Home loan terms explained

Taking out a home loan to purchase a property can be exciting, but what can often dampen your enthusiasm is all the complicated home loan jargon that gets thrown around in the process.

So if you’re feeling a little frazzled by all the home loan mumbo jumbo, the below guide is for you. Read on as we run through all of the most common terms and their meanings.

If you have a fixed rate loan, you may be charged a fee if you decide to break the fixed rate contract before the term ends. This can apply whether you switch to a new provider or pay out your loan early. 

All home loan lenders in Australia are required to display a comparison rate next to the headline rate. This combines the interest rate with any common fees (such as application and ongoing fees) to show you the “true” cost of the loan.

The purpose of a comparison rate is to make it easier for borrowers to compare apples with apples. Just keep in mind that comparison rates are calculated with a specific scenario in mind, for example a $150,000 loan over 25 years.

Conditional pre-approval is when a bank agrees to lend you a certain amount of money to purchase a property, while not yet formally approving you for a home loan. This lets you narrow your search to properties you can afford. 

Once you have made an offer, the lender will then value the property you have bought and if they are satisfied your financial conditions haven’t changed - and you haven’t overpaid for the property - they can provide you with formal approval.

This is the difference between your home’s market value and the outstanding balance on your loan. For example, if your property is worth $600,000 and you owe $400,000 on your loan, you will have $200,000 in equity.

An establishment fee, also called an application fee, is a fee charged by lenders to cover the costs involved when setting up your home loan.

Many loans nowadays let you make additional repayments on top of your minimum repayment amount. On variable rate loans these tend to be free and unlimited. On fixed rate loans, however, you might find that extra repayments are capped at a certain amount each year.

When you sign up for a fixed rate home loan, your interest rate will remain the same for a set period (typically between 1 and 5 years). Fixed rate loans are generally preferred by borrowers who are on a strict budget and need repayment consistency.

The downside of a loan with a fixed interest rate is they generally don’t provide the same features and flexibility as a variable rate loan. What’s more, if you try to switch home loans or pay out your loan early, you may face a high break cost fee.

When the lender removes the conditional approval of the loan and officially approves you for the home loan. Formal approval usually occurs after you have made an offer on a property and the bank has valued the property.

A green home loan caters to borrowers who want to build or buy an environmentally friendly home. It offers special or discounted rates for property that meets a lender’s sustainable home conditions — typically you'll need a score of 7 stars or higher under the Nationwide House Energy Rating Scheme.

A guarantor is someone, generally a family member, who will provide security for another person’s home loan. For instance, parents will often act as guarantors for their children if they can’t come up with the necessary deposit themselves, by providing security against the loan in the form of another property.

Once you’ve built up enough equity in your home, some lenders will allow you to top up your loan, i.e. borrow more. A home loan top up can be a cheaper alternative to other credit options if you want to do things like renovate, buy a new car or take an overseas trip.

With standard home loans you will pay both the principal (the home loan amount owing) and the interest charged by the lender for providing you with the loan. But if you go for an interest only loan for an agreed period (usually 1 to 5 years), you will only repay the interest on the loan.

This is a popular option for investors, who tend to rely on capital gains to make a profit and want to put any extra money they have towards purchasing their next investment property.

It’s also an option for first home buyers who want to decrease the size of their ongoing home loan repayments, at least temporarily. Just keep in mind that not paying off the principal will only result in you paying more interest over the life of the loan.

Banks need to make a profit from lending you money and the main way they do this is by charging you a percentage of the amount you have borrowed. This is known as the interest rate.

Some home loan lenders will offer a competitive introductory rate, which is available for the first few years before reverting to a higher rate.

If you take out a loan with a deposit of less than 20%, most lenders in Australia will require you to purchase lenders mortgage insurance. LMI is a form of insurance that protects your lender in case you default on your loan. The cost of lenders mortgage insurance will vary depending on your deposit and loan amount and can either be paid upfront or added to your loan amount.

A line of credit facility functions like a revolving line of credit that you can draw on whenever you wish (up to an agreed amount). If you’re signed up to a standard home loan, usually you’ll need to refinance to a new loan to gain this flexible feature.

