All lenders are obliged by law to include a comparison rate when advertising a loan interest rate, but in the mortgage marketplace, comparison rates are often misunderstood amongst borrowers.
Essentially, a comparison rate is a way to help consumers identify the true cost of a loan. It is a rate that includes both the interest rate and the fees and charges relating to a loan, combined into a single percentage figure.
Most people just use the loan interest rate to compare different loans. Although this is a good start, it doesn’t take into account other costs such as establishment fees, approval fees, any upfront or ongoing fees that comprise the overall cost of a loan.
A comparison rate is made up of the following:
- the amount of the loan
- the term of the loan
- the repayment frequency
- the interest rate
- the fees and charges connected with the loan
It does not include the following:
- fees and charges associated with loan options or events that may or may not be used by the borrower, such as early repayment or redraw fees
- government charges such as stamp duty or mortgage registration fees
- doesn’t take into account features such as fee waivers, repayment flexibility, redraws and offset accounts which vary widely among loans and can reduce their cost significantly
- specific loan terms which will match with your own personal circumstance for comparison
- Fees and charges which aren’t available at the time the comparison rate is provided
A deposit bond is an alternative to paying the deposit from your own immediate funds. Deposit bonds can be issued for all or part of your deposit, usually up to 10% of the home purchase price. Once you’ve settled, the deposit bond amount is paid back to the lender. The fee for a deposit bond is usually less than the fees for breaking a fixed term or similar to get access to the cash you need.
Deposit Guarantees can be a low cost alternative compared to other options such as overdrafts, bridging finance or breaking a fixed term investment. It can be very useful if you have cash tied up in other investments such as shares or a term deposit or are waiting on the settlement of an existing property.
There are many situations where a purchaser has the ability to purchase a property but when it comes to the deposit they may not have easy or readily available access to a cash deposit or would prefer not to use their cash immediately.
For instance, if you are still waiting for the settlement on a property that is being sold, or you have a fixed term deposit account that you’d rather hold onto until settlement. Instead of using your cash for the deposit, you can use a Deposit Guarantee as an alternative.
Another benefit is for first homebuyers who may not be able to provide the deposit upfront until they receive a government grant or gift from family, which is often not accessible until settlement. In these situations a Deposit Power Deposit Guarantee is the ideal solution.
A Deposit Guarantee can often simplify the process of buying a property. For purchasers it provides a quick and convenient way of accessing a deposit without having to arrange other time consuming and expensive options such as bridging loans, the sale of shares or an equity release from existing property.
The deposit guarantee simply takes the place of the cash deposit required in the contract. A guarantee certificate is produced which is held by the sellers’ representative until settlement (usually their solicitor or conveyancer).
At settlement the purchaser simply pays the full purchase price including the deposit amount at which point the guarantee becomes void.
Equity is the difference between the value of your home and the amount you owe on it. For example, if your home is worth $900,000 and you owe $500,000, your equity is $400,000. As you pay off your home loan, your equity increases. You can borrow against the equity in your home to buy an investment property.
Lenders mortgage insurance (LMI)
Lenders mortgage insurance (LMI) is a security cost which is required if you want to borrow more than 80% for a standard loan, meaning if you don’t have a 20% deposit saved you will be stung with insurance which could end up costing you thousands. Essentially, LMI protects the lender if a borrower is unable to meet their mortgage repayments and the property has to be sold.
Depending on your lender’s requirements, Lenders Mortgage Insurance allows you to borrow up to 95% of the purchase price of your home, with a lower deposit than is usually required.
If the proceeds from the sale of the property are insufficient to cover the outstanding loan balance and other costs incurred by your lender in relation to enforcing the mortgage, the lender is able to claim any shortfall in accordance with the terms of the insurance policy.
Lenders mortgage insurance is calculated based on the loan amount and the loan value to ratio (LVR), the higher the loan to value ratio, the higher the risk to the lender and the more you will pay for LMI.
How can I avoid paying lenders mortgage insurance?
- Save 20% or more as a deposit
- Get someone to go guarantor for you loan
Loan To Value Ratio (LVR)
LVR is an acronym that stands for ‘loan to value ratio’. LVR is calculated by how much of a deposit (equity, or lack of) you have towards your home’s purchase price. Simply divide the loan amount by the value of the property.
A high LVR or a low LVR can greatly impact your success when it comes to applying for or switching home loans.To a lender, the lower your LVR the more likely they are to lend. Quite simply, it means you have cash equity in the property and should you default on the remaining money, they have retrievable cash not only from your loan but from the sale of your house.
Quite often home loan lenders will reward lower loan to value ratio’s (LVR) with superior home loan interest rates, terms and perks.
Ways your LVR will affect your borrowing if you have a high LVR:
- You may get a higher interest rate
- You may not be approved for a home loan
- You may be limited in how much you can borrow
- You may need to pay LMI (lenders mortgage insurance)
Different types of gearing
Gearing simply means borrowing money to buy an asset. In the case of property, you have taken out a loan to purchase a property.
Negative gearing means that the interest you are paying on the loan is more than the income. As a result you are making a loss.
Neutral gearing means that the interest you are paying on the loan is equal to the income.
Positive gearing means that the interest you are paying on the loan is less than the income. As a result you are making a profit.
The positives of negative gearing
So, if negative gearing means that you’re making a loss, how can that be positive?
Obviously nobody wants to get into property investment to lose money. Even though most property that you will buy will be negatively geared, that is the rental income is not as much as the interest repayment, the benefit comes from the capital growth.
Risks associated with negative gearing
While there are some certain benefits associated with negative gearing, it isn’t without its pitfalls.
When you negatively gear your property, you still record a loss. And a loss is a loss. Before you commit to negatively gearing your investment property (or multiple investment properties) it is worth considering what the repercussions of doing so are.
- What happens if you have difficulty filling your rental property at any one time?
- What if there is a dramatic turn down in property values and your investment fails to increase in value?
- What if interest rates rise very quickly and you have just agreed with your tenants that you will not raise rents for at least 12 months?
These are not questions that should be answered quickly or treated lightly. Take the time to do your due diligence and know how you would cope if any of the above scenarios came true. If you are confident that you could easily handle any losses in income etc, then you are on the right track.
Of course, if you do choose to negatively gear your property, there are some easy ways for you to minimise the risks associated with doing so.
Minimising the risks of negative gearing
Choose your investment property wisely: Buying a property that is located near all the major amenities and appeals to a wide range of tenants should help you to ensure your investment property is never vacant for very long.
Manage your income: When managing an investment property, there are times when it will cost you a significant amount of money – when the property is vacant, when it needs repairs etc. So, before deciding on negative gearing make sure you have enough income to successfully manage all the expenses that come with owing a property – not just day to day expenses, but all expenses.
Protect yourself and your investment: As a property investor, it is critical that you adequately protect and insure not only your property, but yourself in the event that unforeseen circumstances arise. It never hurts to be prepared for the worst case scenario. You can speak to your mortgage broker or financial planner to learn more about the types of insurances you should have as a property investor.
Negatively gearing an investment property is not a decision that should be made lightly. Before making any decisions, it is important to consult with a professional. A mortgage broker can step you through the whole process, identify the risks associated with negative gearing and help you formulate a plan to not only minimise the risks, but tackle any hurdles that you may face during your investment journey. Speak to us at Paragon Lending Solution to see the various ways in which we can help.
Stamp duty is a charge which is applied by state governments in Australia and is in relation to the transfer of land or property.
The State Government charges may vary depending on the purpose of the security purchased. For example the charges will differ if you buy an owner occupied property as a First Home Owner or as the one who has owned a property before.