Home loan terms explained
Taking out a home loan for a property is exciting but what can often dampen all of this excitement is the complicated home loan jargon that gets thrown around.
In fact, according to a survey by mortgage provider ME, only 41% of Aussies are confident they know enough to find the right home loan for their situation.
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 debunk some of the common home loan terms…
When you apply for a home loan, the lender may charge you a fee upfront for assessing you for the loan, which is usually dubbed an application or upfront fee.
If you take out a home loan with a fixed interest rate attached, you may be charged a fee if you try to break the fixed rate term early by switching to a new provider or paying out the loan early.
All home loan lenders in Australia are required to display a comparison rate next to the headline rate, which combines the interest rate with the common fees (e.g application and ongoing fees) to show you the “true” cost of the loan. The whole purpose of a comparison rate is to make it easier for borrowers to compare apples with apples. But keep in mind comparison rates only use one scenario, for example a $150,000 loan over 25 years.
When you apply for a home loan and the lender has assessed that you meet their lending criteria they will provide you with conditional pre approval. This means you can go and make an offer on a property up to the amount specified by the lender. 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 will provide you with formal approval.
This is the amount you own of the property’s value after the home loan is taken out of the equation. For instance if your property is worth $600,000 and you owe $400,000 on your loan, your equity will be $200,000. If you take out a home loan with flexibility you may be able to draw upon the equity in your property through a home loan top up or line of credit facility for things like renovation.
Extra repayments facility:
If you take out a home loan and just make the required monthly repayment, you will end up paying a large amount in interest. But if you’re savvy and decide to take out a loan that comes with the option of making additional payments on top of your regular payments at no extra cost, you will not only save yourself a pile in interest but also shorten the life of the loan too.
Fixed interest rate:
With a locked in rate your home loan interest rate will remain the same over the fixed rate term (usually 1 to 7 years). Fixed rate loans are generally a great option for first home buyers who are getting used to making home loan repayments or other 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 come with the same flexibility as a variable rate loan and if you try to switch home loans or pay out your loan early, you may be hit up with a high break cost fee. Whereas break cost fees were banned on variable rate loans in 2011.
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.
The home loan lender needs to make a profit from lending to you and the main way they do this is by charging you interest on the loan principal daily. The interest rate that is charged is generally called the “headline rate”.
Home loan top up:
Once you’ve built up a significant amount of equity in your home some home loan lenders will allow you to draw upon that equity to top up your loan i.e borrow more. A home loan top up can come in handy if you want to do things like renovate, buy a new family car or take an overseas trip but don’t want to take out another loan.
Some home loan lenders will offer you a competitive honeymoon rate for the first few years, in order to entice you to take out a home loan through them. It’s important to remember that while the rate may be extremely low for an introductory term, often after the honeymoon period comes to an end the revert rate may be much higher.
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 are relying 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 that first home buyers sometimes opt for as their ongoing home loan repayments will be lower. Just keep in mind that not paying off the principal will only result in you paying more interest over the life of the loan.
Lenders mortgage insurance (LMI):
If you have a deposit of less than 20% (so an LVR over 80%) most lenders in Australia will charge you the cost of lenders mortgage insurance. LMI is an insurance that the home loan lender takes out to protect themselves if you can’t repay the 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.
Line of credit facility:
Think of a line of credit facility just like an overdraft facility. It’s basically a revolving line of credit that you can draw on up to an agreed amount whenever you wish. 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.
Loan to value ration (LVR):
When assessing you for a home loan, the lender will look at your loan to value ratio, which is basically the lender asking, “What percentage of the property value do you need to borrow?” 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). And voila your LVR will be 90%.
Low doc home loan:
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 is required making 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 repayment on your loan is stashing any cash you have in an offset account. Think of it just like a bank account, as you can get your salary deposited into it and you’ll receive a debit card for everyday purchases. The balance in the offset account is offset daily against the home loan principal. Simple example: You’ve got a home loan of $300,000 and have $10,000 in an offset account, this means you’ll only be charged interest on $290,000
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. So when you sell your old home and move to the new one you can keep 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 owing on your loan, while the interest as we discussed above under “headline rate” is the rate that is charged to you on a daily basis by the lender.
A handy feature if you’ve made additional payments on your loan and then need to access that extra cash due to an unexpected expense like a new family car or home upgrade. It’s worth noting that redraw facilities are usually only available with variable rate loans.
When a home loan borrower decides to switch from one provider to another, usually due to the new provider offering a lower interest rate and/or more flexible features. Just keep in mind if you go for a fixed rate loan, if you try to refinance to a new provider you may incur 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.
After you’ve made an offer on a property and the lender has provided you with final approval, settlement will occur where the lender makes the final payment to the seller and the property is officially yours.
Split rate loan:
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. What this means is a portion of your home loan will have a fixed interest rate giving you some peace of mind against rate rises, while the remainder will be left variable allowing you to use flexible features like an offset account.
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.
Variable interest rate:
The most popular type of home loan rate in Australia is a variable interest rate, which will change over the life of the loan depending on the economy. So if rates go down you’ll benefit from lower repayments but by the same token if rates increase your repayments will too. You might call variable rate loans a bit of a gamble but generally they come with some great features like fee free extra repayments, a redraw facility and an offset account.
Now that you’ve had a full rundown of the different home loan terms, kick off your home loan search in our comparison hub.