What Is Equity?

Equity is the difference between what your property is worth and the amount you owe on it. For example, if you had a home loan of $200,000 on a property worth $500,000, you would have $300,000 equity available in your property. Equity grows as the loan size decreases or the property value increases (usually both at once).

If you have significant property equity, you may wonder if you can increase your home loan (or take out a new loan) against this equity.

Myth

Many borrowers mistakenly believe that having substantial equity in their property will automatically qualify them for a loan. After all, the risk to the lender seems relatively low: If you default on your loan, the lender could take legal possession of your property and sell it to recover the amount you owe them quickly.

Reality

Equity is one factor lenders consider when deciding whether to approve a loan. Mortgagee in possession sales, which occur when the lender takes legal possession of a property and sells it to recover the outstanding amount owed to them, are often messy and drawn-out affairs, so they are certainly not a first resort for lenders.

In addition to having sufficient equity in your property, lenders also need to be satisfied that you have adequate ‘borrowing capacity’ to repay the loan; this is, you are receiving sufficient income to be able to afford the ongoing repayments you’ll be required to make, along with any other financial commitments you may already have.

They’ll also consider several other factors when deciding whether to approve your loan. These include, but are not limited to, the property’s location, credit history, assets and liabilities, expenses, and loan purpose. 

So, while equity is an essential factor that lenders will undoubtedly consider when deciding whether to approve your loan, it is not the only factor, so significant home equity is no guarantee that you’ll be approved. A mortgage broker can consider all these factors and provide information about your likelihood of being approved for a loan with a wide range of lenders, saving you a lot of time and hassle.

The Exception

There is one situation where you can borrow based on the equity in your property without having to satisfy regular borrowing capacity requirements, which is in the case of a Reverse Mortgage. These are only available to a small portion of borrowers, usually those aged 60 and over, and are only offered by a few Australian lenders.

In effect, a Reverse Mortgage allows an eligible borrower to borrow funds solely against the equity in their property. The amount you can borrow against your property usually increases as you age. No repayments are made while you live on the property, but interest and fees will accrue and compound during the loan’s life. Once you sell the property or pass away, you or your estate must repay the loan plus all accrued interest and fees. 

Myth

Sometimes, as Mortgage Brokers, we advise clients that they don’t have enough borrowing capacity to afford the home loan amount they initially hoped for. When this happens, we will continue to work with clients to help them understand ways to improve their borrowing capacity in the future or to adjust their home purchasing budget based on what they can currently afford.

Often, when someone has insufficient borrowing capacity for the amount they hope to borrow, they ask us if having a guarantor on their loan will help them get it over the line. This is because there is a common misconception that a guarantor’s income can be used to increase borrowing capacity.

Reality

Generally, banks lend 80% or less of a property’s value. This is because if a borrower fails to repay their loan and the lender has to sell the property, the lender can be reasonably confident that it will recover all monies owed even if the property has dropped in value. 

When borrowing more than 80%, most lenders charge Lenders Mortgage Insurance, or LMI, to the borrower (although it’s important to note that some lenders and home buying schemes allow borrowers to borrow more than 80% without LMI). LMI is a type of insurance that covers the lender (not the borrower) against any potential losses if the property has to be sold for less than the amount owed against it. It can cost thousands to tens of thousands of dollars, depending on how much is being borrowed.

A guarantor is commonly only used when a borrower wants to borrow more than 80% of the value of a property without paying LMI. A guarantor, almost always a parent, provides security to the bank by offering their property as additional collateral. This means the bank has additional property that can be sold in case of a loan default.

Having a guarantor does not replace the borrower’s need to show they can repay the loan. The borrower will still need to demonstrate sufficient borrowing capacity to afford the loan without assistance from the guarantor. A guarantor can help reduce the amount of deposit required by the borrower and help the borrower save on LMI costs.

The Exception

Like all good rules, this one also has an exception – but only in a few cases. In some situations, a spouse may be able to guarantee the other spouse’s loan. Outside of spouses, one Australian lender allows eligible high-net-worth individuals to provide a ‘servicing guarantee’ for other eligible family members; however, eligibility criteria are very strict and are not available to most borrowers.

Myth

Many borrowers believe that a high credit score is the main factor in obtaining a loan approval. Additionally, many borrowers think that a good credit score means they’ll be offered a better interest rate than someone with the same loan but a lower credit score.

