Making sense of industry jargon
One of my biggest challenges as a new finance graduate at the bank was explaining complexity in a simple way and to such an extent that clients could clearly comprehend what was being explained and not totally confused in a never-ending banking jargon world complete with acronyms and process charts
- After all, in the subject of other people’s money, comprehension is rather important you might think
Not to say my clients were intellectually challenged - in fact quite the opposite I’ve learned more from my clients than any university degree! – it was more that I hadn’t found a way to communicate financial jargon to individuals who were not in the industry or that I assumed everyone must just understand for some unknown reason.
- Like sure I fully understand when my sister starts discussing complex taxation law and the list goes on
So, I put together the first 24 translations to a series of common industry jargon translation to ensue and hopefully alleviate ambiguity. And yes, I’m still open to being challenged on too much jargon! So here goes with 24 common ones not exhaustive by any means:
1. Amortization – the gradual repayment of principal and interest within a set timeframe is called amortization
- Usually, 30yrs is standard but is important to ensure the correct amortizing term that is appropriate for you and your objectives specifically which we can provide advice on
2. Break costs – if you decide to repay some or all your fixed lending and the current market rate has decreased, you are likely to be susceptible to break costs that the bank will charge to execute repayment of the fixed loan
- Always check with bank prior to repaying in full
3. Capital gain – or ROI an amount by which your asset (property) has increased over and above what you paid is a “capital gain” or “Return on Investment”
- Is usually expressed as a percentage to the original investment for example you purchased a property four years ago for $500K and sold it today for $800K is a capital gain of $300K or return on original investment of 60% (300/500) *100
4. Carded rates – the interest rates that a bank advertises openly on their website or otherwise is termed carded rates
- Hint carded rates are always much higher than what we arrange but a good gauge as a starting point for negotiation
- We never advise accepting carded rates without question
5. Cashback – an amount of money a bank will offer a borrower if borrowing proposed amount
- Typically measured as a basis point conversion to the volume of lending
- For example, $10K “cashback” for a $1M refinanced loan is 100bpts or 1% (10000/1000000) *100
- With cashback the caveat is if you repay some or all within a set timeframe (usually three years), you are subject to repay some or all the cashback depending on when and how much is repaid know as:
6. Clawback – the amount of money a bank recovers of the cashback given is termed a “clawback”
- Typically, if you repay all the lending in year 1, 100% of the cashback is repayable, year 2, 66%, year 3, 33% and any time after year 3 (even 1 day), 0% is recoverable
7. CPI – Consumer Price Index a previous finance lecturer said it perfectly when describing inflation as “too much money chasing too few products/services”
- In NZ we measure inflation via stats NZ’s quarterly CPI output, measuring a percentage change in the prices of goods and services over time as a weighted average
- As inflation increases, expect RBNZ to address this with prescriptive measures
- As inflation decreases (or even deflation), RBNZ will equally address
o Both increases or decreases in CPI can give borrowers proactive insight into interest rate strategy
8. DTI – Debt to income ratio being the amount of debt expressed as a ratio to income – for example if your income is $60K and your lending is $360K you have a DTI of 6 ($360K/$60K) meaning you have a debt 6 times larger than your income
9. Fees – sometimes, the bank will charge a fee for borrowing as in the case with business lending or sometimes low equity (although lately observing 1% cashback for 90% LVR – subject to change)
10. Finance date – the date in which you agree to become unconditional on a property is the finance date
- Typically, 10 business days after reaching an accord with the vendor which gives time to satisfy due diligence on a proposed property including but not limited to:
o Building report
o Legal Advice
o Valuation
11. Interest only – typically an option for investors to preserve cashflow (so they can of course invest in more property)
- Does not repay any principal which is fine as investors do not rely on amortization as a way of making repayment
- They usually rely on capital gains to sell some or all property in repayment of debt in the hope of having unencumbered property thereafter producing a passive income
- Some clients also utilize this option to preserve cashflow through volatile economic times in full knowledge they are not actually repaying any lending but surviving a period of elevated economic risk
- It’s imperative to receive financial advice prior to implementing interest only in any circumstances to understand full ins and outs
12. Interest rate – the rate at which debits your loan balance for borrowing money from a bank or other provider – a lessor interest rate is preferable or credits if you have savings
- Is typically negotiable and the rate advertised is not the first rate you should take without question
- When interest rates attract higher than normal pricing is described at a premium
- When interest rates attract lower than normal pricing is described at a discount
13. Loan principal – the amount of the original loan that is borrowed without interest and the amount that interest, cashback and repayments are calculated against
14. Low equity – any lending that is >80% LVR is deemed to be “low equity”
- This lending is deemed higher risk to the bank of which the banks charge a premium interest rate for the privilege
- The level of premium (or margin) is depended on final LVR position but increases in increments as the LVR becomes more elevated – example:
between 80.01% – 85% LVR you’ll pay a premium of 0.35% p.a.
between 85.01% – 90% you’ll pay 0.75% p.a.
between 90.01% – 95% you’ll pay 1.20% p.a.
over 95.01% you’ll pay 1.50% p.a.
15. Lump sum payment – as the name suggests is balloon payment outside of the normal repayment arrangement – usually from savings or unexpected inheritance, sale of property/assets etc.
