

$350000 5 years Nil $9100 (excluding GST)

The fact that most people seeking this type of financing have other financial needs will provide the Finance Broker with more opportunities. Lenders provide the required product and accreditation training along with the software to enable the Finance Broker to give quotes and lodge the deal electronically. It is currently not a requirement for general finance brokers to be licensed outside of WA; however, it will no doubt be looked at in the current national regulation process being undertaken. Car yards in Australia still do not need to be licenced to offer finance. Lenders will be more open to accepting writers that have undertaken some form of accreditation training. As we know it is not in anybody’s interest for the Finance Broker to waste the client’s time or the lenders time by submitting deals that do not fit the criteria required by the lender.



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Typical client profile - equipment finance One tends to think that only companies require equipment financing when in fact clients can be an individuals, Sole Traders, Partnerships or Public or Private Companies. As we know in selling, it is always dangerous to make assumptions. Lenders normally require the clients, if self-empl oyed, to have been operating their business for a minimum of two years. They are not averse to reviewing this requirement if the story and evidence presented is strong enough to allow a waiver to their lending criteria. Clients applying for the finance are also required to have a good credit history, trade references and Credit Reference Reports. Here again there are new lenders that will approve finance to clients that have an adverse Credit History as long as the full facts are known. Normally these types of approvals have an extra risk margin in the charged interest rate. If the applicant is a company, Directors are required to guarantee the loan. They should normally have asset backing, such as real estate or the financier will consider on a case by case basis and may require a deposit of up to 20% before they will approve the balance for the purchase. An individual or sole trader applicant may, in the opinion of the lender also require a guarantor. To prove serviceability borrowers are required to provide the last two years’ financial statements along with company and personal tax returns. You will find most lenders provide a calculator, which will demonstrate that the client meets their lending requirements. Low documentation loans are now also becoming available through some lenders.

Assets that can be financed - equipment finance There is quite an extensive list of assets that can be financed but remember that clients do not actually have to mortgage their house when seeking this type of finance. The financier normally relies on the guarantees signed and the security taken over the assets being purchased. Typical assets that can be financed are as follows:

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Aircraft



Boats (commercial and pleasure)



Commercial vehicles, trucks, trailers, boats



Earth moving and agricultural machinery



Engineering equipment



Fishing licences (cray boats)



General business equipment



Medical and dental equipment



Motor vehicles and motor cycles



Office equipment (computers, hardware, printers, copiers etc.).




You must also be aware that caution is required in financing or seeking finance for the following, and reasons why. 





Specialised equipment—the lender must consider resale in the event of a default. Specialised Equipment can be described as equipment built for a special purpose, for example mining equipment. Sale and lease back transactions—this can be a way of capital raising for the company. Fixtures and fittings—shop or restaurant fit out. As you can imagine a lender would have great difficulty in selling the second-hand equipment and if used as security for a loan via a ‘fire sale’ would be lucky to produce 25% of its true value. In addition, you can imagine the cost of the labour and other material used to install these fixtures and fittings would not be recoverable.



Furniture is another asset purchase that loses its value very quickly once installed and no doubt we have all been along to those closing down sales that produce great bargains for the purchaser but not the seller.



Clients who rent their business premises are normally asked to obtain a Landlord’s Waiver or Right of Entry Agreement in order for a lender to take possession of the goods/chattels that are fixed, in the event of default by the borrower. Alternatively you may have a truck with a crane attached and the two items are financed by two different lenders. This can create problems.

The location where the equipment will be situated needs to be taken into account as the lender will also need to consider this in the approval process. It is fair to assume that equipment l ocated in isolated areas will incur extra costs in the recovery process. Valuers are also faced with this issue when placing a value on the asset. The lender will record its interest over the asset on a register noting the engine, serial, registration numbers and the VIN to assist with the identification of the asset. This in formation can also be obtained from the Register of Encumbered Vehicles (REVS), which is maintained by each state’s respective DOCEP government department.

Asset inspection and valuation - equipment finance Lenders will require the Broker to inspect the goods and complete an inspection report particularly if the Supplier is not known to the Lender i.e. not a recognised Supplier or the transaction is classified as a private sale or as part of the Lenders policy. The Broker will need to complete and sign an inspection form that will include verifying such details as serial number, chassis number, registration number etc.



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Other Lender policies such as amount of borrowing may require the Broker to obtain an inspection and valuation from the Lender’s preferred Valuer. This is an important aspect of equipment financing as frauds can evolve through the lack of due diligence. It is important that the correct item is being offered as security and that the goods do actually exist.

Suite of equipment finance products The following types of loans are loosely termed Commercial Lending. In the past only a very small number of broking companies were involved in this type of lending. Today, there are more brokers being accredited to market commercial loans. Some of the lending institutions are requiring two years’ experience for some of the commercial lending areas. Loan types generally classified as commercial include:

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

Chattel Mortgage



Chattel Mortgage - Consumer



Financial lease



Novated lease



Operating lease

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Rental finance



Debtor financing / Factoring



Commercial property/industrial finance

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Residential business loans




Commercial Hire Purchase Preamble

Commercial Hire Purchase (CHP) has the same principle as leasing except the customer can claim the allowable depreciation on the goods financed as a tax deduction. This is distinct from leasing where the lessor (owner) claims the depreciation tax deduction. You will need the clients to seek accounting advice as to what is the best option for his business. If disposal occurs midterm it may have capital gain tax ramifications.

Ownership

At the date of the final payment of the loan title transfers to the hirer.

Potential clients

This form of finance is generally suitable for business owners or individuals who use the accrual method of accounting for GST. A sales representative who uses his car for business would find this beneficial.

Possible tax benefits and implications

Interest paid and depreciation may be claimed as a business tax deduction provided the goods are used to earn an assessable income. Where there is a balloon payment there are no tax guidelines. It may be written as a nil amount. If the asset is sold at a higher value than the balloon payment Capital Gains tax may apply. GST may be claimed upfront if the borrower is on an ‘accrual basis’ GST may be claimed over the term if the borrower is on a ‘cash basis’ If balloon payments are factored into the midterm of the contract professional tax accounting advice should be sought.

Payments

Payments of principal and interest remain constant over the term of the loan. A balloon payment can be structured into the loan to reduce the payments, which assists the cash flow of the business. The goods may be refinanced for a further term. Loan terms are generally between one and five years. Structured payments are available for those clients that have a seasonal income (rural and fishing industries)


Security

A charge is taken as security over the goods being financed.

Amount financed

The amount of the loan can be 100% of the security or a lessor amount if a deposit or trade in is involved.

NCCPA

As this loan is purely for business purposes, it is not covered under the National Consumer Credit Protection Act (NCCPA) (i.e. it is a non-regulated loan).

Early Payouts/ Extra Payments

Early payouts will incur break costs. Refer to your Lender regarding extra payments.

Interest

Fixed rate (i.e. it remains constant, along with the repayment amount, for the term of the loan.


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Commercial Hire Purchase

Escrow

–

This facility provides interim finance to allow progress payments, made by the lender on behalf of the borrower, on equipment being constructed or installed over a period of months. The lender makes the progress payments upon receipt of authorisation from the hirer. Once the hirer confirms that the equipment is constructed or installed satisfactorily, a standard hire purchase agreement can be entered into with the lender.

Chattel Mortgage Preamble

There is really no difference between a Commercial Hire Purchase and a Chattel Mortgage other than ownership.

Ownership

The borrower owns the goods/vehicle under a chattel mortgage.

Potential clients Possible tax benefits and implications

This is a flexible product that suits businesses that use the ‘cash’ method of accounting for GST. The interest component of the loan and depreciation may be claimed as deductions provided the goods are used for earning an assessable income. The upfront ownership allows the client an ABN holder on a ‘cash’ arrangement can obtain a full input tax credit for the GST paid on the purchase price of the goods. Because of the upfront GST claim this product has become popular. Balloon payments are allowable but clients should seek accounting advice on the GST implications.

