The meaning of equity

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From: John Lewen


I have a question about equity that I'd like answering. I talked to a financial advisor recently as part of the process towards the purchase of a property. I have $30000 deposit and we used $170000 as the loan amount (ie a $200000 property - disregarding costs) in our discussions. When the subject of equity came up, I assumed that the $30000 I put in to the property would be equity I could draw against (eg, possible line of credit use), as it would be secured by the $200000 value of the property. However, he explained that his financial institution did not regard that as equity that could be drawn against. He spun some figures around that basically said that if I defaulted on the loan it would cost them more than the money I had in the property to dispose of it and get their money back. Is this correct? Is it the usual practice for financial institutions or was I being spun a line of bull? It would seem to me that at least some of that $30000 of mine would be equity straight away and therefore available for me to draw against. Could someone please help me out here? Any other information that would be useful to me in this context would also be appreciated.

Cheers

John Lewen
 
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Sim

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Reply: 1
From: Sim' Hampel


Lenders generally require you to put a deposit of 20-30% down before they will lend you money on a property. Of course you can lower this requirement by paying Lenders Mortgage Insurance (LMI), down to around 5% or less in some cases.

One of the main reasons for doing this is to cover themselves if you default on the loan and they need to sell the property to recover their money. By keeping this buffer between what you owe and what the property is supposedly worth, they can be more sure of getting their money back if they are forced to sell below full market value.

This deposit you put in, and indeed any extra money or any principal repayments you make all increase your equity in the property. By technical definition, your equity is calculated as simply the value of the property minus the outstanding debt (loan amount).

So using your example:

<PRE>
equity = value - debt
= 200,000 - 170,000
= 30,000
</PRE>

Now this figure expressed as a percentage of the value is 15%. Hence you have an 85% LVR (Loan to Value Ratio), which is not uncommon.

Now for exactly the same reason you were required to put a deposit of 15% in, the bank will not let you draw out any more than a maximum of 85% of the value of your property (the actualy maximum figure varies depending on lender and on whether you pay LMI).

So, even though you technically have 15%, or $30,000 of equity in your property, the lender will require you to keep this available to cover themselves if you default. This is standard practice, and the result is that this money is effectively "dead" equity.

Now there are two magical things that happen. One, the value of your property goes up, say by $20,000 to $220,000. Also, you make some extra repayments, so your debt drops to $160,000.

You go to your bank and ask for a LOC for 85% of the new value of your property. They look at how much you owe, and the current value and work out the following:

value = $220,000
debt = $160,000
85% of value = 220,000*0.85 = $187,000
difference between 85% of value and debt = 187,000 - 160,000 = $27,000

... and so they set you up with a LOC for $27,000 !

Cool huh ?

If this hasn't really helped you understand, I suggest you spend some time with an independant mortgage broker, who can advise you on how to best structure your borrowings, and explain in more detail how it all works !

 
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Reply: 1.1
From: Kevin Forster



Better still if it's not explained grab some books from the library or local bookstore that explain this. I think Jan Somers books may explain it or else get a hold of "Making Money Made Simple" by Noel Whittaker. It has a lot of financial things explained in laymans terms.

I only say this because mortgage brokers get paid to set up loans for people by the financial institution. And Sim aint going to be coming around to my place to install a video capture card and CD burner for free :)

Kevin
 
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Reply: 1.1.1
From: Rolf Latham


Hi Kevin

Please elaborate on your views here, I think this could prove to be a very valuable discussion point.

Ta

Rolf
 
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Reply: 1.1.1.1
From: Kevin Forster


Rolf

What I was meaning is that imagine, if you had say 20 appointments for the week and each one all you did was explain what DSR, LVR and how they are calculated and what the difference between a P&I loan and an IO loan but no one wanted a loan from you. If this happened for 3 months a mortgage broker would go broke. My understanding is that most mortgage brokers get paid by the financial institution rather than the consumer if they get new business for the FI.

The real point I was making is that not only should people learn about IPs but also the financial side. In some ways, setting up your financials correctly can make or break you in getting out of the rat race rather than the type of property, suburb etc.
 
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Reply: 1.1.1.1.1
From: Rolf Latham


Hi Kevin

It happens to some extent that way anyway. On average, depending on the quality of your "qaulifying" most brokers would be good to convert 10 to 30 % of imquiries into sales.

My attitude to that is very very simple. You cant just take the good deals and dump the difficult. Commonly the hard deals are where you will get your largest referal base from.

Or in other words the more dead enquiry you get the more good business you get, so ask away.

Our surveys show that > 95 % of clients perceive the broker to be on the clients rather than the lenders side. The important thing here is to ensure you use an independent broker rather than a mobile lender.

Ta

Rolf
 
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Reply: 1.1.1.1.1.1
From: Robert Forward


I completely agree with Rolf here on this one. Actually that is why I use Rolf for my mortgage brokerage.

Cheers
Robert

Property Inspection Reports @
http://www.creativefinance.com.au

The Sydney "Freestylers" Group Leader.
 
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Finance Buyer Agent

Reply: 1.1.1.1.1.2
From: Ross Sondergeld


Hi Rolf,


You said, ( Re:- Finance brokers) "Our surveys show that > 95 % of clients
perceive the broker to be on the clients rather than the lenders side."


My favourite topic. (Representation!) ;)

So who does the finace broker work for in a traditonal money lending
situation ?

P.S. I've got some stuff from a guy in the US that acts as a BUYER AGENT in
the money business. That's right... a "Finance Buyer Agent".


Does anyone in Australia do that yet?