- Always check with the bank prior to making the lump sum payment for hidden costs such as break costs or clawbacks
16. LVR – acronym for loan to value ratio – in general terms if you are purchasing a property, what is the loan volume as a percentage of value of that property.
- For example, you purchase a property for $1M and have an $800K loan is an LVR of you guessed it 80% ($800K/$1M) *100
- These are nice round numbers and does get more technical but gives understanding of the principle
- In general, 80% LVR or under is where you will have the most bargaining power with the bank but fully possible >80% just has more expensive pricing
17. Margin – can either be a positive or negative margin and is the additional amount added or deducted to your carded rate
- In this case a negative margin is a good thing for example BNZ has carded 6mths of 6.85% but we can negotiate a negative margin of -6bpts leading to your discounted rate of 6.79%
- The opposite is true for a positive margin which relates to low equity lending or business lending (more risk = more margin) for example the BNZ positive margin on 85.01% - 90% LVR is .75% on top of carded rates (no special rates allowable) equating to 7.6% for a 6mths rate
18. OCR – acronym for Official Cash Rate or the interest rate at which the RBNZ sets for overnight transactions between banks and forms the basis of lending or borrowing to or from trading banks – in short, a change in the OCR impacts the interest rates you pay or receive (if you have savings/investments)
- Reviewed seven times per year with four of which being the issuance of Monetary Policy Statements
- Is a tool utilized by RBNZ to keep inflation within 1-3% as measured by CPI
- RBNZ can lend or borrow as much as it wants with the caveat that more cheaper money leads to inflation as we have seen
19. RBNZ – Reserve Bank of New Zealand their main function is to ensure the financial stability of NZ notably inflation as measured by CPI (currently 3.3%) with a targeted remit between 1-3%
- They set the rules for NZ banks (such as DTI and LVR restrictions) in the interests of financial stability
- Equally, low inflation/deflation is a problem for RBNZ in as much as high inflation as we observed through Dec 2014 – Dec 2016 with low inflation as opposed to more recently in June 22 at 7.3% leading to RBNZ economic stimulatory or compressive policies respectively
- The theory is cheaper money encourages more economic activity whilst more expensive money encourages less as we have seen regarding the mostly inverse relationship between increasing interest rates and decreasing CPI
- As you can imagine RBNZ achieving its 1-3% CPI is a rocket scientist level balance act
20. Repayment – the repayment arrangement entered, is typically a table repayment paying principal and interest over 30yrs gradually amortizing lending – the longer your loan is in place, the less interest you pay
- There are hacks to this such as lump sum payments or increasing your regular repayment (see “time savings calculator under resources”)
- There are other forms of repayment such as proceeds from sale of property or inheritance
21. Servicing – a bank not only looks at equity when deciding on a loan application, the evaluate your income vs expenditure and debts inclusive of proposed borrowing at a stress tested rate to determine your ability to “service” a proposed loan
- More recently this involves DTIs in addition to bank calculated requirements
- DTI of 6 for owner occupied and 7 for investors is now RBNZ mandated policy that the banks comply with
22. Settlement date – the date in which you settle on a property in full after agreeing unconditionally to purchase said property is your “settlement date”
- This date varies from transaction to transaction but broadly 20 business days after you agree to unconditionally purchase a property
23. Valuation – the value a bank assigns to your property is defined as the “valuation”
- This does not mean what you think the property is worth or even what a registered valuation advises
- The bank always takes a “lower of” approach when you purchase a property
- For example, at $900K purchase price but the registered valuation returns at $1M, the bank will say the property is worth $900K and calculate your LVR off $900K – or at 80% LVR will lend $720K (900*.8)
- When you apply for a loan top up the lower of rule is not as relevant and the valuation can be determined by:
o Online valuation – most banks utilize valocity of which Hawkeye Finance also utilize and will in most cases forward your “ival” to you as an insight into your property valuation as the bank views it – the online valuation likely is not what your property is actually worth or what you would sell for but for our purposes of topping up the loan/releasing equity, if it works with just online valuations
o Registered valuation – some properties will be mandatory for a registered valuation “RV” for example new builds or any lending >80% LVR of which we will facilitate the process excluding payment
o Or if the online valuation doesn’t support your goals and you’re of the view the registered valuation is higher, we order one (could be extensive renovations completed that online valuations do not detect for example)
24. Yield: yield is an annualized percentage to give an idea of the annual cashflow from an investment in comparison with competing investment if that asset were sold and the funds utilized to purchase another investment such as stocks or place in a PIE
- Gross yield is calculated by dividing the annual gross income by the value of the investment
- For example, $1M investment property generating $50K per annum is 5% gross yield
- (50000/1000000) *100
- It enables comparison between other asset classes (such as a term deposit or commercial property)
- Typically, with residential investment properties, gross yield is a one-dimensional view in expectation of capital gain
- Commercial properties typically have higher yields (more risk)
Summary
This list could keep going but will follow up in an ensuing post and further definitions of the jargon so look out for the next one!
In the interests of empowering our clients with knowledge, we’ll be putting some detail behind common industry jargon and hope will be a little more unambiguous with this knowledge.
In an ensuing episode fire through any other definitions and will be sure to cover them off!
Fine Print
This article is not financial advice, is informational only and should not be considered as formal advice if considering any of these discussion points. Interest rates, break costs and other costs can change without notice so is important to discuss directly with us to deliver formal advice unique to your circumstances.