a deposit. It will also ensure your finances are squeaky clean when it comes time to apply for finance by doing things such as reducing the number of credit and store cards, and paying down or paying off personal loans — these can all negatively impact your borrowing capacity.
If you are re‐entering the market after a period — perhaps following a relationship breakdown or the death of a partner — and already own a property, then a broker will also be able to help you understand how much equity you may have available to recycle into another property. We're going to talk about this element in chapter 6.
WHAT IS EQUITY?
Equity is the difference between the current value of a property and its outstanding mortgage, minus about 20 per cent of the value, which the lender likes to retain as a safety net.
For example, a property valued at $800 000 with a mortgage of $400 000 may have about $260 000 in equity that could be used to purchase another real estate asset.
WHAT'S WITH ALL THE ACRONYMS?
It's about this time in a new, or returned, property buyer's journey that they start to come across a whole bunch of terms and acronyms that it will pay for them to understand. And, when it comes to finance, the two big ones to do with your mortgage are LVR and LMI.
LVR is short for loan‐to‐valuation ratio — the ratio of your property loan compared to the value of the property you want to buy. So, if you purchase a property for $500 000 and you have a deposit of $100 000 — 20 per cent of the purchase price — then you have an LVR of 80/20.
Most first‐time buyers don't have a 20 per cent deposit, because it is difficult to save such a high figure while also paying rent and normal household expenses. However, just because you have less than this figure as a deposit doesn't mean you won't qualify for a property loan, although it might mean you need to change where and what you are looking at buying (more about that in later chapters). Your broker will be able to provide advice on the lenders best suited to borrowers with higher LVRs of, say, 90/10 — 90 per cent (loan) versus 10 per cent (deposit).
In Australia, the catch is that you will need to pay something called lenders mortgage insurance (LMI) — yep, another new acronym to learn. LMI is a fee that is charged to borrowers with a deposit smaller than 20 per cent of the purchase price of the property.
Now, it might sound like it's an insurance policy for you, but it's not. It's insurance for the lender via an additional fee from the buyer because of the perceived higher risk in lending money to a borrower with a smaller deposit.
Here's the truth about LMI: no one likes paying it, but if it makes the difference between you getting into the market sooner — or even at all — then it can be used to your advantage. That's because paying LMI, which can also be capitalised (added) onto the loan, is often a small price to pay compared to the potential capital growth the property could earn you over the additional years you will own it. For property investors, having larger property loans can also provide tax advantages, given it is only the interest component of a mortgage that is tax deductible — you should discuss this with your accountant.
NICOLA TELLS:
HOW LMI HELPED PAY FOR A PENTHOUSE
I bought the first three properties for my portfolio when I was single, earning an average wage.
My first one, in 2007, was when the Brisbane property market was going through a rare growth phase. There were buyers everywhere and not much stock on the ground. The deposit I had saved wasn't enough to secure me anything likely to improve my finance lot in life.
So my younger brother and I decided to buy something together, with some help from our parents, and I made peace with paying LMI to make it happen.
I bought my brother out of his share of that property a few years later. I ended up borrowing against that property twice more to add to my portfolio.
I recently sold that first one, which was a townhouse in a rather bland (at the time) middle‐ring suburb, and it has helped finance my dream property — a riverfront penthouse.
UNDERSTANDING MORTGAGE REPAYMENTS
A key decision to make when you're applying for a mortgage, or refinancing an existing one, is whether you want to have fixed or variable interest rates on the loan. There is no right or wrong answer to this question, because it will depend on what the best strategy is for you at the time.
A fixed interest rate is usually a lower percentage than variable. Sometimes this can provide financial peace of mind, especially if there may be a change to your income in the short term, such as changing jobs, studying, or having your first, or your next, child.
However, fixed‐rate mortgages generally have a number of limitations, including restricting how much of the principal loan amount you can pay off over the fixed‐rate period, which is generally between one and five years.
A property loan with a variable interest rate means that the interest rate can go up or down depending on the monetary policy of the Reserve Bank of Australia (or equivalent) as well as your lender's own interest rate movements. There's no question that choosing between a fixed rate and a variable one can mean thousands of dollars in savings over the life of the loan, which your mortgage broker can outline
Loan structure is just as important, though, if you ask us.
Many borrowers get so fixated on interest rates that they forget about loan structure entirely, so they rush in and sign up with a lender for a five‐year fixed rate just because they're the cheapest, without reading the fine print. Then not long after, their circumstances change unexpectedly — life is like that — and they find themselves stuck with a loan that they can't change or refinance because the only thing they considered was the super‐low interest rate that was dangled like a golden carrot in front of them at the time.
BREAK FEES — WHAT ARE THEY?
You need to be aware of break fees, so here goes.
A break fee represents the bank's loss if a borrower repays their loan early or switches their loan product, interest rate or repayment type during a fixed‐rate period.
When the bank agrees to lend you money at a fixed interest rate, they obtain money from the ‘money market' out there at wholesale interest rates based on you making your repayments as agreed until the end of the fixed‐rate period. If you don't, and wholesale interest rates change, then the bank may make a loss. They try and recoup this loss by charging you a break fee.
These considerations are why it's vital to consider — as best you can — all your options, as well as the likelihood of
