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What's going on? The credit crunch and what it means for borrowers

By Greg Carroll of Attitude Finance www.attitudefinance.com


Well the last few months have certainly proven interesting with the impact of the Global Credit Crunch starting to hit home locally. We have seen a number of companies and executives go from high-flyers to teetering on the brink of extinction. We have seen banks and other lenders increase rates by more than moves made by the RBA and have a number of lenders now reviewing the viability of their business models.


So why have Banks moved rates even when the RBA hasn't?

It is pretty much as they are saying publicly; their cost of funds has increased. Despite what most people think banks don't source the bulk of their lending funds from deposits. Prior to the credit crunch banks and lenders were able to raise funds in the securitized market. This essentially meant they were able to parcel up their loan book and offer it to big investors like superannuation funds. The super funds liked this because it offered bricks and mortar security with a nice return to boot. The appeal to lenders was that this provided a relatively low cost source of funds.


Primarily because of poor lending standards and fraudulent activity in the US loan market the securitized market dried up overnight. Super funds got burnt by investing in loan books that were presented as being AAA rated but were in fact extremely poor or "toxic" as described by some. So now the super funds don't want to invest because they don't trust any one and therefore no more cheap funds.


This has meant lenders have had to come back to the Bank Bill market for their funding. As the graph below shows the Bank Bill Rate is sitting quite a way above the cash rate. Meaning higher costs to lenders and consequently higher costs to borrowers. And despite the "rantings" of some of the ill-informed media, lenders margins are being squeezed and a number are not passing on the full cost to borrowers.

 

There is a lot of commentary at the moment that the RBA may have come to the end of their tightening cycle. For those concerned about rising rates this should provide some relief. Based on the above picture if the RBA did start reducing the cash rate, lenders are not likely to follow suit straight away. They are likely to wait for the bill rate to fall to a point that they can recover some margin.     


So what's going to happen?

There is no doubt all this doom and gloom brings a fair amount of uncertainty into the market with many asking where to from here?


History provides a good insight. Unfortunately it is likely that everyday borrowers will pay the price for the bad decisions of others. This is likely to come in the form of tighter lending policies and increased paperwork to support any loan application. This will generally mean the amount you can qualify for today and the amount you will be able to qualify for in the near future is likely to be different. More often than not this amount will be less.


Higher interest rates have already had an effect on borrowing capacity. Let's look at an example using the capacity test of one major lender. 12 months ago when interest rates were sitting at around 7.4% a person earning $80,000 pa could have qualified for a loan of up to $490,000. Now with rates sitting around 8.74% that same borrower can only qualify for a loan of $436,000. That's a drop in capacity of 11% and certainly scales back the purchase options for the borrower.


But it is not just pricing where the impact will be felt. Banks and lenders have already begun making some changes to policy and it seems likely that more changes are likely to come.


Areas that are likely to be targeted first are those that are considered higher risk such as:

         100% lending and lending above 80% of a properties value

         Lending with credit impairment

         Low doc lending

 

Other areas where lenders are likely to focus is a return to genuine savings requirements, tighter guidelines around employment and income, and a further tightening in capacity testing.


So what does this mean for you?

There has been a fair amount of commentary in the media about the level of property on the market currently with days on market extending and auction clearance rates down. The media loves bad news but when I listen to or read a report from respected property researchers and analysts like Michael Matusik, Terry Ryder, BIS Shrapnel and others, the underlying theme that keeps coming through is that we are still experiencing an under-supply of property. Quite simply there are not enough homes being built to keep pace with population growth. This current surplus of stock is likely to be short lived and will be soaked up over the next few months and conditions will tighten again, which will put pressure on property prices.


So what are the possible implications for you? You may have decided that you will hold off purchasing to see if prices come off. But in holding off you may find your borrowing capacity and consequently your purchasing capacity has been reduced through a tightening of lender policy.


A worse possible scenario is that prices don't come off the way you expect but your capacity is still reduced through tighter lender policy. Which means you the type of property you can consider is substantially less than what you could look at today.


So what does this mean for you and what actions can you take? I think the key word is "action". If you do have plans to purchase property, or you are considering restructuring your finance to access more funds I would start taking action sooner rather than later.

 

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