Home loan facts

Selecting a home loan or investment loan from the plethora of choices in the marketplace can be time-consuming and at times daunting. Deciding which lender, which home loan product, choosing the type of repayment and interest rate can be over whelming.

Then you need to take into consideration whether you require other services, for example, credit cards, offset facilities, or a branch network.

If you get it right, life is easy, get it wrong, it will cost you thousands of dollars.

Finance jargon

P&I – Principal & Interest Payments

I/O – Interest Only Payments

LVR – Loan to Value Ratio

LMI – Lenders Mortgage Insurance

Home loans are basic products.  The credit provider lends an amount of money over an agreed period, which is known as the loan term.  The standard loan term for a home loan is 30 years.

The borrower agrees to repay the money in instalments, i.e., weekly, fortnightly, or monthly over the loan term.  And agrees to pay interest on the money borrowed to the credit provider.

The longer the loan term, the lesser the repayment, which makes it more affordable.  However, be aware, the longer the loan term the more interest you will pay.

Interest is calculated daily on the outstanding loan balance, so the more frequent you deposit money into the loan account or offset facility the less interest is charged.  Therefore, the debt can be paid off sooner.

There are only 2 options when it comes to repayment types, they are Principal and Interest Payments, known as P&I or Interest Only payments.

Option 1:  Principal & Interest Repayments (P&I)

The Principal portion is the money going towards paying off the debt.  The interest is the money being paid to the provider for lending the money, otherwise known as the cost of using someone else’s money. Loan Repayment Calculator

Option 2:  Interest Only Payments (I/O)

By paying the Interest Only, you are not reducing the principal amount.  Thus, the monthly loan payment is less because there is no principal portion included in the repayment.

Most Lenders will offer an initial 5-year Interest Only term before you are expected to commence making principal payments.  This means, after the initial 5-year Interest Only term has expired, the monthly repayment will convert to P&I.

Consequently, once the Interest Only term expires and the loan convert to P&I the repayments will be higher as the remaining loan term to reduce the principal is only 25 years.

Interest Only terms suit most property investors or are a means of reducing your outgoings if your financial circumstances have changed and you need ease your monthly commitments. Loan Repayment Calculator

Loans with P&I repayments attract a lower interest rate than Interest Only loans Lenders charge a loading to the interest rate when it is Interest Only.  In some circumstances the cost difference makes it completely impractical to choose an Interest Only loan.

Before taking out an Interest Only loan, it is recommended that you consult with your Accountant or Financial Adviser to ensure the repayment type is suitable for your goals and objectives.

In our opinion it is always advisable to being paying off the debt.

Loan to Value Ratio is a crucial part of the assessment process and the higher the LVR the risk for the Lenders.  Lenders require you to have some financial interest in the security property, they will not lend you 100% of the property value.

The higher the LVR, the higher the risk is for the Lender.  Lenders are risk adverse my nature therefore they mitigate their risk by charging higher interest rates for high LVR loans and taking out lenders mortgage insurance.

As mentioned above, Lenders are risk adverse and one of the ways to mitigate the risk is by insuring the loan against any losses.  Most Lenders will take out an LMI premium against the loan when the loan to value ratio exceeds 60% at its own expense.

Once the LVR exceeds 80% the cost of the LMI premium is passed onto the borrower.  LMI protects the Lender, NOT the borrower even though the borrower is now paying the premium.  The higher the LVR the higher the cost of the premium.

Unlike your regular insurance premiums where you renew the premium each year.  When LMI is taken out, it is for the life of the loan and only paid for once.  The cost of the premium is payable at settlement and capitalised onto the loan amount.  Which means you will be paying interest on the LMI premium as well.

If you vary the loan after settlement by borrowing additional funds and the LVR remains above 80%.  Then the Lender will need to insure the new borrowings and you will incur another LMI charge on the new money.

One of the most common features of home loan is Redraw.  Redraw is created by making additional payments above the scheduled principal payment as per the loan agreement, thus creating a surplus of funds otherwise known as Redraw. Extra Repayment Calculator.

Not all loans offer Redraw and those that do will allow you access to those surplus funds.

However, you cannot access more than the available Redraw, ensuring the loan will be paid off in full as per the scheduled loan term.

Some, but not all, Lenders will charge a fee to access Redraw.  Again, some, but not all, set minimum Redraw amounts, anything from $0.00 to $1,000.00 depending on the lender.

An Offset Facility is a transaction account linked to an eligible home or investment loan.  The money in this account will offset the money owed, thereby reducing the interest charged for the month.

As mentioned above, interest charged on a home or investment loan is calculated daily on the remaining outstanding loan balance net of offset.  The more money in the Offset Account, the less interest charged, thus enabling you to pay more off the principal.

An Offset Account gives you all the features of a regular transaction account, i.e. ATM access, EFT, BPay and Direct Debit, with the bonus of saving you money and reducing your home loan term.

An Offset Facility can be a great tool.  It can save you thousands of dollars in interest and take years off the term of your home loan.

However, most Lenders charge a fee for an Offset Account and in some instances, a slightly higher interest rate.   Therefore, we would complete a cost benefit analysis before making a recommendation to a client, as having an Offset Facility could work out more expensive. Home Loan Offset Calculator.