Reality

Many lenders consider a borrower’s credit score or credit history when deciding whether to approve a home loan application. However, even with a perfect credit score, a lender will consider many other factors when determining whether to approve your loan application. These factors include but are not limited to, your income, employment situation, property location, assets and liabilities, expenses, and loan purpose. 

Some lenders do not use credit scoring; instead, they consider your overall conduct and history part of the approval process.

Additionally, in most cases, a credit score is not usually a key factor in determining the interest rate you will be offered. Most lenders offer a standard rate for each loan type they offer. For example, a basic no-frills loan may attract a lower interest rate than a packaged loan with many features.

Depending on the loan size or other products held with the same lender, lenders may discount their standard rate for specific individuals. However, you’ll unlikely receive a rate discount solely due to a good credit score.

The Exception

While an excellent credit score won’t usually get you a better interest rate than someone with an average score, a chequered credit history can impact you. Not all lenders and loan types are available to people with poor credit histories, so the loan options available to these borrowers are often more limited. In many cases, lenders and loan types available to borrowers with poor credit histories may have higher interest rates than mainstream loans.

Talking to an experienced mortgage broker can help you understand what options may be available based on your unique situation.

What Is A Comparison Rate?

A comparison rate is designed to help you compare the overall cost of loans at a glance by factoring in both the current interest rate and additional charges such as annual or monthly fees, establishment fees, and discharge (loan closure) fees. Comparison rates are calculated using a standard formula set by the National Credit Code: They assume a loan size of $150,000 over a 25-year term with monthly repayments.

Myth

The first question most borrowers ask us is, “What is the lowest interest rate you have available?” A great interest rate is undoubtedly important and is one of the key factors to consider when choosing a home or investment loan. However, it’s a common misconception that the loan with the lowest interest or comparison rate is always the best deal.

Reality

The loan with the lowest interest rate is sometimes the best deal or the right fit for your needs and circumstances. There are many reasons for this, including but not limited to the following:

• Not all home loans offer the same features. For example, having a redraw facility, an offset account, or the flexibility to make additional repayments may be necessary and ultimately save you money in the long run. However, the loan with the right features may not be the lowest-rate loan.
• Different lenders have different policies and turnaround times, so not all lenders and loan types are appropriate for all borrowers regardless of rate.
• Interest rates are only part of the total cost of a loan. The fees for each loan must be considered when determining whether it is a good value proposition overall.
• Interest rates can – and do – change over time. This means it’s hard to be sure that today’s lowest-rate loan will still be the lowest-rate loan a month or a year from now.

Likewise, comparison rates rarely tell the whole story. Since they are calculated using a loan size of $150,000 over a 25-year term with monthly repayments, they will not be accurate for most people’s circumstances. (According to the Australian Bureau of Statistics, the average loan size in Australia as of April 2024 is $627,791!) .Additionally, comparison rates are based only on current rates, likely to change over time.

What Is Pre-Approval?

Home loan pre-approval, or approval in principle, is when a lender agrees to provide you with a loan up to the agreed amount, providing certain conditions are met.

It involves submitting a loan application to a lender, including your personal and financial information.

This is usually done after you decide you’d like to purchase a home or investment property, but before you’ve found the property you intend to buy or before a property you are interested in goes to auction.

Myth

Many borrowers, particularly first-time home buyers, believe that having a loan pre-approval ensures that their loan will be approved when they are ready to make a purchase.

Reality

Pre-approval gives you a good idea of your borrowing capacity. However, it does not automatically mean your loan application will be approved when you find the property you want. In most cases, pre-approval should be considered a guide only. 

There are a few reasons for this. Firstly, most lenders do not ‘fully assess’ pre-approvals. This means they will indicate a likelihood of approval up to a specific limit based on the information provided in the application.

However, the lender will usually not conduct extensive checks on your income, supporting documents or credit history until you are ready to proceed with a complete loan application.

Note that some lenders thoroughly assess pre-approvals in certain circumstances, so it’s essential to chat with an experienced broker to discuss which lenders might be a good fit for your situation.

If your financial situation changes between pre-approval and the time you decide to proceed, or the bank takes a different view of your financial situation than the information you initially provided, it is still possible for the loan to be declined.

Additionally, the bank must be satisfied with the property you intend to use as security. Suppose the property valuation is lower than expected, or they have concerns about location or structural issues. In that case, they may decline the loan (or reduce the loan amount) even if you meet all the other criteria.

