If you’re an Australian with a mortgage, you’re probably paying too much interest, even if you got the best deal you could afford back when you first signed on the dotted line.
Today, you may be in a financial position where you’re eligible for a much more affordable home loan and not even know it, all because of Australia’s rising house prices.
Why you’re likely paying too much for your home loan
The biggest cost involved with almost any home loan is the interest rate. Lenders base the interest rates they charge on the level of risk involved when lending money to a borrower. To a bank, the less likely you are to pay back a loan, the higher the rate of interest they need to charge to cover their potential losses if you default on your repayments.
One figure many lenders use to gauge a borrower’s riskiness is the Loan to Value Ratio (LVR) – an expression of how much money is being borrowed compared to the total value of the property being purchased. Generally, the higher the LVR, the higher the level of risk, and the higher the interest rate the bank is likely to charge.
Five years ago, Marcia bought a studio apartment for $300,000. At the time, she could only scrape together a deposit of $30,000, or 10% of the purchase price, meaning she needed to borrow $270,000. This gave Marcia an LVR of 90%.
Because Marcia’s bank considers any borrower with an LVR higher than 80% to be “high risk”, they charged Marcia an above-average interest rate compare to their standard home loans. Additionally, she had to pay Lender’s Mortgage Insurance fees to further cover her bank in case she defaults.
Why you may be in a better financial position than you realise
If you’ve glanced at the news at any point over the past few years, you’ll have likely noticed that house prices have been steadily rising in most Australian capital cities. Some areas have seen more growth than others, though a few have had their property values decrease (e.g. Perth).
If you previously bought property in a growing area, your home or investment will likely have increased in value (also known as capital gain or capital growth). Because you own the property, this capital growth increases the level of equity you have in your property – equity being your property’s value minus the amount still owing on your mortgage.
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