Splitting your banking needs can pay off, here’s how
In the dynamic world of personal finance, managing your money effectively is essential to achieving your long-term financial goals. One strategy that has gained traction is split-banking.
Two Definitions of Split-Banking
Like many financial terms, split banking can also be called different things, or mean different things to different people.
Split-banking is different to open banking. Open-banking is also known as "open bank data." Open banking is a banking practice that provides third-party financial service providers open access to consumer banking, transaction, and other financial data from banks and non-bank financial institutions with application programming interfaces (APIs). Open banking will allow the networking of accounts and data across institutions for use by consumers, financial institutions, and third-party service providers. Open banking is becoming a major source of innovation that is poised to reshape the banking industry.
Split-banking is one way to describe the practice of holding accounts with multiple financial institutions to manage various financial needs. This approach provides individuals with greater flexibility, control, and strategic advantage in handling their finances. When it comes to lending (mortgages) specifically, this might also be called things like:
Or, something else!
Advantages of Using Multiple Banks
Using the services of different banks simultaneously can offer a range of benefits. Here’s how:
1. Diversification and Risk Management
Just as diversifying your investment portfolio across different assets reduces risk, diversifying across multiple banks can safeguard your financial assets. If one bank faces challenges, your other accounts remain unaffected, ensuring financial security.
Split-banking allows you to segregate funds for specific purposes. For example, with property investment, you can establish different banking relationships for different properties, making it easier to track and record expenses and income. This makes reporting easier when it’s time to do your tax return.
3. Great Deals
Interestingly, people seem more attached to their banks than to marriage. Statistics show that people are more likely to get divorced than to change banks. This is despite the money to be made by utilising multiple lenders. This phenomenon is well-known by the banks, who often capitalise on this inertia to their advantage – they’ll commonly offer better deals to new customers than to existing customers. While personal circumstances can evolve significantly over time, individuals often hesitate to switch banks due to the perceived hassle and complexity of the process. Banks recognise this trend and may offer enticing deals to attract new customers while relying on the comfort of familiarity to maintain and profit from their existing clientele.
If you’re dealing with multiple banks, you can shop around for the best deals – whether that’s on term deposit rates, mortgage interest rates, credit cards, or something else.
4. Property Investor Benefits
This approach is commonly discussed by mortgage brokers (“mortgage advisers”) as a strategy to minimise risk and optimise borrowing options for their clients. Read on to find out why.
Optimal Borrowing Choices
Even in New Zealand, where the big banks are broadly similar, different banks and lenders have varying lending criteria, interest rates, and loan terms. Some banks offer more favourable terms than others for those buying apartments, some banks offer more favourable terms than others to parents, some banks look at bonus or commission income differently when assessing lending applications, and so forth. As you’d expect, bank policies all change regularly too – the same bank that offered you great lending terms three years ago might not be so generous today!
By diversifying across lenders, borrowers can tap into a wider range of borrowing options, potentially securing more favourable terms for different loans. By strategically choosing lenders based on their strengths, borrowers can create a more tailored and advantageous borrowing portfolio.
Lender diversification offers borrowers greater flexibility. In case one lender is unable to meet a borrower's specific needs or preferences, having access to other lenders ensures that the borrower has alternative options available. This flexibility can be particularly beneficial when borrowers have unique financial situations or when their needs change over time.
If you have all your properties and mortgages at one bank, the one bank can take collective security over all of them. Even if you have different entities and bought them at different times with different loan accounts, the bank secures the debt against all assets held with them.
If you’re an existing property investor and you have a major change to your property portfolio, such as 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 according to their calculations, and their assumptions around a worst-case interest rate.
When anyone sells a property, it is normal to expect you want to keep the proceeds to spend on what you want – to invest in a more diversified way, buy another property, maybe a boat, perhaps a holiday, and so on. However, when a credit assessment is triggered, the bank is going to look at all of your lending and assess it according to their current policies.
If their policies have changed and they now have tighter lending criteria, then they can force you to use the money from the house sale to pay down debt. This commonly happens if you’ve changed jobs and your income has dropped, or if you’ve gone from a two to a one income household to raise children.
Sure, it’s great that your debt will decrease when you repay the bank. But the issue is, you thought you were going to have access to these funds and now you don’t. Using multiple banks helps to avoid this situation.
