Mortgage terms demystified

Offset account, redraw facility, loan-to-value ratio – homebuyers are frequently hit by these words as they traverse the mortgage market in search of the perfect home loan. Yet, a national survey of 1,006 Australians commissioned by State Custodians in 2018 revealed that one in five Australians do not understand 11 key mortgage terms.

11 Basic Mortgage Terms You Should Know

According to Sam, a mortgage broker, “people often avoid asking questions for fear of looking silly. However, without knowing the basics, such as the meaning of comparison rate or other features, you cannot compare home loan deals and would probably end up overpaying on your mortgage.”

Financial literacy is the first step to financial health. Today, we demystify some notorious mortgage terms that have been baffling Australian homebuyers since years:

Principal and Interest – Principal refers to the amount owing on a loan. For example, if you borrow $300,000 to purchase a property, the amount of $300,000 would be considered the principal amount that you must repay the bank.

In addition, your bank also charges you interest on the principal amount. Most buyers choose to pay both the principal and interest together to reduce their loan amount gradually. This is known as a Principal and Interest loan or a P&I loan.

Some buyers, mainly investors, may opt to pay only the accumulated interest for a fixed period. This is known as Interest-only or IO loan. In this scenario, your repayment in the fixed period is generally lower but can shoot up by three times once the interest-only period is over. Speak to a mortgage broker to understand your options better.

Bridging Loan – A bridging loan allows you to buy a new property while you are still looking for buyers for the existing one. If you plan to use the sale proceeds from one home to buy another and are still looking for a buyer, bridging finance can help you fund the new property for a short term in between.

Speaking technically, bridging loans are not much different from traditional loans, except that they are for a short duration and interest-only.

The amount of money you can borrow is calculated as follows:

(Market value of your new property + the outstanding mortgage on your existing home) – (The sale price of your existing property) = The principal amount of your bridging loan

Note that you must have built a good amount of equity in your existing home to apply for a bridging loan.

Refinancing – Refinancing refers to replacing your existing mortgage with a new, ideally better, mortgage deal. There are several reasons why you may choose to refinance your home loan. These include switching to a lower interest rate (and lower repayments, consequently), debt consolidation, unlocking the equity in your home loan, etc.

Here’s a word of caution, though. Keep in mind that refinancing your loan is not free of cost. Calculate your breakeven point to determine your savings before making the switch.

Lenders Mortgage Insurance – Lenders Mortgage Insurance or LMI is an insurance that protects the lender if a borrower fails to make repayments. Therefore, LMI enables home buyers to purchase a property with less than 20 per cent deposit by protecting lenders against payment defaults. The risk of lending is transferred from the banks to the insurer, facilitating high LVR loans for the borrowers.

You can pay your LMI premium as a lump sum or roll it into your loan amount, in which case it will also attract interest.

Line of Credit – A line of credit can be explained as a revolving credit account that can be used to withdraw money on a need basis. The credit limit is pre-approved by the lender and interest is payable only on the amount of money withdrawn.

Offset Account – An offset account is a transaction account linked to your home loan that can be used to offset your interest costs. For example, if you have a $500,000 mortgage and $50,000 in your offset account, you’ll only be charged interest on $450,000.

Redraw Facility – A redraw facility allows you to access or redraw the extra payments you have pumped into your home loan.

Comparison rate – A comparison rate is a calculation tool that allows you to understand the true cost of a loan. In addition to the interest rate, the comparison rate also takes into account the repayment term, fees and charges, helping you compare apples with apples when you compare two home loans.

Note that the comparison rate is calculated on a standard loan amount of $150,000 over a period of 25 years, which means the figure would differ for your actual loan amount. A comparison rate calculator can help you calculate this number.

Loan-to-value ratio (LVR) – LVR is the ratio of the mortgage compared to the value of the property. If your home is valued at $500,000 and your loan is $400,000, your LVR is 80 per cent.

Split Loan – A split home loan refers to a situation wherein you divide your loan into parts so that you pay a fixed rate of interest on one part and a variable interest rate on the other.

Portability – Having portability in your mortgage allows you to change homes while using the same home loan to finance the new property. This saves the hassle of setting up a new home loan and may also save you money on application fees and mortgage stamp duty.

Now that you are acquainted with the basic home loan terminology, head to our website to compare mortgage rates starting as low as 3.49 per cent per annum. All the deals on HashChing are broker pre-negotiated, which means you can find rates that are as much as one per cent lower than lender advertised rates published elsewhere.

Still confused? Our expert brokers would be happy to help you. Post your query online or fill up this contact form so that we can put a mortgage broker in touch with you.

By Vidhu Bajaj,
HashChing Content Writer


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