Payments

Fixed interest and principal payments apply for the term of the loan. Clients can choose a loan term of between one and five years. The GST refund can be paid off the loan to reduce the loan balance and therefore the interest commitment. Repayments can be in advance or in arrears.

Security

The lender takes a mortgage or charge over the goods financed.

Amount financed The amount of the loan can be 100% of the security or a lesser amount if a deposit or trade in is involved.

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NCCPA




Interest





Finance Lease A Financial Lease is a contract for business purposes whereby the lessee (borrower) has the use of the equipment for an agreed period of time whilst making lease payments to the lessor (financier).

Finance Lease Purpose of loan

Lease business equipment including motor vehicles, trucks, plant equipment and smaller items. The equipment is purchased by the lender and then leased to the business.

NCCPA coverage


Security

This contract gives the lender security by means of an encumbrance on the goods purchased. If the client defaults on the contract, the lender is entitled to sell the goods to regain the money still owing to them. The borrower would still be liable for any shortfall. The lender is the owner of the goods.

Term of loan

Usually one to five years.

Interest


Lease payments

Repayments are usually made monthly.

Finance options

Leasing may be financed with a residual balance at the end of the term. This is calculated as a percentage of the purchase price. The amount of the residual will generally stay within the Taxation Guidelines.

General tax implications

The borrower may claim tax deductions from having a lease. The borrower would claim the lease payments as an expense. These amounts will depend on the ratio of business use to private use.



Ownership

The lessor is the owner of the goods. The lessee pays for the use of the goods by manual regular monthly payments. The ownership transfers once the residual / balloon payment has been made at the end of the lease.

Amount financed

The lease amount is for 100% of the value of the goods. No deposit or trade in can be taken into account.

Residuals: The table below gives an indication of the residual values allowable by the Taxation department. It shows the decline in the value as the term of the lease lengthens. These values are determined at the commencement of the contract. You will note that there are different percentages allowed depending on the kilometres travelled per annum. Please note below figures are for training purposes only and not to be used for taxation advice.



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Term

Sales Reps. Travelling more than 30,000 km per annum Residual value range

Sales Reps. Travelling less than 30,000 km per annum Residual value range

12 months

50% - 60%

60% - 70%

24 months

40% - 50%

50% - 60%

36 months

30% - 40%

45% - 50%

48 months

20% - 25%

35% - 45%

60 months

15% - 20%

25% - 35%

Lease

Escrow

–

This facility is funded and managed in the same manner as commercial hire purchase – Escrow as described previously.

Novated Lease This type of lease is a three way lease. This is generally between lender, employer and employee. The employee signs a lease agreement with a financier, and then sub leases the goods to the employer. They then sign a ‘Deed of Novation’ so that the employer makes the commitment to pay the lease payments while the employee is employed. If for any reason the employee is no longer employed by this employer, the Deed of Novation becomes null and void. The employee then becomes liable for the lease payments. A “fully maintained” Novated lease covers ALL of the costs associated with the item i.e. Maintenance operating costs such as petrol, tyres, registration, RAC/NRMA, insurances etc. in the case of cars and all costs of maintaining other items such as computers and office equipment.

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Novated lease (motor vehicles only) Purpose of loan

Lease motor vehicles.

NCCPA coverage


Security

This contract gives the lender security by means of an encumbrance on the goods purchased. The contract is written in the name of the employee. If the client defaults on the contract, the lender is entitled to sell the goods to regain the money still owing. The borrower would still be liable for any shortfall. The lender is the owner of the goods.

Term of loan

Usually one to five years.

Interest

Fixed rate (i.e. it remains constant, along with the repayment amount, for the term of the loan).

Lease payments

Payments are usually made monthly.

Finance options

Leasing may be financed with a residual balance at the end of the term. This is calculated as a percentage of the purchase price. The amount of the residual will generally stay within the Taxation Guidelines (see table under Financial lease).


The borrower may claim tax deductions from having a lease. The borrower would claim the lease payments as an expense. These amounts will depend on the ratio of business use to private use.

Ownership

The lender (lessor) owns the motor vehicle. The employer is the payee. The employee is the lessee.

Potential clients

Employees who are seeking an alternative, beneficial way of financing a motor vehicle.

Benefits to the employee

Payments can be structured to suit the client’s individual needs, with your budget and cash flow taken into consideration. With fixed rentals the lessee is protected against market fluctuations. Tax effective as payments are made from pre-tax earnings. Can be portable should the client change employers.

Benefits to the employer

If the employee leaves the company, the car is no longer the employer’s responsibility. Payments can be made easily via direct debit. Can claim on tax deduction for the lease rentals.



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Chattel Mortgage - Consumer A consumer chattel mortgage is similar to a hire purchase, but is designed for funding items for personal use. They are used most commonly for purchasing motor vehicles

Chattel Mortgage - Consumer Purpose of loan

Purchase of goods for personal use. These may include motor vehicles, motorcycles, registered boats, caravans etc.

NCCPA coverage

As this loan is purely for personal purposes, it is covered under the National Consumer Credit Protection Act (NCCPA) (i.e. it is a regulated loan.)

Security

The contract for this type of loan is a mortgage over the goods purchased. The document signed by the borrower gives the lender security by means of an encumbrance on the purchased goods. If the client defaults on the contract the lender is entitled to sell the goods to regain the money still owing. The borrower is liable for any shortfall. In most cases the item being used for security will need to be registered to enable a mortgage to be taken.

Term of loan

Up to seven years

Interest

Calculated on the daily outstanding balance. • Fixed rate (i.e. it remains constant, along with the repayment amount, for the term of the loan. • Variable rate.

Repayments

Repayments can usually be made weekly, fortnightly or monthly.

Finance options

Consumer Mortgage may be financed in the following ways: • Balloon payment at the end of the contract period (the amount of the balloon payment – usually a percentage of the amount financed – will depend on the term of the loan, the age and the type of goods financed). • Fully amortised – i.e. paid out in full via equal monthly repayments over a specific period.

Early payout

There is usually an early termination charge for a fixed term contract that is paid out early, but not for the variable rate product.

Operating Lease The Operating Lease is a fully maintained lease generally including all servicing items and running costs of the goods during the lease term. Ownership of risk transfers to the lender along with the benefits of the ownership and this also allows you to reduce your costs by not having to purchase the fleet / equipment upfront. It also allows you to build in the maintenance costs and spread them over the period of the lease term. The most common example of this is Fleet Management Companies such as Easifleet and companies that lease photocopiers or fax machines where there is a maintenance component in the contract.

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Operating Lease Purpose of loan

Lease business equipment including motor vehicles, trucks, plant equipment and smaller items. The equipment is purchased by the lender and then leased to the business.

NCCPA coverage


Security

This contract gives the lender security by means of an encumbrance on the goods purchased. If the client defaults on the contract, the lender is entitled to sell the goods to regain the money still owing to them. The borrower would still be liable for any shortfall. The lender is the owner of the goods.

Term of loan

Generally 24 – 36 months. Most Operating Leases will have a limitation to the number of kilometres allowed to be travelled (in motor vehicle leasing cases) or photocopies to be made, etc.

Interest


Lease payments

Payments are usually to be made monthly.

Finance options

Leasing may be financed with a residual balance at the end of the term. This is calculated as a percentage of the purchase price. The amount of the residual will generally stay within the Taxation Guidelines.


The borrower may claim tax deductions from having a lease. The borrower would claim the repayment as an expense. These amounts will depend on the ratio of business use to private use.

