Ok, lets look at a basic breakdown on what you need to know about finance in the Real Estate game.
SERVICEABILITY
As you may have come to realise, if you can't afford to buy a property outright, you will need to get finance from a lender.
In order to get finance from a lender, you need to show the bank that you can afford to pay the repayments on the loan, plus live life comfortably. This is calculated on "your income, minus, your liabilities/expenses".
They will factor in all of your every day living expenses, most of which will be based on your personal situation. For example, if you are single with no kids, your everyday living expenses will generally be less than a married couple with 2 kids.
Thus, the banks want to know you can afford to live comfortably PLUS pay down your loan without coming into financial hardship. This is what the banks deem as serviceable.
Things that negatively affect your serviceability include;
Dependents
Personal Loans
Car Loans
Credit Cards
Any other debts
Bad credit
Inconsistent income - can include casual or probationary status too.
LVR
Now, the catch is that, even if you are deemed to be able to service the loan, the banks won't lend you 100% of the purchase price, because that would mean they would be putting themselves at risk.
Therefore, they will only give you a percentage of the purchase price - for example, they will give a client 80% of the purchase price, this is leaving room to move, in case the clients completely default on their repayments and the lender needs to sell the property, they will be able to sell the property for a minimum of 80% of the purchase price and still walk away with what they invested.
This is what we call in layman's term a buffer. The percentage figure is known as LVR, or Loan to Value Ratio, eg. 80% loan to the value of the property. Normally the maximum a bank will lend you will be 95% of the value of the property.
DEPOSIT OR EQUITY
Ok, so the bank will give you 80% of the value of the property, that's great, but that means you have to come up with the other 20% (or 5% if its a 95% lend - you get the drift).
There's 3 ways you can do this;
1. Save for a deposit - Obviously this is pretty basic. But in most cases the lenders want to see that you can save up for a deposit over time. For first home buyers, some of the lenders will actually factor in 6 months worth of rental history to represent "genuine savings"
2. Use equity in your current home - Attention! you must own a home to use equity! This means, that you have a current mortgage that is less than the value of your home then you have equity on your home. Eg. your home is valued at $500k and you only owe $300k, then you have $200k in equity in your home which you can "redraw" to use as a deposit on another property. Read our article Property Investor Dictionary for more on equity.
3. Use a Guarantor - In some cases, particularly for first home buyers, you can get someone to go guarantor on a property by covering your deposit. Most times this will come from a family member who will use a portion of their equity to cover the deposit. The Guarantor can be paid out over time and then released off the title on the loan.
It is also good to note, for most states, the First Home Owner Grant can be used towards your deposit on your first home.
LMI
What happens when you go over 80% LVR? The banks will normally charge a fee called LMI or Lenders Mortgage Insurance. This is an insurance fee that will be added to your loan. The higher the % the bank invests into the property the more risk the bank takes, therefore they get insurance to cover the difference. LMI is not always a bad thing, in some cases, it may mean you can put in less deposit but borrow more, for a small fee. Keep an eye out for our upcoming article on "LMI can be your friend".
VALUATION
Ok great, so you have the deposit sorted, your serviceability stacks up and you are approved for a loan. Before you can purchase the property, the bank needs to assess what they are investing in. This is done through a Valuation. Banks will normally have a panel of independent Valuers which they will send out to assess the property, on their terms, before they will give you the loan. Bank Valuations are normally pretty conservative and based on comparable sales, with a "glass half empty" view.
NOTE - Bank valuations are very different to Real Estate Appraisals. It is not abnormal for bank valuations to be 3-5% less than the asking price. You can often get varying results from different valuers, as it is based on their opinion.
If there is anything else you wish to know about home loan basics, then please feel free to contact us.
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