Investment Finance

The Banks Secret Weapon: Part Two

Wednesday, June 16th, 2010

We continue on with Gordon and Sally’s story about their investment property…

Banks won’t lend 106% of the purchase price against a property without a much higher interest rate
and a huge mortgage insurance fee (which, by the way, only covers the lender… not you – you pay
the premium for their peace of mind!)

As you can see in the diagram below, the bank has actually stripped a whopping $273,000 from
Gordon’s home to secure the loans used to fund the purchases of their investment properties.
Unbeknown to Gordon and Sally, the loans on their investment properties are actually limited to
80% of the value of each property, (80% LVR), a comfortable $1.25 security for every $1 borrowed.

To meet Gordon’s demand for stand-alone loans, the bank simply split the loans into deductible and
non-deductible sub accounts.

Their bank stripped $273,000 from the equity Gordon had in his home to cover his 20% ‘hurt money’
he and Sally were (unwittingly) required to contribute, plus purchase costs. They were totally misled
into believing the bank was actually lending 106% against the investment properties.
But it gets worse for Gordon and Sally, much worse.

Under the AMMC, the family home’s ‘exposure to debt’ (that is the debt their home is liable for),
rocketed from $325,000 to a massive $1.438M, nearly 60% higher than the value of his home.

Gordon had no awareness of what the bank had done, and neither do most investors who borrow
money for investments with the same lender as they have for their home.

Suddenly their home is at the mercy of the bank, and they had no idea as the bank manager had
never explained the effect AMMC could have on their own home. Little wonder, a recent survey of
bank managers found that less than 25% of them understood the full implications of the AMMC for
the borrower; many more didn’t even know it existed! How frightening is that?

So, what triggered Gordon and Sally’s catastrophe?

Life had been pretty good for Gordon and Sally, so they decided he would take his long service leave
so they could travel for three months.

Gordon arranged direct debits from their savings account to cover the repayment shortfall after
rent.

It was while Gordon and Sally were overseas that disaster struck. One of their tenants lost his job
and missed a rental payment creating a shortfall in the repayment of $1,170. The bank automatically
issued a default notice demanding immediate payment.

Unaware of the events that were unfolding at home, Gordon and Sally were trekking towards “Base
Camp” in the Himalayas.

Six weeks later they arrived home, exhausted, but exhilarated from their epic journey. The next day
they started to wade through the mountain of mail that had accumulated over the two months
they’d been away.

Upon tearing open the first of a number of letters from Gordon’s bank, his blood ran cold as he
scanned the headline “Notice of Default”. He scrambled to rip open a second letter from his bank as
beads of sweat appeared on his forehead. This time the headline in red screamed “Letter of
Demand – immediate payment required.”

By now their loan was two months in default and the third repayment was due in just 5 days.
Terror set in as Gordon scrambled to find the statement for their savings account. He found it was
overdrawn by $2,751.28. He then fumbled to find their credit card statement; it was just shy of its
limit.

Including default interest, they were now nearly $4,500 behind in payments. Their savings account
was overdrawn and their credit card was nearly ‘maxed out’. They needed over $7,000
immediately. Where were they going to find that sort of money?

Their loans were now in default. If all requirements of the order were not met within 28 days, the
provisions of the All Monies Mortgage Clause provided that ALL loans would be ‘deemed’ to be in
default and would be called up or action taken to sell any or all of the securities (properties),
including their home, to recover any outstanding loans. Remember, the bank is exposed to a single
client for in excess of $1.4M, so alarm bells were ringing… and loudly.

Gordon and Sally’s predicament was now dire. It proved impossible to liquidate these investment
properties within 28 days and equally impossible to secure new finance while in default.

One tenant losing his job had cost Gordon and Sally their $1.9M portfolio, including the family
home, in just a few short months.

The worst was to come… their relationship was at breaking point as they faced their financial ruin.

Find out on our next post what Gordon and Sally’s grave mistakes were….

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