Benefits

These leases are only available through businesses. The benefits to the business include: • Working capital remains free • Tax implications as above • No unexpected servicing/maintenance costs • Ability to upgrade machines at the conclusion of the lease • No risk of resale value of the equipment.

Rental Finance Rental Finance operates in a similar way to Leasing but the renting company retains ownership of the equipment. When capital expenditure is not a business advantage or equipment is quickly outdated rental finance / lease may be suitable. The lender retains full ownership of the goods / equipment and they are returned at the end of the rental period or new terms negoti ated.



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Rental Finance Purpose of loan

Examples of rental purposes can include: • Installation of security systems • Renting office equipment/computers.

NCCPA coverage


Security

This contract gives the rental company security by means of ownership of the goods. If the client defaults on the contract, the renter is entitled to retrieve the goods and to collect the rental money still owing. The borrower would still be liable for any shortfall.

Term of loan

Generally 24 – 36 months.

Interest


Rental payments

Payments are usually to be made monthly.

Finance options

There are generally three options at the end of the rental period. These are: • Return the goods to the renter • Re-write the rental agreement with new goods • Purchase the current rental goods.


The borrower may claim a tax deduction by claiming the rental payments as an expense.

Debtor Finance/Factoring Debtor Finance is a short term finance facility available to all businesses with debtors who have sufficient credit standing to interest a third party, such as a finance company, in the purchase and collection of debts owed to the business, usually with recourse to the business if the debts remain unpaid (costs vary from between 3 –6% of the value of invoices purchased and there could also be an establishment fee. Fees are a one off cost paid at the time the factor financier purchases the invoices. The borrower assumes the bad risk and there can be an agreed additional cost. Funds are injected by use of this facility into the working capital of the business, thereby improving cash flow, and the administrative time taken in following up for payment is reduced. The facility operates through the sale by the business at a discount of the obligations of its debtors to a third party, known as the factor who assumes the responsibility for the collection of debt. The amount of discount is usually charged according to an agreed sc hedule, which is often calculated at a rate slightly higher than the overdraft rate, but this will vary with the size of the debts and the credit rating of the debtors.

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Some benefits of factoring are: 

Cash is usually made available within two working days and saves administrative costs.

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Ability to increase sales and profits without the need for extra capital to finance it. Cash to invest in appreciating assets instead of non-productive money tied up in debtors. Cash available to take advantage of bulk buying opportunities or favourable terms for early payment. Cash available for contingencies. Debtor Finance eliminates the need to offer customers discounts and incentives for prompt payment of accounts. Debtor Finance is not a loan therefore fixed assets used to support Bank loans and facilities are not affected.

Equipment finance - specialist areas Marine finance Commercial Lenders provide funding facilities for companies/sole traders for trawlers, recreational cruisers and fishing vessels. This is a specialised area and education and product knowledge is highly essential to enter this area of finance.

Retail Boat dealers are a good source of business and cater for those people seeking pleasure craft/yachts for personal use. These types of loans can be financed by way of leasing, commercial hire purchase or chattel mortgage.

Aircraft finance There are a limited number of lenders providing funding facilities for financing aircraft. As with marine finance, this is a specialised area where funds are available for a small single engine aircraft through to helicopters and jet aircraft. Loan arrangements can be made for single owner operators or companies with a large fleet of aircraft. It is normal for lenders t o seek a 30% deposit for this type of funding. However, this will be dependant on the financial strength of the client.



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Equipment finance – other product features Structured quote A structured quote is anything that is outside a standard monthly instalment. You are now able to generate quotes on quarterly, semiannual and yearly payment structures. You also have the ability to load one-off lump sum payments into the contracts payment schedule. There are now two options available: 1. You can load in a specific amount to be paid off the contract during the term 2. You can specify a month where the GST will be paid back into the contract. Please note: these new quoting structures are only available on CHP and Chattel Mortgage deals. If a structured quote is required for a Lease please contact the lenders Business Support area.

Revolving or bulk limit Having this facility approved allows the clients to draw funds for financing of goods up to the approved lenders limit. A revolving limit allows the client to re-draw funds that have been repaid, up to the current approved lenders limit. These limits are reviewed on an annual basis. Please note that the equipment being finances still needs to be approved by the lender.

Sale and lease back facilities Commercial leasing lenders will offer sale and lease back (or hire purchase back) facilities on many types of assets. This type of funding allows a lender to acquire the existing assets and lease them back to t he client with the benefits of a new lease, provided however they have been purchased within the last three months (maximum). The client must show the lender evidence of being able to satisfactorily service the agreement and have acceptable asset backing.

Cross border leasing This type of lease is for deals of USD $10 Million+ and is used to fund large deals either nationally or internationally and no doubt would not be part of the everyday finance brokers’ portfolio, but we have inserted this in the notes to make you aware that the facility is available.

Infrastructure and asset leasing This type of finance enables expensive infrastructure establishment to be funded that frees up the cash flow of the cor porate or government entities.

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Such areas that require this type of funding are: 

Aviation

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High-tech sector

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Public utilities—water, sewerage, electricity and gas.

Motor vehicle fleets This type of funding allows the corporate sector or governments to free up their cash flows and spread the cost of maintenance over the life of the lease. The fleet managers manage the vehicles on the client’s behalf. Normally this type of financing is looked at by the lender when there are five or more cars with the fleet.

Low doc financing - commercial and equipment finance Low doc loans may be arranged for business clients seeking funding for purchases from say, $3000 to $25000. At times up to $50000 may be available but this is solely dependent on the strength of the client. This means of course that no financial statements need to be produced, but lenders are very strict on the credibility and serviceability of the clients. In turn the lender will charge a higher than normal rate to offset the potential risk involved in this area of lending. The lenders’ requirements would normally be: •

the joint and several guarantees of the Directors

•

a statement of the Directors personal financial position

•

a minimum of two years in the current business

•

a clear report from a credit agency

•

previous/current loan statements showing good conduct

•

trade references.

Commercial property lending overview Commercial Property Lending is where the security is held over property zoned commercial i.e. shops, shopping centres, factories, offices and office buildings, warehouses, etc. Most banks will also treat most development projects such as land subdivisions and residential developments such as blocks of strata units or blocks of flats as commercial property. The usual rule is that if there are more than four units in the development then it is treated as commercial property.



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The usual maximum LVR for commercial property lending is between 60% to 70% depending on the financial strength and experience of the borrower. Most commercial developments need to indicate their future viability by means such as presale of a percentage of the units in unit developments or presale of blocks of land in land developments. In factory or office developments they may have to show evidence of pre-construction lease agreements of prospective tenants to obtain finance approval. Not all lenders allow brokers to submit commercial property loans as it is a specialised field and they prefer to handle these matters in-house. As Commercial Lending requires more expertise in many areas including reading and understanding financials, we have developed a course to further your education and knowledge in this area. Please ask your facilitator or visit our website at www.aamctraining.edu.au for more information.

Deposit bonds What are deposit bonds? Deposit bonds are a financial guarantee in the form of a bond that allows an upfront deposit to be made on the purchase of a property without having to use existing funds/cash. Your client may not wish to outlay cash if funds are tied up in an existing property already or in other investments.

Why use a deposit bond? A deposit bond may act as a short term alternative to cashing in existing investments or applying for bridging finance when a deposit is required. A once-only fee is payable

How is a deposit bond obtained? Deposit bonds may be arranged by phone and issued within 24 to 48 hours, subject to normal terms and conditions. The client’s existing funds remain untouched with nothing more to pay until the settlement date arrives. They are an alternative sometimes preferred by some buyers.

Who can apply for a bond? Any purchaser of a property may apply for a deposit bond including: 

existing property owners who wish to purchase property

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investors who wish to expand their property portfolio

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first home buyers

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commercial property purchasers.

Bonds cannot be issued for savings plans, rent to buy plans, private or solicitor finance, and some off-the-plan purchases. Special conditions do apply.

