How does a Home Loan work?
A home loan is basically made up of principal and interest. Principal is the amount you borrow and interest is what you pay to borrow and use the money.
Home loans generally run for 20, 25 or 30 years. This is the term of the loan.
At the start of the loan your loan repayments will largely consist of interest with a small amount paying off the principal.
For example if you took out a $100,000 loan at 7% over 25 years you would end up paying a total of $212,000 – $112,000 in interest plus the $100,000 principal.
What are fixed and variable interest rates?
Fixed rates lock in the interest rate for a set number of years. Variable interest rates move inline with movements in the banks interest rate and the Reserve Banks interest rates.
Some fixed rate loans lack flexibility and might not allow you to make extra repayments or have substantial penalties for early repayments.
It is possible to split your loan into fixed and variable interest rates giving you the best of both worlds. This can provide the security of a fixed loan with the flexibility of a variable loan.
What is Lender’s Mortgage Insurance?
Lender’s mortgage insurance covers your lenders in the event that you default on your mortgage repayments? If the lender needs to sell a property due to default and the sale proceeds does not cover the loan then the mortgage insurance will cover the shortfall.
Mortgage insurance is required when you borrow more than 80% of the value of the property. Mortgage insurance is paid upon settlement and is non refundable.
What is the AAPR?
Average Annual Percentage Rate – an “artificial” rate that tries to capture all the costs of a particular loan, including fees and charges.
What is an Accelerated Repayment?
An arrangement that lets the borrower pay off more of the loan than the minimum set out in the loan agreement.
What is an Account fee?
An amount often charged by lenders to cover the cost of setting up and maintaining mortgages
What is an All-in-one facility?
A facility which lets you deposit all of your money in your loan account and then draw on that money for smaller expenses.
What is an Application fee?
The fee a lender often charges to cover their costs in setting up a loan approval for a home buyer. Some lenders do not charge application fees, but these lenders tend to charge higher interest rates.
What is an Asset?
The items you own and which are worth money in the open market – generally including your home, if you own it.
What is BAD?
Bank Accounts Debits Tax, a state tax on withdrawals from bank accounts.
What is a Building Society?
An institution which takes deposits and provides loans just like a bank, but without the Reserve Bank oversight given to banks.
What is Collateral?
An asset (such as a car or a home) which the borrower must give to the lender if the loan is not repaid. In a home loan, the home itself is usually the main collateral.
What is Commission?
In home lending, the money that a lender pays to a mortgage broker when a borrower agrees to take out a loan through that broker. All brokers are paid commission.
In real estate, the fee paid to real estate agent by owner for services rendered – usually for selling his/her property.
What is the Comparison rate?
A single “artificial” percentage rate designed to capture all the costs of a particular loan, including fees and charges.
The comparison rate came about because fees and charges have made it so much harder to compare home loans. A home loan with a 6.03% interest rate and no fees may end up costing you less than a 5.97% loan with a $10 monthly fee, a $600 valuation fee, redraw fees and a $2000 early-exit fee.
Australia’s lawmakers have agreed that for a three-year trial period, all lenders and brokers must provide comparison rates:
- in their ads
- in their offices
- at the time they hand you a loan application form
The comparison rate is based on a $150,000 loan paid off over 25 years.
The comparison rate can be useful. Of course, it isn’t perfect. It won’t be so accurate if you’re taking out a $400,000 loan that you expect to redraw from and then refinance in five years’ time. And it requires borrowers to deal with two interest rates rather than one.
What is a Comparison rate schedule?
A list of comparison rates designed to let you choose the comparison rate calculated on the basis which most closely matches your loan. A lender or broker must provide a comparison rate schedule whenever they give a borrower a loan application form.
What is a Credit Union?
A financial services co-operative owned and controlled by the people who use it.
What is a Deposit?
Usually, this is the sum that you contribute to the cost of buying your home.
Lenders normally want a deposit at least 10 per cent of the cost of the property, although some lenders will accept as little as 5 per cent. (When you finally buy a home, the seller will also ask for a different “deposit” – a sum, often 10 per cent of the purchase price that shows that you are serious about the purchase.)
What is a Deposit bond?
An amount of money that guarantees the buyer of a property will pay the full deposit when it’s due. Deposit bonds are often used to give reassurance when a buyer can’t provide cash immediately.
What is a Downpayment?
The money that a home buyer pays to the seller upon the signing of the agreement of sale.
The rest of the sale price is paid within a short period called a settlement period – typically, 90 days. The downpayment may not be refundable if the purchaser fails to complete the purchase without good reason. Often the contract of sale will set out the acceptable reasons for failing to complete the purchase will be set out in the sale contract.
What is EFTPOS?
Electronic Funds Transfer Point of Sale – a facility provided by stores and service providers to let you pay for goods and services with your ordinary lender card, and often withdraw cash as well.
What is Equity?
The value of the “slice” of the home that you actually own – as opposed to the debt, which your bank or other financier owns.
