Interpreting Home Loan Language
Are you considering obtaining a home loan, but struggling to understand the key terms, features and language used? Don’t stress! This is perfectly normal. There are many words used in the discussion of home loans that may be confusing if you haven’t been exposed to them before. Below are some commonly used phrases and their definitions.
Mortgage
An agreement between you and a lender (commonly a bank) that gives the lender the right to take your property if you fail to repay the money you’ve borrowed plus interest.
Deposit
Your initial contribution to the purchase price of a property. The size of your deposit will directly impact the kind of loan you may be eligible for; it gives the lender an idea of what you can afford, it affects how ‘risky’ you are as a customer and whether you need to pay lenders mortgage insurance, it impacts the interest rates lenders may offer you, and it allows you to pay less interest over the life of the loan.
Principal
The amount of money you borrow from the lender.
Interest
Money you pay on top of the principal amount; the cost charged by the lender to borrow the money.
Interest Rate
Typically expressed as an annual percentage of the loan outstanding, used to calculate the interest you pay.
Variable Interest Rate
A type of interest rate that can change over time. This means you may pay more (if the rate rises) or less (if the rate drops) interest moving forward, and is based on an underlying benchmark rate that fluctuates.
Fixed Interest Rate
A type of interest rate that does not change for a certain pre-agreed period of time. This enables you to plan a budget as your repayments will be consistent. Whilst it may protect you should the rates rise, you will be obligated to pay the fixed rate if the rates drop below it.
Loan to Value Ratio (LVR)
This ratio reflects the amount of the loan relative to the value of the property. The LVR will determine whether or not you pay lenders mortgage insurance, and can influence the rate offered by a lender. In most cases, the lower the LVR the better.
Lenders Mortgage Insurance (LMI)
This is a one-off premium added to your home loan when your LVR is above a certain level. It is calculated based on the size of your deposit and how much you borrow. For example, if you want to buy a house that’s worth $500,000, you would typically need a deposit of $100,000 (20% of the property’s value). If you’ve only saved $50,000, but you have sufficient income to support the loan, you may be able to take advantage of Lenders Mortgage Insurance. The lender would then lend you the $450,000 needed to buy your new home.
Stamp Duty
A tax that governments charge for certain documents and transactions, such as purchasing a property. The amount of stamp duty depends on the type and value of your transaction.
Capital Gains Tax (CGT)
The tax you pay on profits made from selling an investment property. For example, if you bought a house for $500,000 in 2018 and sell it for $750,000 in 2023, you have a Capital Gain of $250,000. This is then included in your tax return and will be taxed at your marginal tax rates (subject to CGT discounts).
Offset
An everyday bank account that is linked to your home loan. You can deposit money into it (such as salary or savings), and the balance is then offset against the amount owing on the home loan. For example, with a loan of $250,000 and $30,000 in your offset account; in this situation, you’ll only be charged interest on a loan balance of $220,000 ($250,000 - $30,000). Money in the offset account minimises the interest you pay, whilst still being accessible whenever you need it.
Redraw
A redraw facility allows you to access additional repayments that you’ve made over and above the minimum required repayments. For example, if your monthly repayment is $3,000 but you pay $3,500, you will be able to access that extra $500.
Refinance
Refinancing your home loan is essentially trading your current mortgage for a new one. It involves paying out your current mortgage with a new mortgage. The benefits of refinance vary from case to case but it is usually done to achieve a lower interest rate with a new lender, reduce mortgage repayments and overall interest paid.
Interest Only Repayments
This involves paying only the interest component for some of the loan term, with the principal balance remaining unchanged and owing. These temporarily lower repayments can help with cash flow issues, however the interest rate is generally higher than that of principal and interest repayments, and the total interest accrued on the principal may end up being more over the life of the loan.
Principal and Interest Repayments
Your loan repayment pays down some of the principal balance as well as the interest accrued. This method usually results in paying less interest over the life of the loan as the principal is consistently decreased, and also generally incurs lower interest rates than those of interest only repayments.
Owner Occupied Loan
A loan used to purchase a property that you intend to live in.
Investment Loan
A loan used to purchase a property that you intend to rent out to someone else.
Obtaining a mortgage and purchasing a home is one of the biggest financial decisions we will make in our life, and it can be very stressful.
It doesn’t need to be!
Contemplating a mortgage but not sure where to start? Contact the friendly and helpful lending team at Bob Reus & Co today.
BRCO - Making Mortgages Easy.
Written by Cody Gale
Lending Support Staff