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Can the bond be used at auctions? Auctions require a deposit to be organised before bidding. A deposit bond could be used to give flexibility to bid on a property without a cash deposit. A bond could be issued prior to the auction sale. The maximum bond amount is fixed but the property details are not fixed so it is possible for the potential purchaser to attend a number of auctions. The method is to complete the vendor and property details once the successful purchase is arranged.

Are vendors willing to accept the bond? The vendor will usually be anxious to sell their property as soon as possible and secure a deposit from the purchaser. The bond can be organised within 24 to 48 hours and coupled with the security provided under the bond by the Insurance Company, it will give comfort to the vendor enabling contracts to be signed, and the property sold. Bonds are available throughout Australia and are readily accepted by vendors; however it is at the vendor’s discretion whether to accept the bond. Recommendation: If your client is not purchasing property in NSW then a solicitor or agent should be used to ensure the special condition on the reverse of the Bond is inserted in, or annexed to the Contract of Sale, to amend the deposit provisions. In NSW, the standard 1996 contract includes provision for use of a Deposit Bond.

Does a deposit still have to be paid at settlement? The bond simply acts as a substitute for the deposit stated in the Contract of Sale, enabling the purchase of the property to be carried out more quickly than otherwise possible. It does not remove obligation to pay a deposit to the vendor on the contract settlement date.

What happens if there is a default under the Contract of Sale? If there is a default under the Contract of Sale the vendor can claim the bond amount from the Insurance Company. Once the deposit has been paid to the vendor, the Insurance Company will then recover the deposit amount from the person who defaulted.

Why is an indemnity signed before the bond can be issued? The indemnity is the legally binding right given to the Insurance Company by the client, to recover any part of the bond amount paid to the vendor if there is a default under the contract.

When does the bond terminate? The bond terminates when the Contract of Sale is completed, terminated or rescinded.



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Can a refund be obtained if the bond is not used? If the unused original bond is returned within 30 days of issue then the fee will be partially refunded. There is typically an administration charge of approximately $220 deducted then a cheque for the balance is mailed to the client.

Applicant approval guidelines 

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Every applicant must be able to demonstrate a minimum of five (5) times the Deposit Bond value in approved equity. Special conditions apply for First Home Buyers whereby only two (2) times cover needs to be demonstrated. Only approved assets may be used to assess the five (5) times equity rule.

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Applicants must be able to clearly demonstrate their ability to settle the purchase. Applicants must be able to clearly demonstrate satisfactory income to support all existing and future borrowings.

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Every applicant must have a clear credit history.




Section 2

Loan characteristics Learning outcomes Upon completion of this section you will be able to: 

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identify various types of mortgage loans and the similarities and differences between them understand and apply the generic loan fundamentals analyse the loan requirement of your client and apply this knowledge to the choice of mortgage loan product

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understand the working of loan serviceability

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understand the basics of negative gearing

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have knowledge of the peripheral products offered by lending institutions.

Core lending products There are many different types of mortgage loans in the market. The lenders have different policies and guidelines for the individual products and they often vary from lender to lender. Finance/Mortgage Brokers will be constantly questioned on the terms and conditions of the various Bank products and it is extremely important for the broker to be up to date with product specifications. Brokers should also be advised that the banks change their product specifications often. If you are using prescribed software from your aggregator or franchisee, or if you lease a system, the changes should be managed by the IT departments. However the lender will notify the broker by regular bulletins and it is extremely important that you allow time in your schedule to absorb the changes. Many of the lenders also run up-date sessions or in conjunction with your aggregator or franchisee. It is important to attend as many as you can to keep yourself up to date with the changes. The BDM’s for the lenders also give you excellent assistance if you are in doubt as to a product specification and how to structure loans to give you the best chance of a successful submission. If in doubt, always check before submitting the loan. The following are outlines of the three core products currently in the market.



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Standard variable rate As the name implies this product caters for the clients wanting a loan that has a variable interest rate. This means that the interest rate fluctuates with changing market conditions. As outlined previously, this is determined by the economic climate and is administered by the individual lenders. This product’s rate may move when the Reserve Bank of Australia (RBA) makes interest rate adjustments. Although this change in official cash rates may happen, any changes are at the lenders discretion. All other variable rate products may then be adjusted accordingly. Standard variable rate home loans are the most common home loans in the market. There are slight variations to the basic standard variable home loan such as ‘honeymoon rate’ loans. These will be discussed further in this section. When taking out a standard variable rate loan, the borrower takes on the risk that the rates may increase or to their benefit, may fall. Back in the 90’s interest rates soared to around 18% which forced many people to sell their properties as they could not afford the repayments. Standard variable home loans can be either regulated or unregul ated under the NCCP depending on the purpos e of the loan. As we have learned in the earlier sections, if the loan funds are being used for the purchase of property predominantly for personal or domestic use or residential real estate investment and improvement, it is covered by the NCCP making it a loan. If a residential real estate property is being used a security to provide funding predominantly for business/investment purposes (residential real estate excluded), it is not covered under the NCCP and is deemed an unregulated loan. Let us have a look at the loan types available: Regulated *95% LVR

Unregulated 90% LVR

P&I

Honeymoon Rate Loan Basic No Frills Loan Standard Variable Loan

I/O


P&I


I/O


*Please ensure you check the LVR r equirement with the individual lenders.

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Loan purpose

SVR loans can be used for personal or investment purposes. These may include: • purchase residential owner/occupier property • purchase residential investment property • purchase vacant land • construct a residential home • purchase motor vehicle • purchase shares for personal investment • holiday • other personal requirements

Loan amounts

These are subject to the individual lender’s discretion, but usually the minimum amount would be $10,000 with no maximum amount The maximum is dependent on the borrower’s ability to repay and the LVR.

Term

Up to 30 years, more commonly 25 years.

Repayments

The repayments are usually calculated as principal and interest repayments and can be paid weekly, fortnightly or monthly.

Extra repayments

Usually allowed without penalty.

Early payout fees

There is usually no penalty for paying out a SVR loan.

Redraw facility

Generally available – some lenders will charge a fee.

Fees

Usual fees paid on a SVR contract may include: • Loan establishment fee • Government required fees such as stamp duty (Depending on State), title search and registration of mortgage document • Valuation fees • Progress inspection fees (construction) • Ongoing loan maintenance fees.

Security

Registered first or second mortgage over a residential property.

LVR

Regulated – 95% Unregulated – 90%

LMI requirements

Lender’s mortgage insurance is required for loans above 80% LVR.

This information is general and the individual lender criteria should be consulted for each loan application. Let us now have a look at the options available for the SVR loans.



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Basic variable rate loan As the name implies, this type of loan has most of the characteristics of the standard variable rate loan, but is offered by some lenders as a budget or economy style loan. The main feature of this loan type is the reduced interest rate. This loan is often referred to as a ‘no frills’ or basic loan. In some cases, there is no ongoing fee per month (please check with the individual lending institutions). There are fewer features than those applicable to the SVR products. There is usually no redraw facility. Loan purpose

Basic variable rate loans can be used for personal or investment purposes. These may include: • purchase residential owner/occupier property • purchase residential investment property • purchase vacant land • construct a residential home • purchase motor vehicle • purchase shares for personal investment • holiday • other personal requirements

Loan amounts

These are subject to the individual lender’s discretion, but usually the minimum amount would be $10,000 with no maximum amount The maximum is dependent on the borrower’s ability to repay and the LVR.

Term


Repayments


Extra repayments


Early payout fees

There is usually no penalty for paying out a Basic variable rate loan.

Redraw facility

Generally not available.