Loan to value (LVR) restrictions and other lending rules and regulations change frequently. Some of the regulations might not make much sense, especially for property investors buying new build properties (which occurs mainly for the tax advantages offered, and different lending terms available). This can create technical benefits for savvy investors, for example:
New build properties are exempt from LVR restrictions. This means investors only need a 20% deposit to purchase one (rather than a 35% deposit for an existing property). Most investors don’t have that deposit in cash, they instead use equity secured against their main home and borrow all the money to invest. But, there’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. That doesn’t mean 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.
Of course, split banking isn’t possible or practical for all property investors. Juggling multiple accounts demands a heightened level of organisational skills and financial acumen.
Assessing differences in banks or lenders, and the benefits of them, is also easier said than done.
Mortgage brokers (advisers), including here at Become Wealth, play a crucial role in helping borrowers navigate the landscape of lender diversification. They have access to a network of lenders and understand the various lending criteria like property investment loans, rates, and terms offered by each institution. Based on a borrower's financial situation, goals, and preferences, mortgage brokers can recommend a diversified lending strategy that optimises borrowing options and minimises risks and drawbacks.
Implementing Split-Banking Strategies: A Step-by-Step Approach
Now that we understand the concept, let's explore how to put split-banking into action:
Assess Your Financial Goals: Define your long-term financial objectives. For property investors, there could be some number crunching involved.
For Lending, use a Mortgage Broker: A broker can use their tools, contacts and connections to help assess multiple banks or even non-bank lenders that offer competitive interest rates, lending terms, and the services you require. This won’t (generally) cost you anything other than your time, so it’s going to be worth it! 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. If needed, apply for your 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. You’ll then need to have a lawyer handle some paperwork with the council: the old loan must be de-registered from your title (the legal description of your property), and the new loan must be registered. This might cost a small fee, though this is usually more than made up for by a cashback from your new bank, which your mortgage broker can help negotiate.
Automate Transfers: Set up automated transfers between your accounts to ensure timely allocations for bills, investments, mortgage repayments, and savings. Automation minimises the risk of oversight and late payments.
Regularly Monitor Accounts: Keep a watchful eye on your accounts to track balances, transactions, and performance. This vigilance ensures your investments are aligned with your goals.
Stay Informed: Stay updated on changes in interest rates, fees, and economic conditions. Being informed empowers you to make timely adjustments to your split-banking strategy.
Examples of Success
To illustrate the effectiveness of split-banking, let's consider a couple of theoretical examples:
You have an owner-occupied property, and a flood-damaged rental property in Napier. You are involved in lengthy negotiations with the insurance company to have your flood-damage claim paid. As the property is damaged you are not able to let the property. You therefore might find yourself in financial difficulty, and if you can’t afford to pay your mortgage, the bank could force the sale of your owner-occupied property to cover the debt you owe them. If your debt was at two separate banks, they couldn’t easily force the sale of your owner-occupied home. Naturally, the bank could pursue other legal avenues to recover their debt but at least it will provide you a few more options and time to have your insurance claim paid, or make other repayment arrangements.
Let’s say you own one home and two rental properties. The two rental properties are worth $500,000 each with mortgages of $400,000 each. You want to sell one rental to improve your cashflow and invest the $100,000 proceeds in a more diverse, lower risk way (for instance, in a managed portfolio). The bank conducts a credit assessment, and upon settlement, decides to take most of the proceeds of the sale of the property to reduce your overall LVR position. This is because the bank would take the remaining rental and apply the LVR rule at 65 percent, which is the current rule for rental properties, i.e., $500,000 x 65% = $325,000. That is the amount the bank can lend up to, based on current guidelines. Therefore, your remaining debt of $400,000 is in breach of the bank rules and they take $75,000 from the proceeds of the sale to reduce your LVR position. So, you only get $25,000 from the proceeds of the sale, when you were expecting $100,000! Again, if it was at separate banks then you could decide yourself what to do with the $100,000.
If this is all sounding pretty technical and complicated, the please contact one of our team. We are here to help.
The Bottomline: Use Multiple Banks
Diversification is the number one rule of investing. It applies equally to banking and lending too.
Remember, the key lies in aligning your banking strategy with your unique financial goals and circumstances to secure a brighter financial future.