Myth

Potential home buyers have traditionally been advised to aim for a 20% deposit to purchase a property. For example, if you want to buy a property worth $500,000, a deposit of $100,000 would be optimal. Many people still believe that a 20% deposit is still mandatory.

Reality

A 20% deposit is still the ‘gold standard’ when saving up a deposit to purchase a property. A 20% deposit means avoiding paying the Lender’s Mortgage Insurance, or LMI (see definition earlier in the article). Sometimes, a 20% or more deposit can land you a better interest rate.

However, the rising cost of living makes saving up a 20% deposit out of reach for many people. 

Fortunately, there are still options to enter the property market with a smaller deposit; in some limited cases, you may need as little as a 2% deposit plus sufficient extra funds to cover expenses such as legal fees, moving costs, and stamp duty.

Below is a list of some of the options that may be available:

• You may be able to borrow more than 80% of the property value by paying LMI to the lender. Usually, the amount you can borrow using this option is capped at a maximum of 95%.
• As a first-time home buyer, you may be able to have a close relative (usually a parent) act as a guarantor on your loan. That means they put their property up as security for your loan in place of you paying a full 20% deposit or paying LMI.
• You may be eligible for a state or federal government scheme that allows you to enter the property market with a deposit of as little as 2% – 5%, depending on your circumstances. Places for these schemes are limited and have strict eligibility criteria. They are only available to restricted groups of buyers, including some eligible first-home buyers, rural home buyers and single parents.
• If you have an existing property with more than 20% equity, you may also be able to use this in place of a deposit to purchase an additional property.

Additionally, some schemes are designed to help eligible first-home buyers save a larger deposit inside their superannuation by taking advantage of concessional tax rates.

How Are Finance Brokers Paid?

While finance brokers may charge fees for some or all of their services, the most significant portion of their income (or sometimes all of their income) usually comes from commissions they receive from lenders. 

Most of the time, when a finance broker successfully settles a loan with a lender, that lender will pay the broker an upfront commission equal to a percentage of the total loan amount drawn down (i.e. used) by the client (although some loan types, such as bridging loans, tend not to pay any commission to brokers). 

In addition, the broker will usually receive a monthly trailing commission from that lender for as long as the loan stays active. The trailing commission is equal to a small percentage of the amount the borrower owes each month.

Myth

Since finance brokers receive commissions from lenders, borrowers may worry that a broker will be more likely to push them into a loan that pays a higher commission regardless of the client’s best interests. 

Reality

Several safeguards are in place to ensure that mortgage brokers do not push clients into loans that pay the broker the best commission.

Firstly, most lenders pay a similar percentage in upfront and trailing commissions. Where there is a commission difference between various lenders, this will be small in most cases.

A broker must outline multiple options to potential borrowers (where numerous options are available) and disclose any anticipated commission in writing to ensure the client is fully aware of any incentive the broker will receive for each option.

Secondly, finance brokers are required by law to act in the best interest of their clients and keep extensive written records demonstrating the options they have considered and how they have put their client’s needs ahead of their interests. This requirement is known as Best Interest Duty and is regulated and enforced by ASIC. 

In addition to the legal obligation for finance brokers to act in their client’s best interests, there are strong practical reasons for doing so.

If a client ends up with a loan that doesn’t meet their needs and decides to refinance or close the loan within the first two years, the broker often has to repay some or all of the commission earned from the lender.

This effectively means that if a broker prioritises their commission over the client’s best interest, they risk losing any commission they initially earned.

Therefore, it’s in the broker’s best interest to ensure clients receive the most suitable loan. This leads to satisfied clients and protects the broker’s earnings.

By focusing on providing the best loan options, brokers build trust, encourage long-term client relationships, and secure their financial stability.

Several safeguards are in place to ensure brokers have a legal, ethical and professional obligation to act in their client’s best interests. Having said that, it’s essential to know that if you feel this obligation has been breached at any time, you have every right to seek a second opinion.

Additionally, brokers must provide you with a document outlining both internal and external channels for raising concerns or complaints, and you also have every right to pursue these options if you feel your concerns have not been adequately addressed.

If you’re looking for a home or investment property loan, it’s crucial to have access to accurate and personalised loan advice. With over 25 years of experience in the lending space, NBS Home Loans can help you sort fact from fiction when it comes to home and investment property loans. For more information, call Marty Walmsley on 0434 103 326 or email at marty@nbshomeloans.com.au.

NBS Home Loans. No BS, just great loans and great service.