Fees

Usual fees paid on a Basic variable rate contract may include: • Loan establishment fee • Government required fees such as stamp duty, (depending on State) title search and registration of mortgage document • Valuation fees • Progress inspection fees (construction) • Ongoing loan maintenance fees

Security


LVR


LMI requirements

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Introductory/honeymoon rate loan Lenders often offer teaser rates to encourage borrowers to use their funds. These loans operate the same as the standard variable loans but they have a period in the beginning of the loan where the interest rate is lower than the standard rate. This is usually somewhere around 1% lower for a period usually no longer than 12 months. One specific area to note is that some lenders will impose payout penalties if the loan is paid out within the first three years. Loan purpose

Introductory/Honeymoon rate loans can be used for personal or investment purposes. These may include: • purchase residential owner/occupier property • purchase residential investment property • purchase vacant land • construct a residential home • purchase motor vehicle • purchase shares for personal investment • holiday • other personal requirements

Loan amounts

These are subject to the individual lender discretion, but usually the minimum amount would be $10,000 with no maximum amount The maximum is dependent on the borrower’s ability to repay and the LVR.

Term


Repayments


Extra repayments


Early payout fees

Allowed, some lenders will charge a fee i.e. 30 days interest penalty based on the current SVR and original amount financed. A sliding scale bases, percentage of the loan amount.

Fees

Usual fees paid on an Introductory/Honeymoon rate loans contract may include: • Loan establishment fee • Government required fees such as stamp duty, (depending on State) title search and registration of mortgage document • Valuation fees • Progress inspection fees (construction) • Ongoing loan maintenance fees.

Security


LVR


LMI requirements




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Fixed rate loan As the name implies these loans have the interest rate fixed for a certain term and therefore the repayments remain constant. This loan is available for the borrower who wants certainty in their interest rate and repayments for a certain period of time, thus protecting themselves from any increase in rate. These loans can usually be fixed for somewhere between one and five years although there are products available for seven and 10 years. At the end of this fixed period, the lender will renegotiate another fixed period at their discretion and at the current l ending rates. If the borrower wishes, they can at this stage, convert the loan to a variable rate. Lenders have made some changes recently where clients can change and increase their payments, but not to exceed $5,000 in any one year (check individual Lenders’ policies). Loan purpose

Fixed rate loans can be used for personal or investment purposes. These may include: • purchase residential owner/occupier property • purchase residential investment property • purchase vacant land • construct a residential home • purchase motor vehicle • purchase shares for personal investment • holiday • other personal requirements.

Loan amounts These are subject to the individual lenders discretion, but usually the minimum amount would be $10,000 with no maximum amount The maximum is dependent on the borrower’s ability to repay and the LVR.

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Term

Fixed period from one to five years. Longer periods are available from some lenders. Including this period, the total period of the loan can be written up to 30 years, more commonly 25 years.

Repayments

The repayments are usually calculated as principal and interest repayments and can be paid weekly, fortnightly or monthly. It is quite common to have interest only payments available in particular for investment borrowing.

Extra repayments

Some lenders will allow up to a specific amount of extra repayments per annum.

Redraw

Some lenders will allow but will charge a fee.

Early payout fees

There will usually be a fee charged for early termination of a fixed rate contract.

Fees

Usual fees paid on a fixed rate loan contract may include: • Loan establishment fee • Government required fees such as stamp duty, (depending on State) title search and registration of mortgage document • Valuation fees • Progress inspection fees (construction) • Ongoing loan maintenance fees

Security


LVR


LMI requirements





In many cases borrowers, because of interest rate fluctuations, choose to operate split facilities (part of the loan amount fixed rate and/or, part of the loan amount variable rate and/or part of the loan amount, line of credit) to reduce the impact should this type of situation occur with increased interest rates.

Line of credit This type of loan is basically an overdraft using the home as security. A limit is set (this is determined by the value of the property and the ability for the borrower to repay) and the borrower may then deposit and withdraw from this account staying within the limit. The interest is calculated on the daily outstanding balance and is debited monthly to the account. The minimum repayment on the account must therefore be the interest charged. The account is usually operated in a way that the borrower deposits wages (income) to the account and then uses a credit card (up to 55 day interest free) for the monthly purchases. One withdrawal is then made to pay off the credit card. This keeps the l oan account balance as low as possible for the month, and therefore the interest that has been calculated throughout the month is on the reduced balance. The sequence then starts again for the following month. Loan purpose

Line of credit loans can be used for personal or investment purposes. These may include: • purchase residential owner/occupier property • purchase residential investment property • purchase vacant land • construct a residential home • purchase motor vehicle • purchase shares for personal investment • holiday • other personal requirements.

Loan amounts

These are subject to the individual lender’s discretion, but usually the minimum amount would be $20,000 with no maximum amount. The maximum is dependent on the borrower’s ability to repay and the LVR.

Term

Evergreen or commonly 25 years.

Repayments

Repayments on a line of credit can be interest only or principal reductions. Payments can be made at any time.

Early payout fees

Normally no – check with lender.

Fees

Usual fees paid on a line of credit loan contract may include: • Loan establishment fee • Government required fees such as stamp duty, (depending on State) title search and registration of mortgage document • Valuation fees • Ongoing loan maintenance fees – usually $8–$15 per month. Some lenders will charge annually or six monthly.

Security


LVR


LMI requirements Lender’s mortgage insurance is required for loans above 80% LVR.



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Amortising line of credit These loans operate in the same manner as an Equity Line of Credit with one main difference. The Equity Line of Credit requires a minimum monthly payment of interest only whereas the amortising Lines of Credit require a minimum monthly payment equalling that of principal and interest. This means that if the loan is written over a term of 25 years, then the calculated principal and interest repayments for this term would apply. The borrower may however pay in excess of this and redraw on the account only up to the limit now determined by these principal and Interest (P&I) repayments. Loan purpose

Line of credit loans can be used for personal or investment purposes. These may include: • purchase residential owner/occupier property • purchase residential investment property • purchase vacant land • construct a residential home • purchase motor vehicle • purchase shares for personal investment • holiday • other personal requirements.

Loan amounts

These are subject to the individual lenders discretion, but usually the minimum amount would be $20,000 with no maximum amount. The maximum is dependent on the borrower’s ability to repay and the LVR.

Term


Repayments

Repayments on a line of credit can be interest only or principal and interest. Payments can be made at any time.

Early payout fees

Normally no – check with lender.

Fees

Usual fees paid on a line of credit loan contract may include: • Loan establishment fee • Government required fees such as stamp duty, (depending on State) title search and registration of mortgage document • Valuation fees • Ongoing loan maintenance fees – usually $8 - $15 per month. Some lenders will charge annually or six monthly.

Security


LVR


LMI requirements

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Construction loans Most lenders will finance properties under construction for owner occupied or investment purposes. Construction loans may be a little more complex than the standard residential purchase as they require funding progressively. The lender will make payments to the builder at various stages of construction. Lenders will generally require borrowers to use any type of variable rate loan product until the construction has been completed. At this stage the borrower can switch to a fixed rate or line of credit type product. This may incur a switching fee. This should be checked prior to the application being lodged. Clients usually purchase a block of land before entering into an agreement with a registered builder. To secure the block of land, you would make a loan application (Max LVR 90%) and go to settlement on the block of land. At the same time it is sensibl e to request a preapproval for up to the total end value, (costs of Land and House together – max LVR 95%). Therefore, the clients secure the block of land and then they know they can go shopping for a builder. Once the clients have found a house they wish to buil d, in addition to the normal loan application requirements, you must also supply the following: 

Registered Builders Certificate

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Fixed Price Building Contract

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Council Approved Plans

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Specifications and schedule of progress payments.

