Have you ever found yourself looking at personal loan contracts or mortgage loan application forms, flicking through them quickly without much knowledge or regard for the terminology used in them?
Have you seen terms such as LVR, LMI, interest-only loan, leverage, home equity loans, collateral, CPI, HPI, inflation, deflation self-managed super and a raft of others? I thought it would be a good place to start by explaining what these terms mean to everyday people so that they know what they are looking at when they get a loan application form or when brokers and accountants give suggestions about how and where to invest money.
- Loan to Value Ratio (LVR): The loan to value ratio is typically stated as the amount of money borrowed based on the deposit taken by the bank as a fraction of the total purchase price. This particular term is commonly used to determine how much the bank wants as a deposit for a particular loan format and is primarily used for mortgages and not other asset purchases. An example would be a person buying a house for $1000000 in Sydney with the maximum LVR allowed being LVR 80 (or 80% of the cost price being borrowed) meaning that the minimum deposit required for the property is $200000.
- Lenders Mortgage Insurance (LMI): This is a fee paid by borrowers who decide that they do not want to deposit the minimum to meet the LVR required for a certain loan structure. It is supposedly a way to alleviate credit risks for banks based on the fact that the borrowers haven’t got the amount of money required for a deposit normally. LMI means that banks are willing to lend borrowers more money as the contractual agreement states that the borrower is willing to pay more in the long term.
- Interest-only loans: The term “interest only” is intentionally vague as it does not describe the implications it has on future repayments and is almost always a loan given for speculative purposes. The reason I say that interest-only loans are for speculative purposes is primarily the fact that the repayments on the loan do not pay off any of the principal costs of the loan, i.e. you are not paying anything off the initial property price in the hope that it will go up in market value.
- Leverage: Leverage is simply the ratio of borrowed money to money used as a deposit (i.e. if a borrower puts down 100k and they buy a 500k house, the leverage is 5:1, or “five to one” leverage).
- Home-equity loans:
- Low-doc loans:
WILL UPDATE SOON