The split banking strategy – Use this to improve your equity

Property investors need to know about (and understand) the Split Banking strategy.

Why? Because it can be used to free up equity and buy more investment properties – more quickly. It works especially well for investors who put their money in New Builds.

It’s no secret, we’re big fans of split banking – or as we’ve called it in the past “cheating on your bank” or “polybankery”.

But it doesn’t just work well for New Build investors, all property investors should consider spreading their lending across multiple banks.

So, in this article, you’ll learn what split banking is, how it can improve your equity, and whether it could be the right strategy for you.

Do you have a question or comment about split banking? Feel free to leave your thoughts in the comment section at the end of the page.

What is split banking?

As the name suggests, split banking involves splitting (or spreading) your lending across multiple banks.

Said another way, you will use multiple banks to acquire your lending. The benefits of split banking are three-fold:

#1 – It can increase the equity you can access to expand your property portfolio (in some situations).

#2 – It can protect you from banks forcing you to pay down debt if you don’t think that’s the right decision.

#3 – It can help you better control what happens to the money you get when you sell an investment property.

As simple as that all sounds, in practice – like a lot of financial strategies – it can be a complicated subject to grasp.

How does split banking increase the equity I have to invest?

Split Banking works particularly well for investors of New Builds because it can allow you to borrow more.

Why? Well, New Builds are somewhat of an anomaly.

New Build properties are exempt from LVR restrictions. This means investors only need a 20% deposit to purchase one (rather than a 35% deposit).

As we know, most investors don’t have that deposit in cash, so they use equity secured against their main home and borrow all of the money to invest.

Here’s the catch – the day the property settles it’s no longer deemed a New Build in the bank’s eyes. Instead, it’s an existing property.

This means that 20% deposit goes to 35% overnight. Don’t worry, it doesn’t mean that you need to tip more equity into the property.

But, there will be an impact when you want to expand your investment portfolio and purchase your next investment property.

That’s because the next time you want to take out more lending, you’ll trigger what’s called a credit assessment.

This is where the banks look at your lending to see whether you can afford any more. At that point, instead of requiring you to have 20% equity in your (formerly) New Build property, they’ll then require it to have 35% equity before they lend you any more money.

So, there can be issues if you:

• Use your own home as the deposit for your investments, and

• You have your own home and investment properties with the same bank, and

• You invest in New Builds, and

• You want to expand your property portfolio further in future

And while there are a few criteria, almost 100% of the investors we work with here at Opes Partners fit all of the above. So, they need to consider Split Banking.

This can get a bit “mathy”. The person best placed to explain your situation to you is your mortgage broker. But, let’s go through an example, to show you what happens if you don’t use Split Banking.

Split banking example

Let’s say you have an owner occupier home worth $1 million, and a $500,000 mortgage.

Using our equity calculator, you would see that you can borrow up to $300,000 as the deposit for an investment property.

This means you could purchase up to $1.5 million worth of New Builds, since they only require a 20% deposit (depending on your income and other debt criteria).

So, you use half of that money to buy a New Build and think: “I’ll buy another one later.”

You decide to use the same bank you use with your own home.

Here’s how your lending looks before you settle that property:

Before the New Build settles, your investment is taking up $150,000 of what you could potentially borrow against your main home.

But, look at what happens once that New Build settles and becomes an existing property in the bank’s eyes.

The LVR of the investment property drops to 60% and you can’t borrow as much against it.

That means instead of sucking up $150,000 of what you could borrow against your own home, it now uses $300,000 of that potential borrowing.

So you thought you’d be able to borrow enough to purchase another investment property. But now you can’t. Why? Because you didn’t use split banking.

How would split banking help you borrow more?

When you use split banking you will borrow the deposit (20%) for your New Build investment against your new home.

Then you’ll take the rest of the lending out (80%) from a different bank.

So this is what your lending would look like at your main bank:

Note: deposit for new build secured against the equity in your own home.

What happens when you want to go to purchase your next New Build investment property? Now, that extra $150,000 is still available, and you can buy the property and expand your portfolio.

Yes, the other investment property still has an LVR of 60%, but that lending is not on your main bank’s balance sheet. So, the bank won’t consider the equity side of that property when deciding whether to lend you more.

Again, this can get mathy, so if you’re still struggling to get your head around it – don’t worry. That’s normal. You can always ask your mortgage broker to explain this to you in more detail.

What do I need to use the split banking strategy?

To use this strategy, you need to have two or more properties … Or you need to be about to buy your second property.

Put simply, you can’t split 1 mortgage (your own home) across 2 banks (most of the time).

While we do heavily encourage split banking, it can be harder to get the lending approved.

Why? Because instead of jumping through the hoops of one bank, you are having to perform for two.

Each bank’s tests are different, so you must pass both banks' income standards.

For this reason, some property investors need to buy their first investment without a split banking strategy. But others will get it set up from the get go.

If you can’t set up the split banking strategy straight away, you can implement it later on in your investment journey. You do this by using the dollar-for-dollar LVR exemption from the Reserve Bank.