You will need to forward copies of these to the lender and ask for unconditional approval. The bank will send these documents to the valuer to make an ‘on completion valuation’ and ensure the client is going to have built what has been agreed to in the contract. The banks insist the client use their agreed own funds first, usually towards the purchase of the block of land. If the First Home Owners Grant (FHOG) is being used, this will go to the builder in the first progress claim. Usually there is four or five progress claims. Once the builder has completed a stage of construction, they will send an invoice to the lender & to the client. The client must inspect the construction and usually advises the lender by signing an authority to authoris e the lender to pay the progress claim, drawn from the loan, to the builder.



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The valuer would normally make two inspections —one at about mid construction stage and one on completion. The final progress payment is not usually made until after the final inspection. There are usually four progress payments made to the builder over the term of construction. The general stages of payment may differ, dependent upon the state and may also be referred to differently as follows: 

Pad (slab) down or foundation stage

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Walls constructed – plate high, frame stage

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Lock up stage

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On completion

During the construction period, the clients’ payments will be interest only, calculated on the current outstanding debt. When the loan is fully drawn their repayments of P&I will commence. If clients have chosen a Fixed Rate Loan, this rate and term will commence at the time of final draw down. Below are two scenarios to assist with you understanding construction loans. Facts to take into consideration: 

In both scenarios our borrowers are first home buyers and they are receiving the First Home Owners Grant

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They have genuine savings as deposits

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They have additional funds for miscellaneous costs

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They have a contract of sale s ale and full plans and specifications from the builder.

Scenario 1— 1—Purchase a house and land package Value of land:

$200,000

Price of house to construct

$180,000

Total Security

$380,000

Maximum LVR = 95%

$380,000 x 95%

Maximum loan amount

$361,000

Deposit required = 5% (genuine savings)

$380,000 x 5% $ 19,000

In this scenario, the borrower would only need to submit one loan application to cover both the house and land purchase as a package. They would need to fund a deposit of $19,000 plus costs. (The funds for costs can come from savings, first home owners grant or gifts.)

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Scenario 2— 2—Purchase vacant land and begin construction within 12 months Value of land:

$200,000

Total Security

$200,000

Maximum LVR = 90%

$200,000 x 90%

Maximum loan amount

$180,000

Deposit required = 10% (genuine savings)

$200,000 x 10% $ 20,000

Within the 12 month period, the borrower must: •

$180,000

Find a registered builder

• Arrange plans, specifications specification s and price of home •

Sign a fixed price contract

•

Commence construction constructio n

Value of: • House

$180,000

• Land

$200,000

New total security

$380,000

LVR = 95% (house and land)

$380,000 x 95%

Maximum loan amount

$361,000

In this scenario, the borrower would need to submit one loan application to cover the land principle purchase and would settle the land portion of the contract. They would be wise at the application stage to apply also for an approval in principle for the construction of the house. Although the exact amount is unknown, an approximate figure can be approved awaiting plans and specifications etc. The borrower would need to fund a deposit of $20,000 plus costs. (The funds for costs can come from savings, first home owners grant or gifts) Once the construction is ready to commence, the land loan would be combined with the cost of the construction and one loan would emerge. This scenario demonstrates an excellent way for clients to secure a block of land, especially when new land is released. This then gives them time to decide on a house to build. You will notice the difference in Scenario 2 where to purchase the land first, then construct the house at a later date, clients will need to save or have in their account the 10% deposit for the block of land (plus costs), (5% of the value of the purchase price is still required to be genuine savings). In Scenario 1, they actually needed 5% (which must be genuine savings, $19,000) of the total land and house package deposit to be able to purchase the land and construct the house via one application.



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Family pledge/equity Family pledge allows borrowers to access finance for the full pro perty purchase price, plus a further 10% of the cost s involved. To enable this, an immediate family member provides a l imited personal guarantee for the pledged amount, supported by equity in their existing property. This type of loan is suited to first home buyers with no deposit, who have an immediate family member that is willing and able to offer security support. Its purpose is for purchase or construction of a residential owner occupied or investment property. In an environment of increasing home prices and declining affordability, it is difficult for borrowers to save the required deposit to purchase a home. The family pledge product allows borrowers to own their own home sooner by allowing them to borrow the full purchase price plus an additional 10% to cover costs.

Popular loan features/packages With many of the loan types that we have discussed previously, the lenders can offer certain features and benefits and also package the various loan types together. The following will give a general outline of some of those features and packages offered.

Split facilities This is not a type of loan, but more the different combination of loans. Split facilities, as the name implies, allow borrowers to have a portion of their loan as one type of loan e.g. Standard variable, whilst the other portion can be another type e.g. Line of Credit. The reasons for using this type of facility are many. Perhaps the client wants to fix a portion of their loan to safeguard themselves in the event of a rise in interest rates. They may wish to have the flexibility of a line of credit, but they do not want the temptation of retaining a high loan balance. They can therefore have a portion on line of credit and a portion on another product. Using a split facility gives you the benefit of having two or more loan types with only one ongoing fee (with most lenders). An example of a typical split could be for a $250,000 loan, the borrower may decide that they would like to have the convenience of having money at call and although they only need $220,000 to purchase their home, they borrow $200,000 at a Standard Variable rate and then have $50,000 on a line of credit. They could then use the $20,000 required from the line of credit and have $30,000 available for personal use. This may include such things as holiday, home improvements, unexpected household or car repairs etc. The borrower would then have

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the major part of the loan at the lower standard variable rate and would only be paying interest on the line of credit for th e outstanding amount not the credit limit. Another popular split is that of having part of the loan standard variable and part fixed. We learnt in an earlier section that standard variable rates fluctuated with the economic environment but the fixed rates remained constant for the term of the fixed rate contract. This gives th e borrower comfort in knowing that if rates rise it will only affect a portion of their loan. These combinations of products are extremely popular and brokers should be very conversant with the various combinations available.

Mortgage offset The Mortgage Offset account is an option available to certain types of loans. It can have the same effect as a line of credit whereby the balance of this account is offset against the loan balance thus saving interest. This is often attractive for the borrower who still wishes to operate a savings account to know how much money that they really have saved. It works simply by linking a standard variable loan to a standard cheque/savings account. This means that if a borrower has a loan balance of $100,000 and a savings account balance in a 100% offset account of $10,000 the borrower will only be charged interest on $90,000 being the difference between the two accounts. Some lenders will only allow part of the savings balance to be offset against the loan balance. This type of loan can work as effectively as Lines of Credit without the borrower feeling that they have no money in the bank. Loan repayments must be made on the full approved loan amount. These offset accounts can be used for both owner occupier loans as well as investment loans and can be tax effective in the way that the interest that the borrower would normally earn on the savings account would be classed as income and taxed accordingly. In this instance, there is no interest earned on the offset account. Note: Post March 2004, this product will be deemed a ‘deposit product’ and as such will be captured under legislation applicable to ASIC Public Statement 146 (PS 146). In essence this means you cannot give advice on this product unless you are licensed under the applicable code.



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Professional packages These are usually packages put together by individual lenders to cater for specific high net worth clients. They include combinations of loan types, loan peripherals such as credit cards and accounts at favourable rates and offers of other bank services. Eligible applicants may be categorised by profession, income levels, and increasingly the level of borrowings. The products used are normally a combination standard variable/ honeymoon rate products, mortgage offset or line of credit. The combined total of the loan package decides the discounts applicable. These products are generally discounted by around 0.5% –1% and usually have discounted or nil ongoing fees. A compulsory favourable Credit Card may also form part of this package. Other features include fee free banking and access to Financial Planners and Private Banking on favourable conditions for an annual fee. These packages vary from lender to lender.

Interest only This is used mainly for investment purpose lending, e.g. purchasing a rental property. The borrower may wish to pay interest only as this is more advantageous for tax deductibility. This is normally available for most loan types, standard variable, fixed rate loans and Equity Lines of Credit.

