Home loans for buy-to-let property

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04 Jul 2013

Following the global financial crisis of 2008/2009, South African banks have generally been more conservative in financing buy-to-let properties, compared with the boom years, which may have also contributed to slower buy-to-let buying.

Following the global financial crisis of 2008/2009, South African banks have generally been more conservative in financing buy-to-let properties, compared with the boom years, which may have also contributed to slower buy-to-let buying.

According to Ewald Kellerman, head of sales at FNB Home Loans, since there is no coordination of bank policies, the competitive nature of the financing industry encourages banks to push the limits of risk taken on with these types of transactions.

Kellerman explains that these types of home loan applications are of a more complex nature compared to applications for primary residential property buying and require special considerations when considering whether to grant a loan.

Be that as it may, the latest FNB report reveals that buy-to-let residential property investors are making a comeback to the market, albeit at a slow pace recording 8 percent of total residential property buying.

More buy-to-let investors choose KwaZulu-Natal recording 11 percent followed by the Western Cape at 8 percent and Gauteng 6 percent, as buyers in the Western Cape and Gauteng regions buy homes for residential purposes other than second homes, according to FNB.

Home loan applications

For those applying for finance to buy these properties, Kellerman says when assessing applications, the expected future rental income of a property being bought cannot be taken into account to help the applicant qualify for a home loan.

Before the property is bought and the rental agreement is in place, the expected rental amount is undetermined, what’s more, there is no guarantee that the expected amount will be earned, or that there are tenants ready to move in on the day that the property is transferred.

“Furthermore, the National Credit Act requires banks to determine affordability and to ensure that the applicant can afford the loan at the time of granting the bond,” he says.

He points out that given this requirement, it is not possible if the rental agreement is not in place yet from both a legislative, and a credit risk perspective.

“The income stream of a rental property is by nature volatile, non-performing tenants, eviction issues or even vacancy between one tenant moving out and the next one moving in could severely affect the regularity of the cash flow generated from the property.”

Fixed rates are offered on most home loans and are typically a little more expensive than the variable rate available at the time (price dependant on market conditions), but could offer a level of certainty of the monthly payments.

In the case of holiday rentals, properties tend to attract much higher rentals in peak periods and generate low or even no income out of holiday season.

Kellerman points out that it is not possible to merely take an average of the rental amount for the purposes of assessing affordability of the applicant to qualify for a home loan.

“Depending on the volatility, only a portion of the rental income can be taken into account in the affordability calculation when being assessed for an additional buy-to-let unit.”

Kellerman says expenses relating to the property, such as rates and taxes, levies and homeowner’s association fees (where applicable) have to be taken into account in the assessment to determine the buyer’s full commitments and ability to repay the loan on the property.

Regardless whether the property is occupied or not, the owner is still responsible for these expenses and the full cost of ownership could also include general maintenance and insurance on the structure.

The Tenant Profile Network report revealed recently that in the first quarter of 2013, nationally, 84 percent of tenants were in good standing, which includes sub-categories of 71 percent of tenants who Paid on Time, plus 3 percent paid in the Grace Period and 10 percent, Paid Late, 8 percent of tenants were in the Did not Pay category while 8 percent made a Partial Payment.

“If the investor conducts his primary transactional account with the bank where he/she applies for the home loan, it is much easier to assess the full extent of the income and the expenses related to the investment property,” says Kellerman.

The clarity of information allows the bank to make a much more informed decision on future credit applications and if the bond account of investment properties is held with the same bank, the strength of the relationship could result in a much better chance to qualify for further lending and increase one’s investment property portfolio, he explains.

Deposit and interest rates

As with buying primary residence, a deposit can further reduce the risk and in turn the interest rate of a new home loan account.

“An upfront payment proves the investor’s commitment and reduces the potential loss on an account, allowing the bank to afford the investor a better interest rate based on the reduced level of risk.”

A home loan is still arguably one of the most useful investment vehicles, offering a risk-free and tax-free saving, says Kellerman.

In Banks and your home loan application, Kellerman did say that most banks still offer 100 percent loan-to-value bonds although these are not very common, as such, new home loan applicants are required to put down a deposit of between 10 and 20 percent.

He says this interest rate has a huge effect on the profitability of the property and can improve the total return significantly, as such, would-be buy-to-let investors are encouraged to use the opportunity to benefit from paying a larger deposit.

He notes that although interest rates are currently at an all time low, the risk of increasing interest rates could threaten the profitability of the buy-to- let investment and introduce an additional form of risk.

On interest rates, he says fixed rates are offered on most home loans and are typically a little more expensive than the variable rate available at the time (price dependant on market conditions), but could offer a level of certainty of the monthly payments.

“A useful alternative is to fix your instalment at a higher level than the current minimum repayment and this would allow you to repay the loan quicker, creating interest savings, and help to buffer possible future increases in interest rate.”

A home loan is still arguably one of the most useful investment vehicles, offering a risk-free and tax-free saving, says Kellerman.

“Fixing the instalment at a higher level offers this interest saving and provides a certain level of consistency in the repayment amount.”

However, he says should the bank lending rates rise, the argument quickly tips in favour of renting rather than buying and is expected to further increase the demand for rental properties in the short term.

“This rising demand for rental properties and slow growth in supply is expected to ultimately drive up yields to a point where buy-to-let property becomes a much more attractive investment.”

While banks will remain cautious on lending, he says they will continue to support this market with responsible lending to enable a much larger buy-to-let market to support the growing demand for housing in South Africa. – Denise Mhlanga

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