When you take out a loan, your lender doesn’t advance the funds directly to you. Rather, they will release the funds to the party selling the property on settlement day. This is known as drawdown.

When assessing your ability to service a loan, one of the main things your lender will look at is your loan to value ratio. This is the amount you wish to borrow as a percentage of the total value of the property. 

For instance if the property’s value is $500,000 and you have a deposit of $50,000 this will mean you will need to borrow $450,000 (90% of the property’s value). Your LVR will therefore be 90%.

If you’re a sole trader or own your own business, an alternative option if you can’t provide the standard documentation is a low doc home loan. While less paperwork demands can make it easier for you to get approved for a loan, low doc home loans usually come with higher rates and fees.

An alternative option to making extra repayments on your loan is stashing any cash you have in an offset account. In many ways, this is just like a bank account, in that you can have your salary deposited there and receive a debit card for everyday purchases.

The key difference is the balance in your offset account is offset daily against your home loan principal. A quick example: if you’ve got a home loan of $300,000 and have $20,000 in an offset account, you’ll only be charged interest on $280,000

If you think you might be moving homes down the track and don’t want to have to bother taking out a new loan, you could consider looking for a home loan that comes with home loan portability. This lets you sell your home and move to a new one while keeping your existing loan.

When you’re approved for a home loan and start making repayments you will pay back both the principal and the interest. The principal is the amount you borrow, while the interest is the rate that is charged to you on a daily basis by the lender.

When you take out a construction loan, your lender will release funds at key intervals as your home is being built. These are known as progress payments (or progressive drawdowns), and are paid directly to your builder, not to you.

When you sign up for a fixed rate home loan, there might be a lengthy wait in between getting approved and actually receiving the funds. A mortgage rate lock ensures the rate you’ve been eyeing won’t change in the meantime. 

A handy feature to have if you’ve made additional payments on your loan and then need to retrieve those funds down the track. It’s worth noting that while redraw facilities are common among variable rate loans, they are not always guaranteed on fixed rate loans.

Refinancing your home loan means switching from one provider or loan product to another. A borrower might do this because a new loan offers a more attractive interest rate and/or more flexible features. Just be mindful that if you have a fixed rate loan, refinancing to another product or lender may require you to pay a break cost fee.

Making ongoing home loan repayment over a 25 year period can become tiresome and you may need a little holiday at one time or another. With a home loan that comes with a repayment holiday feature, the lender will allow you to take a break for an agreed amount of time. But this is generally only if you’ve gotten ahead on your repayments.

Typically available to older people, a reverse mortgage is a way for home owners to access any equity they’ve built up in their home. These loans can often be taken in the form of a lump sum or as regular payments, but don’t forget that interest will still apply on any outstanding balance.

When a lender assesses your serviceability, they are essentially gauging your ability to pay off a mortgage. They do this by taking your after-tax income and subtracting your expenses, along with any liabilities you might have (such as credit card or personal loan debt).

After you’ve made an offer on a property and the lender has provided you with final approval, settlement will occur where the lender advances funds to the seller and the property officially changes hands.

Do you like the sound of a loan with both a fixed and variable interest rate? Then a split rate loan could be just the answer. This lets you split your loan into two accounts — one with a fixed interest rate, which guards against any rate hikes, and the other with variable interest rate, which can give you access to more flexible features.

A fee charged by the lender for valuing how much a property is worth. Valuation usually occurs when you’re buying a property or looking to sell your current property.

If your loan has a variable interest rate, it is subject to change over time. Banks might raise or lower their rates in response to changes to the cash rate or simply because the cost of doing business demands it. If rates go down you’ll benefit from lower repayments, but by the same token if rates increase your repayments will too. 

While variable rate loans offer less certainty than fixed rate loans, they tend to offer more in the way of features. For example, most variable rate loans let you make free and unlimited extra repayments and access a redraw facility, and many let you take advantage of an offset account.

Now that you’ve had a rundown of the relevant terms, kick off your home loan search over at our home loan comparison page, or browse the selection below.