Buying your first home is exciting! You get to research the different suburbs you’d like to live in and fantasise about the kind of lifestyle you could lead there, not to mention there is an array of luxe design upgrade options to consider… But when it comes to the finance side of things, it can be hard to decipher the jargon and you might feel needlessly overwhelmed. Here are the top five finance terms, explained.
Also known as ‘conditional approval’ or ‘indicative approval’, this refers to the process of undergoing a full financial assessment before you officially apply for the loan. The lending institute you apply for a pre-approval with will review all your documents and conduct a credit check.
The process will take around 2-3 days, and the outcome is not a guarantee that your application will be approved, but it does give you a good gauge on your eligibility for the loan – and the amount you may be able to borrow. This is crucial to determine before you begin your search, otherwise, you may be inadvertently looking outside of your actual price range.
There are two kinds of interest rates, variable and fixed, and there are advantages and disadvantages to each:
Variable interest rate
- Pros: Variable interest rates can decrease if the Australian cash rate is reduced — meaning you can pay less interest.
- Cons: The reverse is true, too. If the cash rate is increased, you’ll have to pay more interest.
Fixed interest rate
- Pros: You’re protected from future interest rate rises. You’re only locked in on an interest rate for 1 to 5 years, meaning you can always change to a variable home loan in the future.
- Cons: You won’t benefit from falling interest rates, and there may be restrictions on making additional repayments.
The amount of interest you have to pay can be affected by your loan to value ratio (LVR). Your lender will calculate your LVR by dividing the amount of your home loan by the purchase price (or appraisal of the property). The higher your LVR, the greater the risk to the lender and some may apply a higher interest rate to insure themselves against potential loss.
This helps you work out the true cost of a loan per year. It reduces the interest rate (including the interest rate, monthly repayments, and most upfront and ongoing fees and charges) to a single percentage so you can compare home loans more easily.
This is an especially useful tool if you are just dipping your toes in the water or don’t really understand the maths of it. A home loan could advertise a lower interest rate than a competitor but due to other costs and fees, it could actually cost more when you look at it holistically.
The comparison rate should only be used as a guide, as it does not calculate absolutely every possible cost, nor the different features of the loans which may be more beneficial to you as an individual.
A mortgage offset account is a savings account linked to your home loan. In calculating the interest you have to pay on your loan, your lender deducts the amount in your offset account from the amount remaining to be paid on your loan balance. The interest is then calculated on this lower amount, meaning you pay less.
For instance, if you had a $300,000 home loan balance, with $100,000 in an offset account, interest is calculated on $200,000 of your balance. Offset mortgages are great because the amount in the offset account can be withdrawn if needed. This arrangement also offers major tax advantages for owner occupier borrowers.
Lender’s Mortgage Insurance
If the deposit you plan to pay amounts to 20 per cent or less of a property’s total value, you will have to pay lenders mortgage insurance (LMI). LMI protects your lender if you can’t repay your mortgage. The amount you pay for LMI depends on the size of your loan, and the size of your deposit.
For example, if your property is valued at $400,000 and you plan on only paying a 5 per cent deposit of $20,000, your LMI cost (according to Australian lenders mortgage insurer Genworth) would be between $12,000 and $13,000. This can either be paid upfront or capitalised into the loan. If capitalised into the loan, you’ll pay an extra $64.99 per month on top of your loan repayments.
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