Interest in advance This is also used for investment lending purposes where a borrower may wish to pay up to 12 months interest in advance for the following tax year to enable them to claim the interest in the current tax year. These payments can only be made in June each year, for the following tax year and claimable in year of payment. The rate is fixed for the next twelve month period and is usually a discounted rate.

Bridging finance This is short-term finance provided usually when a client is transferring from one home to another and the new home is settling prior to the settlement of the current home. The contract is usually written as a standard variable loan and is reviewed after 12 months. The repayments are usually interest only and are capitalised (added to the loan balance). Calculating the loan amount and interest component of these loans is quite different to standard loans and brokers are advised to check thoroughly each lenders calculation method before writing these loans. Commission is paid on the End Debt of the bridging loan after the original property is settled and the bridging component of the loan is finalised.

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Lo-doc/No-doc loans This is the term to describe loan facilities where the lending institutions require minimal or no documentation to verify income for loan applicants, who are self-employed. There are usually LVR limitations on these loans but the main issue is that in most cases the client selfcertifies their income levels or the level of loan repayment they believe they can afford for the loan they wish to borrow. In most cases the y sign a statement (or obtain one from their accountant) that they earn a certain level of income or that they can maintain repayments at a certain level and supply BAS statements to support their loan application. The reason for these types of loans can be many and varied such as the client’s financials may not be prepared yet or they may have only been in business for a short period of time so there are no financials available. The lenders are taking a commercial risk that the clients understand their commitment and will meet their repayments. They mitigate the risks by limiting the LVR or relying on the client’s previous good repayment his tory and the value of the security property. In the case of non-conforming lenders they also usually charge a higher interest rate to mitigate risk.

Parenting Repayment Break (PRB) Borrowers who are on/or planning to take maternity/paternity leave will have the ability to take a brief break in repayments.

Feature

Product Parameters (Summary)

Max LVR



90% - at time of request.

Loan Purpose



Owner-occupied loans only.

Credit History





Repayment Type



Other









Documentation




Minimum of 12 months of satisfactory loan repayment prior to allowing a Parenting Repayment Break Repayment history must be clear of missed/late payments for at least 6 months. Interest only is not permitted. Parenting Repayment Break may be taken as either: o 3 months 'no repayments' or o 6 months 'half repayments'. Maximum of 2 Parenting Repayment Breaks during life of loan 12 full monthly payments must be made between each subsequent Parenting Repayment Break Repayments to be re-amortised over remaining term following a Parenting Repayment Break. Lender is to retain evidence of: o Evidence of maternity/paternity leave approval o Lenders approval of Parenting Repayment Break o Re-amortisation, serviceability calculations and o Income evidence (if applicable).


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Other loan features Redraw facilities Some loan types allow you to pay extra funds into the loan to reduce the loan balance and then should the need arise; you are able to redraw the extra funds that you have paid. The lender may stipulate a minimum amount able to be redrawn and charge a fee for the service.

Fee-free savings/cheque accounts Some loan packages offer a fee free transactional account (savings/cheque) allowing unlimited deposits and withdrawals. The terms and conditions of these accounts should be checked with each lender. Some lenders also offer fee free credit cards. Interest is still charged after the interest free period of the account, but there are no other account keeping fees, etc.

Fees With all loan types there are going to be fees attached. The following are some of the fees that you will need to explain to your borrower. Actual fees and calculations will be discussed in Section 9.

Ongoing fees These fees are charged on a monthly basis i.e. added to the loan balance. These fees are around $8.00–$12.00 per month. It is advisable to take this into consideration when comparing product costs over a particular term of the loan. These fees can change throughout the life of the loan. Some bank products opt for a once a year fee which at first seem expensive but they are often offset by other features such as no transaction fees or lower rates. These are mainly evident in Professional packages.

Establishment fees These one off fees are charged at the inception of the loan. Some lenders will discount or waive the establishment fee to entice potential customers.

Valuation fees This is a one off fee that is often included in the lender’s establishment fee. If more than one property is required to be valued, a further fee is usually required. Each lender’s fee may differ and therefore must be verified. An indicative figure would be $250 –$300.

Property purchase stamp duty This is a one off fee paid to the government and depending on the state that the transaction is in, can be calculated on the purchase price or the market value of the property, whichever is greater.

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Mortgage stamp duty This is a one off government fee charged as a percentage of the loan amount. (Depending on which State)

Solicitor/settlement agent fee This is a fee charged by the solicitor or settlement agent to prepare documents, attend and finalise settlement on your behalf. The fees can vary significantly from agent to agent and state to state.

Registration of mortgage fee This is a fee to register the mortgage with the land titles office.

Discharge of mortgage fee This is a one off payment required to register the discharge of mortgage to the land titles office.

Register of transfer of title This is a one off payment required to be paid to register the transfer of ownership to the land titles office.

Title search This is a one off payment required to be paid for the search of title to the land titles office.

Bank peripherals and our obligations In this section you will learn of the other types of bank products available and our obligation to advise the clients of their availability. Bank peripherals refer to the bank products other than loans, about which a broker may not have informed the client. While there is generally no obligation for the broker to sell these other products it is very much in their interest to do so. 



Knowledge of the peripheral products increases the credibility of the broker and enhances the sale of the loan product. For example with the popularity and availability of professional packages there is an expectation that these products go with the package. If the broker does not involve himself/herself with the peripheral products the bank certainly will and this can give the client the impression that the broker either did not know, or care about selling the product. The broker, must at all times maximise the experience for the client to ensure an ongoing relationship and advising them of the very favourable products that may go with their package will enhance that relationship.



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

The more products a client has with a bank the more reluctant a client is to move elsewhere. It is always wise to market all the products you can while you are involved to ensure the client will stay with you in the future. The time the clients are writing the loan is the prime time to establish all the other products and ‘bed’ them down with a total range of products.

This highlights your expertise and your interest in giving them a total package. This in turn encourages the client to remain loyal to the person who solved all their finance issues, not just their loan. The broker should always be concerned with putting a protective screen around their clients and the sale of as many products as possible is an excellent way to achieve goals.

Credit cards Most banks offer credit cards as a part of their total lending packages. There are a number of home loan products that will include fee free credit cards in the package. Most credit cards will have an interest free period for up to 40 or 55 days. The calculation of these interest free periods begins from the first day of the billing cycle. For instance, if a billing cycle on the credit card begins on the seventh day of the month, then anything purchased on that card on that day will give clients the full benefit of the interest free period. The cycle will then continue through to the 6th day of the next month. At this stage a statement will be issued giving them (X) amount of days to pay the account before incurring interest. With a forty day interest free period, then the account is likely to be due for payment nine days after the end of the monthly cycle, hence giving them the 31 days of the month plus nine days (total 40) to pay the account. The usual operation of a credit card is that the interest free period is applicable to purchases not to cash advances. Cash advances incur interest charges immediately. We should be able to advise our clients of the operation of the credit cards attached to their lending facilities. In addition to this, we should know if they have interest free periods available. It is also very important for us to know what interest rate the client will be charged if they do not clear their credit card balance in the required time or make cash withdrawals. Some banks will only offer ‘debit cards’. These cards will still be able to be operated through the credit card n etworks, such as Visa. The cards will have this branding stamped on them. The difference is that there is no overdraft amount. The client can only draw upon the funds that they have in their account. If a credit card does not come in the total loan package, it is likely that the bank will charge an annual fee.

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This will differ between banks and this fee should be advised to your client during the course of your presentation.

Cheque/savings accounts As with the credit cards facility, a number of lenders will offer a fee free cheque/savings account into the loan package. The individual banks will have their own schedule of fees for each of the accounts. As an added service to your clients, it is advisable to have brochures of fees and charges for them. The clients would also be able to get this information from the help lines, so have a list of these numbers available.