Some Lenders offer a home loan package on which an annual fee is charged.  In return, you receive a discounted interest rate, an option having an offset facility, debit card and the option of a credit card, all-inclusive for one annual fee.

Borrowers whose loan amounts are of a significant proportion can certainly benefit from the discounted interest rate.

Before choosing this loan package it is worth doing your sums.  It may appear to be a great offer but could work out to be more expensive in the long run.

Variable interest rates mean exactly that.  Based on market conditions, rates and monthly repayments will fluctuate.

Variable interest rates offer greater flexibility than its fixed rate companion.  Account holders can, without penalty, make extra payments, access redraw, link an offset facility, or pay the loan out prior to the scheduled due date.

Some disadvantages do apply.  Budgeting is more difficult due to the variable monthly repayments.  The interest rate will rise and fall with market forces and so will the repayments.  If you have over-extended, subsequent rate rises can soon lead to mortgage stress.

The interest rate is fixed for an agreed period, ensuring the interest rate will not increase during the fixed term.  However, on the other hand, the interest rate will not decrease either.

Typical fixed terms are 1, 2, 3, 4 and 5 years.  At the end of the fixed term, the interest rate will switch to the standard variable rate of the day being offered by the credit provider.

A fixed rate offers the account holder certainty in monthly repayments.  In turn, planning and setting financial goals can be made with confidence.

There are some disadvantages with Fixed Rates and these need to be taken into consideration prior to locking in your rate to a fixed term.

The disadvantages are:

  • If interest rates drop, you will not benefit from the reduction in interest rate;
  • Fixed interest rates offer limited flexibility;
  • Most Lenders set limits on making extra repayments.  These vary from Lender to Lender; some will not allow you to make any additional payments and if you do, you will be charged a penalty;
  • Some will allow additional payments up to a certain amount i.e. $1,000.00 a month, while others allow extra payments of $10,000.00 per 12-month period without being penalised;
  • Most Lenders will not allow you to access redraw during the fixed term;
  • Should you break the Fixed Term Contract, it can be costly as Break Fees may apply.  These can vary from $0.00 to tens of thousands of dollars depending on how far into the fixed term you are; the cash rate of the day; the remaining fixed term and the daily bank bill swop rates.  Basically, if the Lender is going to lose money, it will be you who pays;
  • Break fees can be triggered if the loan is discharged during the fixed term because the account holder has sold the property; refinanced to another Lender or has decided to convert the loan to a variable rate.

A Fixed Rate loan may not be suitable if you are thinking about selling your home in the foreseeable future; want flexibility to make extra repayments and the freedom to switch Lenders if you find a better deal elsewhere.

Mortgage stress is not fun, and over the lifetime of a mortgage, interest rates will fluctuate due to market conditions and your personal circumstance will most likely change significantly as well.

If you have not done so, you are encouraged to complete a budget and put together a risk strategy for life changes, e.g. having children, loss of employment and interest rates rises.

Do you have a plan?

  • Have you considered that, should your circumstances adversely change, how you would make your current and the proposed loan repayments? Budget Planner.
  • Do you know how high your interest rate needed to rise before you found yourself under financial stress? Loan Repayment Calculator.

In our opinion, it would be wise to have considered the above questions and taken an in-depth look at your financial circumstances to minimise the chances of you finding yourself suffering with mortgage stress.

Deposit Bonds allow you to purchase a home or invest in property without having to provide the deposit in cash.  A Deposit Bond Guarantee is a substitute for the cash deposit required when purchasing a residential property – you simply pay the full purchase price at settlement.

Both short- and long-term guarantees are offered to suit any settlement terms. They can be either short term or long term.

Short Term Deposit Bonds

Are available for purchases where the settlement terms are up to 6 months.  Short term guarantees are issued subject to issuing guidelines.  Purchasers need to provide evidence they have sufficient funds available to complete the purchase.

Long Term Deposit Bonds

Are available for purchases where the settlement terms are between 6 and 48 months.  These can be arranged for applicants who own existing residential property and demonstrate the ability to complete the purchase.

There is a charge associated with this. Usually, it’s around 1.2% of the 10% deposit required.

Is a form of deposit that is used regularly when purchasing real estate where the land or plan of subdivision is not yet registered or the dwelling it not yet built.

It is predominantly used as the preferred form of deposit when purchasing a property Off the Plan.

How a Bank Guarantee Works

Normally when you purchase a piece of real estate you are required to pay a 10% deposit. This is usually done by transferring the required deposit into the real estate agent’s Trust Account. When you are purchasing a property Off the Plan or purchasing un-registered land a Bank Guarantee is often the preferred method.

Why?

Instead of handing over your hard-earned cash and letting it sit in the real estate agent’s Trust Account or the vendor’s solicitor’s Trust Account allowing them to earn interest, you deposit the money into a secure savings account that is in your name, usually with one of the 4 major banks. You accrue the interest for the period of time the money is in the savings account.

The account is in your name, however the Title to the savings account is handed over to the vendor’s solicitor and at settlement the funds in the account will be handed over to the Vendor in return to the vendor handing back the Title to the account.

The account may be in your name, but whoever holds the Title to the account owns the money upon release.

If you are purchasing a property Off the Plan then most developers will only accept the deposit being paid in the form of cash credited to their solicitor’s Trust Account, in which it is held until settlement or a receipt of a Bank Guarantee which the developer’s solicitor holds until settlement.

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