A 1 per cent buffer instead of 3: why investors are now choosing to pay more interest

The number: a 1 per cent buffer instead of 3

Every bank in Australia has to test a new loan at 3 percentage points above the rate you will actually pay. That rule belongs to APRA and it has not moved.

Non-bank lenders sit outside it.

A realestate.com.au report this week describes a broker's investor client who was assessed at a 1 per cent serviceability buffer by a non-bank lender for a third investment property. A bank had already declined the same file.

Two points of buffer sounds like a footnote. On a loan in the hundreds of thousands it is the difference between approved and declined.

What changed

Negative gearing can no longer be used in an investor's serviceability calculation following the federal budget changes, according to the report.

Before the change, the tax benefit of a loss-making rental counted toward your capacity to repay. Now it does not. For a household with equity and a plan to buy again, that took a slice of borrowing capacity away without any change to income or spending.

So investors are looking for lenders who assess the same file differently. Non-banks are where they are landing.

Non-bank does not mean unregulated. The report quotes a lender founder on this point directly. These lenders hold an Australian Credit Licence, answer to ASIC, are bound by the National Consumer Credit Protection Act and belong to AFCA, the same complaints body the banks use.

What they do not carry is APRA's 3 per cent buffer, or APRA's cap on how much high debt-to-income lending can be written. Banks have a cap. Non-banks do not. That is why a lender can look at a file a bank just declined and reach a different answer.

The price of the extra room

The capacity is real. So is the cost, and the report is specific about it.

• Borrowers on the nonconforming end of the spectrum generally pay 0.4 to 1.2 percentage points more than a comparable bank rate, and potentially more.
• Many non-banks do not offer an offset account, the option to fix, or even the ability to make extra repayments.
• They can carry more fees.
• Because they are funded through wholesale markets and securitisation, their funding costs can move differently from the banks. Depending on conditions, that can mean larger rate rises.
• No branches and no deposit accounts, so no bundling your banking.

The investor in the report took a higher rate, no fix and no offset, and went ahead anyway. The reason given was that the loan fitted an overall strategy. Their home loan and other two investment loans stayed with banks.

Hold onto that detail. It is the whole point of this article.

What it means if you have equity to deploy

If you own your home with usable equity and were planning the next purchase, the budget change has handed you a decision that did not exist a few months ago.

Option one: stay with a bank. Lower rate, offset, fixed option, extra repayments. Less capacity, tested at 3 per cent, with negative gearing stripped out of the sums.

Option two: use a non-bank for this loan. More capacity, tested at a lower buffer. Up to 1.2 points more interest, fewer features, more exposure to how wholesale funding moves.

The expensive mistake is obvious once you say it out loud. Paying up to 1.2 points more for a loan only works if the asset on the other end outgrows the extra interest. Use that capacity to buy an ordinary property in a street that is going sideways and you have paid a premium to go nowhere, with no offset to soften it.

The report's own advice is to go to a broker and be very clear about what you are trading off. We would add one thing. Decide what you are buying before you decide how you are borrowing.

The Ripehouse reframe: the loan is the second decision

Investors who treat finance as the way to get the next deal done tend to let the lender's answer choose the property. The capacity comes back, and whatever fits inside it gets bought.

We run it the other way around.

Two streets in the same suburb can be having completely different outcomes at the same moment, in days on market, in vacancy, in what buyers are actually paying. The headline suburb figure averages those streets together and hides the gap. That gap is where the extra interest gets paid for, or does not.

So the order matters. First, which asset and which street can carry a dearer loan and still come out ahead. Second, which lender gives you that loan on the best terms you can get. The investor in the report who placed one loan with a non-bank and kept the rest with banks was making a structural decision inside a portfolio. That is the right frame. A non-bank loan is a tool for a specific asset, with the rest of the structure left intact.

Across 997 client portfolios since 2021, the median growth has been 19.0 per cent per year on a 5-year rolling basis, against roughly 4.3 per cent nationally (benchmark: CoreLogic/Cotality). Past performance is not a guarantee of future results. We mention it because structure, the right asset in the right street with the right loan behind it, is what produced it. Timing the lender did not.

None of this is personal advice. Your broker and your adviser need to see your numbers. But the question to take to them has changed. Ask what the extra capacity buys, in which street, before you ask what it costs.

Want to see how we test which street can carry a dearer loan before the loan is written? Join Jacob's free live webinar.