Other lending departments Other lending areas such as personal loans, business loans and commercial loans are also part of the bank’s portfo lio of products. These areas are used by a number of Finance/Mortgage Brokers as additi onal products for their clients. You would need to discuss the availability of these products with your own company managers.

Term deposits This type of account is for investors and is not something that we need to discuss with our clients. This investment account allows clients to deposit amounts of money into the bank at a higher interest rate than the normal saving accounts as they are agreeing to have their money invested for a certain period of time. These rates change regularly but once the client is locked into a specific term, the interest rate would remain constant for that period of time.

Risk management products General insurance A number of banks offer general insurance products (i.e. home and contents, motor vehicle, personal valuable insurance etc.). You are obliged to advise your client that they will be required to obtain insurance to protect their home. This will be required prior to settlement of the loan and a certificate of currency will be required noting the bank’s interest in the property. You are able to advise them that the bank offers this service or whoever you may have an arrangement with, but you cannot force them to use either source. They must be free to make their own choice but with the knowledge that this insurance is a requirement.

Financial planning This service is generally offered by most banks and in particular with some, is a major area of the bank. Again, you are able to advise your clients that the bank or whoever you have an arrangement with, offer this service and suggest that it would be in their best interest to discuss their needs in this area with these financial planners. However you cannot force them to follow your suggestion.



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It is our experience that client loyalty is best served by referring them to a Financial Planner or Insurance Broker with whom you have reciprocal, loyal relationship and you can vouch for the professional ethical standards they exhibit. If the clients choose to accept advice from a bank employed financial planner the planners may understandably be more inclined to direct the clients to bank lenders for future transactions, in spite of your good service. It is the usual practice of a number of banks to do follow up calls with their clients in order to assist them with Financial Planning or Insurance. If you have already passed their details onto an external Financial Planner or Insurance Broker it would be advisable to let your client know that the bank is likely to contact them anyway.

Life insurance Term life insurance This is the simplest form of life insurance. It gives your dependents a lump sum when you die. Like house or car insurance a premium is paid each year for annual protection. The policy has no savings value and unless the premium is paid each year there is no further cover, and the polic y will lapse. The amount of insurance required will vary for each household depending on the size of mortgage, other debts, provisions for children and future income needs. Having decided the amount of insurance required it is necessary to check whether life insurance is provided as a part of your superannuation fund. For example only, experts may recommend life cover of about 10-15 times pre-tax income is required for both income earners. If there have been no nominated beneficiaries, the insurer will pay the agreed insured amount to your estate.

Total and permanent disablement insurance In addition to Life Insurance you may also apply for Total Permanent Disablement (TPD) insurance. This optional benefit is available for an additional premium. If you obtain TPD Insurance in the event of you becoming totally and permanently disabled, the Insurer will pay you the agreed insured amount as a lump sum. It depends on whether you take cover for you own occupation or any occupation and what the insurer considers relevant to their policy when assessing a claim.

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Income protection insurance This gives you financial protection if you are disabled through injury or sickness and are unable to work. If this happens, the in surance company pays you a portion of your monthly income, normally 75% of your annual gross income, which is calcul ated to a monthly amount. Cover can be taken out for certain waiting periods of 14, 30, 60; 90 days and cover can range from two years to age 65 years. Naturally the longer the term of cover and the shorter the waiting period the higher the premium costs. Your occupation and smoking or non-smoking habits along with any other known illnesses are taken into account when assessing your application and the premium. This type of cover is also sometimes referred to as Salary Continuance Insurance. Taxation benefits are available for this type of cover and you should consult your accountant in regards to these.

Business expenses insurance If you are self-employed, this insurance covers the busi ness expenses that you must pay each month even if you are unable to work because of illness or injury.

Trauma insurance In addition to Life or Life and TPD insurance you may apply for Trauma insurance. The optional benefit is available for an additional premium. This benefit eases the financial burden of the costs associated with recovering from a medical crisis. The insurer will provide a lump sum payment to you if you are diagnosed with a range of listed trauma events under their policy. One must remember due to medical advancements these days most people survive the traumas and the average age for claims for this policy is between 45-55 years old.

Mortgage protection insurance Mortgage Protection Insurance is specifically designed to pr otect the borrower against death, disability and involuntary unemployment. Cover varies quite markedly between providers of this type of insurance protection. However, usually on death the payout is limited to the outstanding amount of the loan at the time of death. (Some companies have level cover and will pay any extra amount over the debt owing to the client’s estate, e.g. initial mortgage of $250,000; MPI cover provided at $250,000; current mortgage debt at $200,000. The debt is fully repaid and the extra $50,000 is paid to the client’s estate.)



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Disability benefit is limited to the mortgage repayments up to a maximum figure of approximately $4000 per month (varies between companies) and covers loan repayments for a limited time of around 2½ years (varies between companies). Involuntary unemployment cover meets loan repayments for up to three months. Lenders may make insurance cover a condition of the loan. What they cannot do is force the borrower to take out their insurance product. As such they cannot make MPI mandatory but can insist that the borrower obtain cover prior to releasing the funds. MPI is generally more expensive yet does not provide the full protection that standard life insurance covers, such as Death, Permanent Disability and Trauma cover, and Income Protection.

Duty of Care Under the Duty of Care a broker has a legal obligation to advise clients of the availability of the risk management products to protect themselves against unforseen events as described above. The courts in Australia deem a broker to be a professional. By not raising the need for financial protection, a broker can be judged negligent under the Duty of Care.

Gearing In this section, you will have a very basic look at gearing and when it is used. Brokers without the proper qualifications are not allowed to give any advice to their borrowers about gearing. It is pertinent to advise your client of this and suggest that he seek advice from their accountant or suitably qualified professional. There are three types of gearing: 

Negative



Neutral



Positive

Negative gearing is an accounting term used when an asset is purchased for investment purposes and is returning an annual loss. This annual loss amount is then offset against annual income with the result of decreased tax assessments. Neutral gearing applies when the annual cost of investment is equal to the annual income generated. Positive gearing applies when the annual income generated is greater than the costs and returns an annual profit for the investor.

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A common form of gearing is a client purchasing a rental property. The customer will usually borrow the maximum amount possible. The interest paid on this loan transaction along with other fees such as management fees (approximately 7% - 8% of rental income), maintenance costs, depreciation and other costs are then offset against the rental income. When there is a shortfall in the income received compared with the expenses incurred negative gearing results. This loss amount is then carried forward to the client’s income to decrease the amount of their taxable income. For example, our client has purchased a property for $300,000 and has borrowed $225,000. Purchase price of property Amount of loan

$300,000 $225,000

Income: PAYG income Rental income @ $250pw Total income

$80,000 $13,000

Rental property expenses: Management fee @ 8½% Interest (calculated @ 7% interest only) Depreciation Land and water rates Maintenance Total expenses

$ 1,105 $15,750 $ 7,000 $ 2,000 $ 1,500

$93,000

$27,355

Taxable income

$65,645

Without rental property Tax payable on total income of $80,000 = $23,136 Net income = $56,864 With rental property Total income = $93,000 - $27,355 (expenses) = $65,645 Tax payable on total income of $65,645 = $16,896 Net income = $48,749

The outcome from this scenario is that without the rental property, the client would be earning $80,000 and would pay $23,136 in tax. This would give him a net income of $56,864. With purchasing the property the client would have a gross income of $65,645; he would pay $15,750 in repayments, $1,105 in management fees and $1,500 in maintenance costs and $2,000 in land and water rates. He would pay $16,896 in tax. Net income would therefore be $48,749. This example shows that through negative gearing our client is able to purchase an investment property with the net difference to cash in his pocket being approximately $156.00 per week. This is a very basic example and is used only for th e purpose of demonstration. You must advise your client that they should seek their accountant’s advice prior to making any decisions on Negative Gearing.



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