According to a survey by mortgage lender ME Bank, the majority of first home buyers in Australia do not understand what conveyancing is, aren’t sure what mortgage insurance covers, and are quite ignorant of the auction process. Yet, 70 percent of first homeowners reported that they felt confident making financial decisions, which is quite surprising when they aren’t even well versed with the basics!
The survey that tested the knowledge of 1,000 prospective and existing home buyers in Australia had 61 percent of first home buyers failing a basic property buying quiz (Read the full report here).
According to Nat, a mortgage broker, financial ignorance could cost you dearly. He often meets first home buyers who are aware of most of the common property-related terms, but aren’t really sure what they mean.
According to Mr. Patrick Nolan, ME Head of Home Loans, “Overconfidence and low financial literacy is a risky combo that could be costing first-time buyers.”
It is, therefore, recommended to brush up your knowledge about the property buying process by reading up educational material such as the home loan guidance on the ASIC Money Smart website.
As a starting point, today, we bring you a glossary of the top 20 financial terms you must know:
- Application Fee: The fee paid by you, the borrower, for setting up a loan.
- Borrowing Capacity: Your borrowing capacity is the amount a lender will lend you for buying a property. Different banks have different criteria for assessing your borrowing capacity, but certain common considerations include your current income, assets and debts, credit card limits, living expenses, etc.
You can get an estimate of your borrowing capacity with this handy online calculator.
- Collateral: Collateral is an asset that is used to secure a loan. For example, when you take a mortgage, your house is the collateral that secures the mortgage. And, in case you default in making the repayments, your lender can take over the collateral (or the pledged property) to make good the payment.
- Comparison Rate: A comparison rate is a calculation tool that allows borrowers 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 borrowers compare apples with apples when they 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.
- Compounding: Compounding is a simple, but important, financial concept. It merely refers to the concept of earning interest on previously earned interest.
For example, you invest $100 at a rate of 10% per annum for 5 years. If you were to earn simple interest, you would simply receive interest of $50 on the principal of $100.
However, compound interest is calculated differently. In the same example, if interest were compounded annually, at the end of the first year you would have a total of $110. At the end of the second year, the total would be $121 (10% interest calculated on the original principal, as well as, the interest earned). Thus, the total amount at the end of 5 years would be $161.05.
- Conveyancing: It refers to the legal process involved in transferring a property from one person to another. A conveyancer is a legal professional who carries out title searches, advises on sale contracts, and enables buyers to complete the legal obligations involved in the process.
- Cooling-off period: This refers to a fixed period of time in which the buyer can cancel the transaction after a purchase. Note that there is no cooling-off period when you buy a property at an auction.
- Credit Score: A credit score is a number that represents your creditworthiness. It is a numerical evaluation of your credit history that is drawn from your credit report sourced from various credit bureaus. Lenders look at your credit score or credit rating, available on your credit file, to determine whether, and how much, they should lend to you, if at all.
Your credit score reflects every single aspect of your finances. Any unsettled debts, loan applications, missed repayments or utility bills stay on your credit file for years, bringing down your credit score and affecting your home loan application adversely.
Learn more about credit score.
- Credit Search: A credit search is when a company or a third party check your credit report to learn about your borrowing history. There are two main types of credit searches.
A soft credit check is a quick preliminary check carried out by a lender to check your eligibility for a particular facility or when you request a copy of your credit report to go through it yourself. Such a search does not affect your credit score adversely.
A hard credit check is a thorough assessment of your credit by a lender or a credit card institution or a company when you apply for a mortgage, credit card or open a new utility account, respectively. Such a check stays on your file for 12 months or more. Multiple hard credit checks on your file in quick succession can lead a lender to believe you are desperate for credit, potentially derailing your mortgage application.
- Discharge of Mortgage: Once your mortgage has been repaid in full, your lender will give you a signed document, known as Discharge of Mortgage, which is a written acknowledgment that your loan has been repaid in full.
- Disposable income: It refers to the amount of income remaining after all your general expenses, such as loan repayments, utility bills, kids’ school fees, etc. have been met.
- First Home Buyer: A first home buyer is someone who has never owned a home and is purchasing an owner-occupied property for the first time.
- First Home Owners Grant (FHOG): FHOG is a one-off grant, funded by various States in Australia, payable to eligible first home owners on the purchase or construction of a new home.
To address the issue of housing affordability, the Australian Government had first started the First Home Owner Grant (FHOG) of $7,000 in the year 2001. This amount was doubled to $14,000 in the years 2008 and 2009. Currently, different states are offering different amounts as grants, and you can check the latest information on your State’s website.
- Fixed Rate: A fixed rate is an interest rate that does not change for a set term of the loan. Both the interest rate and repayments are, therefore, fixed for the agreed term that could be up to 7 years, irrespective of the interest rate fluctuations in the market.
- Home Equity: Your home equity is the difference between the market value of your property and the amount you still owe on your home loan. For example, if your property is worth $600,000 and you owe $350,000 on your home loan, your home equity would be $250,000.
Did you know that your lender may allow you to borrow 80 percent of this equity to purchase an investment property or pay for home renovations (read more)?
- Lender’s Mortgage Insurance (LMI): LMI is a one-off insurance payment that protects your lender if you are unable to pay your mortgage. It is usually required for loans that lenders consider risky, such as when you are borrowing more than 80 percent of the property’s value.
Depending on the amount of your loan, LMI can run into thousands of dollars. However, it is possible to roll over your LMI premium into your home loan amount. Note that LMI only protects the lender and provides no protection to the borrower.
- LVR – LVR or Loan-to-Value ratio is the percentage of the money you borrow for a home loan compared to the value of the property you intend to buy. Lenders are generally comfortable lending to you if your LVR is less than 80 percent. For anything more, you might need to pay LMI or provide a parent guarantee.
- Mortgage Protection Insurance: It is a type of insurance that covers the cost of your mortgage repayments in the event of an accident or sickness that renders you unable to work. This type of insurance covers the borrower and not the lender.
- Offset Account: An offset account is a savings account that is linked to your home loan. Here, the balance in your account is offset against your outstanding home loan so that you are only charged interest on the difference between the two.
- Product Disclosure Statement (PDS): According to ASIC, a PDS is an important document that a financial service provider must provide to you when recommending a financial product. PDS should include detailed information about the product’s key features, fees, commissions, and associated risks and benefits.
- Variable Rate – A variable interest rate is an interest on a loan that varies according to the market rate because it is based on an index rate that changes periodically.
We hope that you found this glossary useful. In case you have any home loan query, post it online to receive a resolution, free of cost, from Australia’s top brokers on HashChing. Alternately, fill up this contact form, and we will put a verified mortgage broker in your area in touch with you, immediately.
By Vidhu Bajaj,
HashChing Content Writer