Ever felt a little at sea when people start talking home loans?
22 October, 2015
A recent survey from industry super fund-owned bank ME, found that only 41 per cent of Australians are confident they know enough to have the right home loan for their situation − a concerning statistic given that financial literacy is one of the biggest money savers over time.
But fear no more: this handy little primer will have you up to speed in no time.
Additional repayments: Some loans let you make extra repayments above what you’re required to (mostly variable ones), so that you can pay off the amount you owe earlier. (Handy for reducing the amount of interest you need to pay).
Fixed interest rate: This is when a loan’s interest has been ‘fixed’ at a rate that won’t change for an agreed length of time – no matter how much variable interest rates are going up or down. Commonly though, you are restricted from extra repayments or changes to your loan. There is likely to be a break fee if you want to get out of a fixed rate loan which can be quite high, e.g. you want to sell your house and close your loan.
Interest in advance: When interest is charged at the beginning of a period of time instead of at the end. Normally investors can do this on investment properties. It is a way of lowering their tax payments by bringing forward expenses into a tax year.
Interest-only loan: A loan that lets you make lower repayments for a certain amount of time, by having you only pay the interest on the loan, rather than having to get on with paying the whole loan back. You will have to pay back the loan later in a shorter period of time, so the repayments then will be higher. (This tends to be useful if this is an investment property – if you’re in it for the long haul, it will end up costing you more.)
Lenders mortgage insurance (LMI): This is insurance that banks take out – at extra cost to the borrower – to protect themselves in case the borrower ends up not being able to pay what they owe. This kind of insurance is generally only needed if you’re borrowing 80% or more of the property’s value, enabling you to purchase your property sooner.
Loan to value ratio (LVR): This value compares the amount you have owing on your loan against the actual value of your property. For example, if your property was valued at $400,000 and your loan amount was $340,000, your LVR would be 85%.
Offset account: Offset accounts are a savings or transaction account linked to your home loan. Instead of being paid separate interest, the amount in the linked account is deducted from your home loan when loan interest is calculated. For instance, if you have $30,000 in the linked account and your home loan is worth $400,000, loan interest will be based on a balance of $370,000. This reduces the interest charged, making an offset account a very easy but highly effective way to get ahead with your home loan and save on long term interest costs.
Rate lock: When you apply for a fixed rate home loan, you will receive the fixed rate that applies at the time your loan is settled. This might be different to what the fixed rate was when you applied. To lock in the rate before settlement, typically most banks give you the option to purchase a ‘rate lock’ feature. At settlement you will get the lower of the two rates.
Redraw: If you’re ahead on your repayments, some loans let you take money back out of your loan, to use it for something else – which can be useful in an emergency….or a new car or extension. (Of course, that adds to the amount left owing on your loan, which you will have to pay back.)
Refinance: This means closing down one home loan and creating a new one – the new loan pays off the old loan, effectively rolling the debt into a new loan. Refinancing can be used to move a loan to a different bank.
Repayment holiday: If you’re ahead on your loan repayments, some loans let you apply to take a break from making repayments for a while, e.g. for a new baby or career break.
Split home loan: This is when you split a home loan into different accounts, each with their own separate arrangements. People often do this so that they can set one part of a loan to a fixed interest rate, and the other part to the variable rate.
Top-up: A simple way to borrow extra money – for a holiday, a renovation, a new car or anything else you might need – by increasing what you owe on your existing home loan.
Variable interest rate: Loans with variable interest will have their interest rates go up or down, in response to whatever’s happening in the market. In most cases, they have the advantage of enabling you to make as many extra repayments as you want to reduce your interest bill and the term of your loan.