As finance professionals we sometimes catch ourselves using jargon and acronyms that may inadvertently render our message useless to a person who is not familiar with the language of a lender.
With this in mind, we thought it was a good idea to put together a guide to help you make the most of your finances, by understanding some of the banking terms that are commonly used in the ever-changing world of finance.
LVR: The term LVR stands for ‘loan to value ratio’ and it essentially represents the value of your home loan as a percentage of the property’s value.
The LVR is calculated by dividing the loan amount by the value of the property, for example;
If you are purchasing a property costing $400,000, and you have a deposit of $80,000 you will need a loan for $320,000 which also means you’ll be borrowing at 80% LVR.
Most Banks will have a loan to value ratio (LVR) of 80% as a maximum before Lenders Mortgage Insurance is required.
LMI: Lenders Mortgage Insurance is an insurance policy that some borrowers will be required to pay if their LVR is greater than 80% (in most circumstances). The purpose of LMI is to protect the lender from financial loss if the borrower can’t afford to meet their home loan repayments.
It is important to understand LMI covers the lender, not you (or any other related party such as guarantors). If the borrower defaults on their loan and the sale of the property isn’t enough to clear their Home Loan, lenders can claim on the LMI policy to make up the difference. LMI is calculated as a percentage of the amount borrowed and depends on a number of variables.
HEM: The Household Expenditure Measure (HEM) is a benchmark used to assist with measuring a modest level of monthly household expenditure for various types of families.
Lenders use this as part of their assessment to help determine how much you could afford to borrow.
There are several different methods lenders will use to determine your household living expenses. These include;
- Relying on the HEM based on your family size and income (Australian Bureau of Statistics Data) because it is considered unreasonable for someone to be spending less than HEM.
- They will likely ask you to self-assess your living expenses on your loan application form.
- Often lenders may review your bank account and/or credit card statements they have access to, so they can confirm your self-assessment.
- They will either accept or adjust your stated expenses to match your bank account history.
- And generally, they will use the higher of the above living expense assessment methods to confirm your annual living expenses.
Living expenses continue to be a strong focus area for lenders when assessing an application. As part of this, many have expanded their expense declaration categories to 12 or more. Some of the expense categories include (but aren’t limited to); Utilities & Rates (both owner occupied and investment), Telephone & Internet, Groceries, Recreation & Entertainment, Clothing & Personal Care, Medical & Health, Transport, Education, Childcare and Insurance.
When thinking about your spending habits particularly when you are saving for a deposit, it’s great to use a budget planner to really break down your overall household expenditure. The Seek Financial team support the Money smart budget planner.
Assessment rate: When you apply for a Home Loan, the lender has a responsibility to ensure you have the financial capacity to service the mortgage repayments now and into the future. Of course, no one can predict the future because issues will come up from time to time, however the bank will assess your borrowing capacity on the basis of your current financial situation, as well as factor in a buffer in case interest rates rise. It’s a way of stress testing your capacity to service the debt now and in the future. Each lender has their own stress test or assessment rate and it’s based on the bank’s own appetite for risk, which is why your borrowing capacity can vary significantly from one lender to another.
CDR: Common Debt Reducer is a term that is becoming more frequently recognised over recent times, particularly by investors. It can be common for one party in a de facto or married relationship to apply for a loan as a single applicant. On occasions, they may also look to purchase a property with the help of family, friends or as a joint venture under a co-ownership arrangement. In this situation, many lenders consider any existing joint liabilities/debts as well as household living expenses at 100% rather than basing it on your actual percentage share.
There are several lenders who will apply a common debt reducer which will improve your borrowing power however there are some conditions to this with the main one being that your partner can verify their capacity to support their share of liabilities/debts and/or living expenses through their own income sources. Other conditions can apply, please speak with a member of the Seek team to understand if you qualify for the CDR.
CCR: Comprehensive Credit Reporting is a reporting system whereby lenders share more of your data with credit bureaus such as Equifax and Experian, this is turn will be listed on your credit report. In the past, the only information that was mandatory to share was Negative Credit Reporting. It wasn’t until 1st July 2018 when it was made compulsory for the big banks to contribute positive credit data and they needed to share at least 50% of your credit data with credit bureaus. This increased to 100% on 1st July 2019. At this stage it’s only the big banks (CBA, Westpac, ANZ and NAB) who are required to share this data although many other credit providers have followed and share data within the same time frame. For more information, please head to our Credit Reporting blog.
ICR: Interest Cover Ratio is mostly used by business lenders. The interest coverage ratio is a debt ratio and profitability ratio used to determine how easily a company can pay interest on its outstanding debt. The interest coverage ratio can be calculated by dividing a company’s earnings before interest and tax during a given period, by the company’s interest payments due within the same period. The Interest coverage ratio is also called “times interest earned.” Lenders, investors, and creditors often use this formula to determine a company’s risk level relative to its current debt, or for future borrowing.
Chattel Mortgage: A chattel mortgage (Vehicle or equipment loan) has a similar structure to a fixed rate home loan or mortgage. A finance provider uses the car or equipment you are buying as the security for your loan. Chattel refers to the vehicle or equipment, and mortgage refers to the loan. Unlike a Hire Purchase or a Finance Lease, an Equipment Loan (Chattel Mortgage) gives you ownership right away, paying off the loan over a fixed term.
We know that this is a lot of information, so if you have any questions about anything please don’t hesitate to contact one of our friendly team. Our mission is to give you the facts in plain English, so always let us know if you don’t understand something. There is no such thing as a silly question.
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The above information is general in nature. It has been prepared without taking into account your objectives, financial situation or needs.
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