The value of the “slice” of your home which you own outright – in other words, the amount of money you’d have if you sold the house and paid off your home loan. If you own a $200,000 home with a $120,000 loan, you have $80,000 of equity; if the market suddenly values your home at $220,000, your equity jumps to $100,000 while your loan stays the same. Your equity and debt in your home will together represent the home’s value.
What is an Establishment fee?
An amount often charged by lenders to cover the cost of setting up new mortgages.
What is an FID?
Financial Institutions Duty, a state duty which all financial institutions pay on the money paid to them.
What is the First Home Owner's Grant?
A government grant available to Australians buying or building their first home. The amount varies from State to State and terms and conditions apply.
What is a fixed rate loan?
A loan whose interest rate stays the same for a set number of years – the opposite of a variable rate.
What is a Flat interest rate?
Interest calculated on the original amount of the loan for the whole term.
What is a Holding Deposit?
Refundable amount paid to the real estate agent when the buyer decides to purchase a property. It is a goodwill gesture, not necessarily, practice.
What is a Honeymoon rate?
A rate lower than the prevailing market rate, but which is raised to a higher rate after a short period – 12 months, for instance.
What is Interest?
The charge you pay for the right to borrow and use someone else’s money. It’s expressed as a percentage of the amount you borrow. Interest can be paid weekly, fortnightly, monthly or yearly.
In a typical home loan, the early payments are mostly interest; as the amount of the remaining loan drops over time, the interest bill falls.
What is an Interest only loan?
Only the interest is repaid throughout the course of the loan. The original amount or principal is repaid at the end of the term of the loan.
What is Internet banking?
The ability to transfer money between accounts, pay bills, see statements and perform other financial transactions over the Internet.
What is a Line of credit?
A loan arrangement which lets a customer borrow any amount up to a set limit.
What is a Loan-to-value ratio?
A key measure of a loan’s strength, showing the amount owed as a proportion of the amount borrowed. Lenders will look carefully at this figure.
What is a Mortgage?
A legal document expressing the terms and conditions applying to the lending of money secured by real estate.
What is a Mortgage broker?
A person or organisation offering loans from a panel of lenders. They can select the best loan or loans for a borrower, and then manage dealings with the lender on the borrower’s behalf until the loan is established.
What is Mortgage insurance?
Insurance that lenders take out to protect themselves against the risk that they will have to sell a borrower’s property at a loss compared to the value of their loan.
It is often required on loans where the borrower is borrowing more than 80 per cent of the home’s purchase price. Though included in a borrower’s costs, it protects only the lender, not the borrower.
What is a Mortgage offset account?
An account used to pay off a home loan: the contents of the account are paid straight into the borrower’s home loan, reducing the amount left to be paid.
Effectively, you deposit money in your mortgage instead of depositing it for the bank to lend to other people. In most ways, it works much like an ordinary savings account. So you can get your money when you need it (although with some offset accounts, you may need to give the bank or financier some notice). But by depositing extra money in your mortgage, you reduce your interest charges. You also avoid paying tax on the interest you would otherwise earn on your deposit – meaning you pay no more tax than you have to.
Who is a Mortgagee?
A Person or legal entity who lends the money.
Who is a Mortgagor?
A Person or legal entity who borrows the money.
What is Portability?
The ability to retain your existing home loan if you move homes, essentially replacing the old home’s security with the new one’s.
What is a Prepayment?
The act of paying off the loan ahead of schedule; it often attracts penalty fees.
What is Principal?
The money a lender lets you borrow to buy a home. When you buy a home, the principal of your loan, combined with your downpayment, covers the total sales price.
When you make payments to the lender each month, you pay back a portion of the principal as well as additional fees in the form of interest charges.
What is a Redraw?
A feature which lets you make extra payments on your mortgage and then “reborrow” the money when you need it. Typically redrawing extends the term of the loan or increases the repayments.
Who is the Reserve Bank?
The body responsible for maintaining Australia’s financial system, and for setting the official short-term interest rates on which many variable-rate home loans are based.
What is Serviceability?
The borrower’s ability to make payments as they fall due (called “servicing” the loan).
What is Settlement?
Completion of a conveyance where the balance of the contract price is paid and ownership of the property passes from seller to buyer.
What is a Split loan?
Still relatively unusual in Australia, a loan repaid partly at variable rates and partly at fixed rates.
What is Stamp duty?
State tax paid by the purchaser, calculated as a percentage of the sale price of a property.
What is the Term?
The length of time over which the loan is repaid – for a home loan, usually between 15 and 30 years.
What is the Transfer?
A document registered at the Land Title Office and noted on the certificate of title, which verifies change of ownership of a property.
What is an unencumbered property?
A property free of encumbrances, covenants and restrictions.
What is a Valuation?
A report by a registered valuer giving their opinion of the value of a property.
What is a Variable rate loan?
A loan whose rate changes as outside rates change – unlike a fixed rate, which stays the same for a set number of years.
The outside rates are effectively set by the Reserve Bank, an independent authority that reports to Parliament. Depending on your arrangements with your bank, a change in your variable rate may not change your actual payments; instead, you may just pay off your loan faster or slower.