The new year has revealed a few cracks in the already questionable property investment strategy of placing little equity down, using an interest only loan, desktop revaluing the property ASAP, before ripping out that equity to buy another property.

It’s something that works, as long as the property market continues to move higher and lenders are prepared to keep extending these investors more and more credit on favourable terms. The second one is now becoming very clouded.

Last year the Australian Prudential Regulation Authority (APRA) began a crackdown on interest only mortgages. Interest only has become a mainstay of many property investment strategies. Since then, stories have emerged of prominent property investors running into cashflow problems. While companies that “advise” investors are finding their clients’ lenders are moving them to principal and interest loans.

Shock horror – they may have to start paying the principal back! Who’d have thought?

The owner of one company (don’t call them an adviser, lest ASIC take interest) was squealing that his members’ (don’t call them clients, lest ASIC take interest) payments would be increasing by nearly 50%. While according to the Australian Financial Review, another investor, Nathan Birch, regularly featured in breathless media profiles touting how many properties he’d purchased before age 30, was sued by a lender for falling behind on payments.

These issues raise two important points.

Firstly, the companies involved in “advising” investors with these strategies exist in a grey area. It helps them get away with not being regulated in any meaningful way, despite the fact they’re facilitating financial transactions in hundreds of thousands of dollars and taking a cut somewhere along the way.

This is financial advice, whether they want to accept it or not because they’re advocating a financial strategy. Albeit particularly terrible financial advice, because the strategy leaves an investor woefully undiversified with a massive level of risk.

Unless this change in lending conditions was accounted for, these investors will be forced to scramble to find the difference or in the worst case be forced to start liquidating assets. Heightening the level of risk, they’ve often put little equity in while making no principal repayments. Why? They clearly assume the market will only go up.

Secondly, according to AFR, Mr Birch was being sued by a non-bank lender and his interest rate was 6.94%. Not cheap in the current era. Visit the website of his lender’s parent company and they’re offering a juicy 5.2% on your savings for 12 months. A lot more appealing than bank interest – and a lot riskier. The money you’re giving them for 12 months is going to investors like this who seem to now be beyond the barge pole of mainstream lenders.

We’ve talked before about those generous, better than bank interest, mortgage debenture funds. A lot of people lost a lot of money when a couple of them blew up 2-3 years ago. There’s no suggestion that’s about to happen again, but it appears there are a whole heap of nervous property investors who’ll either need to sell or turn to a lender of last resort to maintain their grip on their assets.

Anyone pondering the 5%+ interest returns offered by these institutions needs to be aware of this.

As for Mr Birch, he’s recently started talking about getting into cryptocurrencies…

This represents general information only. Before making any financial or investment decisions, we recommend you consult a financial planner to take into account your personal investment objectives, financial situation and individual needs.