A house can be bought with as little as a 5% deposit!
The general deposit that a bank requires is 20% for a ‘standard’ home loan.
So, to buy a house you need anywhere from a 5%-20% deposit plus savings for stamp duty, government fees and other transaction costs including legal and bank fees. Lenders Mortgage Insurance (LMI) will also be charged if your deposit is less than 20%.
Loan to value ratio or ‘LVR’ is the term used to describe the percentage of the loan amount in comparison to the value of the property or security.
The term LVR is used to describe the value of the security which does have an impact on overall loan terms, conditions, and pricing. The standard LVR is 80% of the property’s value which means that the borrower has made a 20% deposit.
The LVR can be determined by dividing the total loan amount over the total security value.
E.g. with a total debt of $500,000 and a property value of $695,000, there is an LVR of 72%.
Other common LVR bands are 90% or 95% but there is no set value for each customer. In reality, the LVR will be based on how much deposit the customer wants to put in.
Lenders Mortgage Insurance or ‘LMI’ is a form of insurance that the bank takes out on behalf of the borrower if the loan to value ratio is greater than 80%. The insurance protects the bank in the event that the property cannot be sold to pay out the full debt if the borrower cannot pay back the loan.
The cost of LMI can be added to the loan and costs approx. 2% of the total loan with a 10% deposit (90% LVR). It can be as high as 5.5% with a 5% deposit (95% LVR).
LMI helps borrowers to buy a property quicker as they can complete on a purchase much quicker. Quite often it is more cost effective to pay LMI on a property up front rather than to save a full 20% deposit.
E.g. Sam and Sally have both saved 50k and want to buy a property for 500k. Sam decides to borrow right away and can purchase a property with a 90% Loan. His LMI is cost is 9k which is added onto the loan.
Sally decides to try to save her full 20% deposit and can save 1k per month. It takes Sally just over 4 years to save the full 100k deposit needed to complete the purchase.
Sally is ready to buy her 500k property, but the problem is… The properties that were 500k are now 584k (using a 4% growth rate). She now only has an 11% deposit because the growth rate on property has been much quicker than her savings rate.
LMI is a toll that borrowers can use to purchase a property sooner, there is a cost but in most cases this is outweighed by the benefits of property ownership which can include capital growth.
Some people will say that LMI is a fee that is paid for the banks benefit, this is correct but keep in mind that the bank doesn’t get the benefit of capital growth so they do have to protect their own downside.
Fixed and variable refer to the interest rate structure of a loan. Fixed rates are locked in for a set period of time and cannot change, furthermore, the repayment on a fixed-rate loan cannot change during the set term.
Variable rates are floating and can be moved by the lender (up or down) depending on the economy. For home loans the banks will typically move variable rate loans when the RBA moves the cash rate but under a variable rate loan the lender can change rates at their own discretion.
The benefits of a fixed rate structure include:
The benefits of a variable rate structure include:
Borrowers can have the best of both worlds with a mix of fixed and variable possible!
Refinancing is the process of establishing new loans to replace existing ones. Refinancing is now common practice given this is now a simple process (thanks to the help from your broker!).
Refinancing can provide a number of benefits:
A broker plays a crucial role in assisting with refinances as they will assess your options and recommend the best possible loans for your situation.
Refinancing can also be an important step to purchasing new properties as a refinance can be the stepping stone to facilitating new loans.
Offset is actually an Aussie invention!
It is a term used to describe a loan feature that allows an interest saving for the customer. Offset refers to the bank charging interest based on the loan amount less the amount of cash held in a linked deposit account. Effectively a customer’s cash is used to offset or minimise the loan balance, it replaces the need for the borrower to manually transfer cash into their loan account to reduce interest costs.
The offset feature is a common feature on most loans however does come with an added cost so its important to assess the benefit of paying a higher rate to access this features.
Offset is also generally only available on variable rate loans but there are some lenders who now offer offset against fixed rate loans.
Equity is the difference between the total value of assets and the total value of liabilities. The borrowers initial deposit is their equity to start off with however the equity position will change as the property value moves in line with the market and the debt is repaid (with principle and interest repayments) or not repaid (with interest only repayments).
Equity is important because this is the borrowers share of the property.
E.g. Kat and Kevin both have home loans. Kevin’s home is valued at 900k and her loan is for 700k whereas Kat’s home is valued at 800k and her loan is just for 500k.
Kevin’s property is worth more however Kat has more equity. Her equity is 300k (800 less 500) in comparison to Kevin’s equity of 200k (900 less 700).
Equity shows the borrowers clearer position, it is also important as an equity value of > 20% indicates that a borrower may be ready to buy a new property!
The brokers job is to help their customers with the loan application process but in reality they do much more. Arranging finance should be the first step in a property search because a property should not be bought without having a loan strategy in place.
A good broker will help you to manage the overall property process starting from initial search to ongoing loan management.
Brokers are well versed in property in general and can also provide general advice on properties along with assisting by providing valuation and market insights!
Brokers get paid by the banks when loans are settled. The banks make this payment as brokers do provide a service to the banks and replace their own staffing costs.
Generally the brokers service is free of charge but in some cases an initial fee is charged to the borrower. If this is the case this has to be advised up front and agreed to before the application proceeds.