Put simply, this is a rule where you can still borrow up to 80% against a New Build investment property when:

• You move the mortgage between banks, and

• You don’t increase the original size of the loan

The key message here is: If split banking isn’t right for you now, it might be a solution for you in the future.

And even if you don’t fully understand the math (just yet), talk to your mortgage broker to see whether it’s possible to use it.

How do I set up split banking?

There are two ways you can set up split banking.

Scenario #1 – set up split banking from the start

Split banking is simple to set up when adding a property to your portfolio.

If you’re someone who’s decided they only ever want to use split banking then,

in this scenario, you ask your bank for the 20% deposit for the investment, and another bank for 80%.

For instance, if you’re buying a new build, you’ll typically set up a revolving credit against your own home. And you’ll make this the size of the deposit you need (20% of the new property’s value).

You then go to another bank and apply to get the rest of the lending. For a new build, that’s 80%.

Scenario #2 – set up split banking a few properties in

If you already have multiple properties with one bank, you can still use split banking – it is just set up in a different way.

First, you need to get a loan from a new bank.

You’ll then use that loan to pay back the money you owe to your current bank.

If you already used your main bank to get the money for a New Build, that’s ok. Your mortgage broker can help split this out.

Obviously, there are a few more steps involved, which we will go through next.

What are the steps required to use the split banking strategy?

Step 1 – Talk to your mortgage broker about whether this strategy will work for you. There is a bit of number crunching involved, but this won’t (generally) cost you anything and it’s worth it.

Step 2 – Calculate whether your current bank will charge you any fees if you move to another bank. Sometimes there are break fees. If there are break fees, it may be best to wait until after your fixed interest rate rolls over.

Step 3 – If needed, apply for a new loan at another bank to refinance your existing lending. Your mortgage broker will give you a recommendation about which bank to use, and should make the application on your behalf.

Step 4 – You’ll need to work with your solicitor to handle the legal side. The old loan must be de-registered from your title (the legal description of your property), and the new loan must be registered.

It’s important to note, there will be legal fees involved in changing banks. This is typically between $1,000 – 2,000 (depending on complexity and number of properties). However, you will often get a cashback from your new bank, which you can use to pay for your legal fees.

Other reasons to use split banking

Don’t worry, this strategy isn’t exclusively for New Build investors.

If you’ve got existing properties, you can still use split banking to protect yourself.

The other main benefit is that it gives you control of the money you get when you sell a property (the sale proceeds).

This is really important because, if you have a material change to your portfolio (e.g. you sell a property), the bank can run a credit assessment. This is to see whether you can still afford the rest of the lending you have.

Now, generally speaking, when you sell a property you expect to keep the profit to spend on what you want – another investment property, or a holiday.

But, when a credit assessment is triggered the bank is going to look at all of your lending and, under their current policies.

If their policies have changed, or you have had a change in income, they can force you to use the money from the house sale to pay down debt.

This means if you’ve changed jobs and your income has dropped – or if you’ve gone from a 2 to a 1 income household – this could impact you.

Sure, it’s great that your debt might decrease. But the issue is, you thought you were going to have access to these funds and now you don’t.

Case study: the bank that stole Christmas

Here’s a case study that will make your stomach churn.

Opes Partners Managing Director, Andrew Nicol, was working with a pair of Wellington-based investors. They had bought 3 investment properties and were ready to retire.

They’d just got access to their KiwiSavers and had handed in their notice at their job. Their plan was to sell 1 of their 3 properties and live off the sale proceeds and the government superannuation.

So they sold the property. Then what happened? The sale triggered a credit assessment.

Even though their remaining properties were cashflow positive (and they had no personal mortgage), the bank decided they couldn’t afford the mortgages on their other investment properties.

So without asking, the bank took the money from the sale, and used it to pay down their mortgages. They took their KiwiSavers, and used it to pay down debt.

On top of that, the bank charged the couple break fees, and cancelled their credit cards.

All a week before Christmas.

Terrible.

Unfortunately, this was before split banking was a thing. But now we know how the couple could have stopped this from happening.

If the couple was retiring today, their mortgage adviser would recommend to set up split banking BEFORE they step away from their jobs.

They’d still trigger a credit assessment, but this would happen before their income drops down to just the government superannuation.

That way, if the couple has a mortgage with a bank, and that’s the only property the bank has security over, what happens when they sell? They have complete control over those sale proceeds.

There’s no credit assessment triggered at any of the other banks.

Again, this is all technical and can be complicated. But, don’t let the detail distract you from the key message – that using multiple banks can give you more control over your finances.

Is split banking the right option for me?

While we do enthusiastically encourage split banking, it’s not going to be possible for everyone.

This is why, for this strategy, it’s imperative to work with a mortgage broker, because of the amount of number crunching involved.

Having said that, this strategy can be life changing.

Peter Norris, managing director of Catalyst Financial, says it's “staggering” how many investors he has worked with who have used this strategy to keep borrowing, when they have been previously turned away.

Write your questions or thoughts in the comments section below.