Ross Sondergeld ~ Buyer Agent

~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~
" Imagine buying real estate the easy way...
...with a Buyer Agent on your side!!! "

Buyerside Real Estate Mobile 0412 289 464
Office 9b, 34 Glenferrie Drive Office (07) 5562 1555
East Quay Corporate Park Fax (07) 5562 1248
Robina QLD 4226, Gold Coast Buyerside@hotmail.com
~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~


_________________________________________________________________
Send and receive Hotmail on your mobile device: http://mobile.msn.com
 
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Sim

Administrator
Finance Buyer Agent

Reply: 1.1.1.1.1.2.1
From: Sim' Hampel


I am more than happy to use a Mortgage Broker for my finance (I also use Rolf), as I have spent some time coming to understand the products that are out there and how they work. Finance is a reasonably known quantity, and almost a commodity item these days due to all the competition (in general). So, I am pretty comfortable in evaluating the products that my mortgage broker puts forward and making my own decision about what is best for me.

I am sure there are some better products out there if you search hard enough, but it starts to be impacted on by the law on dimishing returns... the time I spend searching for the a better finance product to get me that extra 0.1% or 0.2% would be better off spent in more productive pursuits.

So who does the broker work for ? Well, I am my broker's client. Without me, he does not make any money. He gets paid a commission from the lender he writes my loan with.

But according to dictionary.com:

broker: One that acts as an agent for others, as in negotiating contracts, purchases, or sales in return for a fee or commission

... by this definition, since he is paid a commission by the lender, it would imply that the broker is an agent for the lender. That's fine, so he works for the lender, however this is not like selling a house, where there is only one of this particular product for sale, and people generally don't buy houses from the same source every week.

Mortgage brokering is essentially a services business which involves taking care of the administrative details of selecting and applying for a largely commodity loan product. The broker only makes money by arranging LOTS of loan products. Rolf relies on a lot of repeat business from his IP buying clients to give him more and easier money... so it is in his best interest to keep his clients happy and recommend good products.

This is similar to a supermarket. Supermarkets are not retailers, they are services organisations. They provide a product aggregation and distribution service. You do NOT get consultants in a supermarket who can spend time with you to help select the best type of milk for your needs. They sell commodity items, and lots of them. This is totally different to houses, cars, televisions, investment products and so on.

Still, some people are concerned about the broker recommending the most profitable product for them over the best product for you. I minimise this concern with two strategies:

1. Learn about the finance you are asking for. If you follow Jan Somers books, she states that the finance is the most important part of your road to wealth. It is leverage that helps you make money. Property goes up in value, but without effective leverage you cannot hold enough property to actually make a significant amount of money. Jan states that she spends more time working out the finance for the next deal than she does finding that "perfect" property.

It is very important to learn for yourself how the finance works. At the end of the day it is you who is responsible for the debt, not your broker !

2. Ask your broker to outline how he gets paid and how much each lender pays him. For most lending, you will no doubt find him recommending one or two lenders out of his portfolio, and it is quite likely that these lenders will pay more than the others. I don't have a problem with this, so long as I can keep his advice in context.

In general there is so little difference between the lenders these days that it does not make terribly much difference between them. Based on your knowledge of how finance works, and your own due dilligence, you should know what is a good deal on finance when your broker puts it in front of you. If you don't know, spend 20 mins checking the basic products available by checking a few websites, including some such as www.yourmortgage.com.au !

There is another reason (often just as important) why my broker recommends some lenders over others, and that is how good their service is. If you get too much grief from the lender while trying to get approval for the finance, and then at settlement, even if you have a broker doing all the screaming for you, it really is stress you could live without. A delayed settlement because of lender incompetence could also be costly too. Once you have settled, a lender who provides good services up front should hopefully provide good service on an ongoing basis too.

- - -

So would I use a Finance Buyer Agent ? If it means that I have to pay them for what is essentially a commodity service ? Most likely not. I have very little problems with my broker right now and how he gets paid. I see no compelling benefits in starting to pay for this myself.

 
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Finance Buyer Agent

Reply: 1.1.1.1.1.2.1.1
From: Robert Forward


Just to add to Sim's statements. I also use a broker as he also understands what your portfolio is doing, if he's competent.

If he thinks that you will have a sticky time with one lender because your nearing "hitting the wall" in regards to serviceability he should be able to get you around this. Again if you hold too many properties that have mortgage insurance on them, you may be in for a rough time trying to continue with them. A mortgage broker should be able to lead you to another financier that doesn't use that particular mortgage insurer.

These two above reasons are the most common reasons why people get their mortgage applications knocked on the head. A broker should be able to get you around this, and just for the record Rolf is good at it.

Cheers
Robert

Property Inspection Reports @
http://www.creativefinance.com.au

The Sydney "Freestylers" Group Leader.
 
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Sim

Administrator
Finance Buyer Agent

Reply: 1.1.1.1.1.2.1.1.1
From: Sim' Hampel


Very valid points too, thanks Rob !

 
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Finance Buyer Agent

Reply: 1.1.1.1.1.2.2
From: Rolf Latham


Hi Ross

You are in sales, so you know that perception = reality, thats why client survey are such powerful marketing tools.

Ask the client for the answer as to who works for whom. One does the right thing by a client not by a title, position, law or a contract but by one's actions.

Mis-Representation rather than representation is probably what you are concerned about, at least in the Real Estate sense. While there are some similarities between Mortgage Broking and Real Estate Sales/Buying there is one major difference:

The Broking Process is totally transparent. By that I mean the Borrower can always check on a clearly defined objective basis as to the value of the product/service being marketed. I believe this is not the case with most Real Estate transactions, since the "value" can be defined in so many different and subjective ways.

Many a lender specifically prohibits the broker charging the client a fee.

Ta

Rolf
 
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