Finance Jargon Demystified
When it comes to the finance market, there are so many options available, varying from lender to lender, and this can make it hard to decide which loan is best for you. Part of our mortgage broking service is to find the most appropriate products and features to suit you, and explain why they are the most appropriate. To help you understand the wide variety of choices available, we have explained some of the common loan product features below.
Interest Only Payments
Most Lenders will offer borrowers the ability to make interest only payments on their loan for a set period. That means that the monthly repayment has no principal reduction component, and the outstanding loan balance will remain unchanged during the term of the interest only period. Generally the terms offered by the Lenders are between 1 –5 years but some lenders may offer up to 10 years. After the initial interest only period, the loan will revert to the normal amortised repayments over the remaining term of the loan. For example, and loan with a 30 year term may have a 5 year interest only term, followed by a 25 year principal and interest term.
Loan portability allows the borrower the option of using keeping their existing loan arrangements, but changing the property that secures it. For example, a borrower may sell their current home, and purchase a new home, and simply transfer the existing home loan to the new home.
A Mortgage Offset account allows the borrower to have any savings or credit balances in their transaction account to offset against their loan facility when interest is calculated. Offset accounts are offered by most Lenders which offer normal transaction type accounts. Most Lenders will offer ‘100%’ offset, which means that any credit balance in the account will offset the outstanding balance of the loan facility. The mortgage offset account itself does not earn any interest. However, benefit in that the interest on the loan charged is calculated on the net outstanding balance, after reducing the outstanding balance by the amount deposited in the offset account. For example, if a borrower had a loan with a balance of $100,000, and an offset account with a balance of $10,000, then interest is calculated on the net balance of $90,000. As mortgage offset accounts are regulated by the Financial Services Reform Act, providing advice on these accounts to consumers may only be done by via the holder of an Australian Financial Services License (AFSL). If a consumer requires a mortgage offset account, the lender who offers the product will provide the consumer with a Product Disclosure Statement which contains all relevant information.
Loan redraw feature allows a borrower to withdraw any additional funds that they have paid of their loan facility over and above the normal minimum repayment. For example, if a borrower has been paying an additional $500 per month off their loan, after 12 months, the borrower would be able to redraw $6,000. The redrawn funds can be used for any purpose. Lenders may charge a fee to redraw extra payments, with costs typically varying from nil to $50 per redraw.
Split Accounts or Combination Loans
Most lenders allow borrowers to split their loan into a number of different products. For example, a borrower may elect to take a combination of a Fixed and Variable Rate loans in order to minimise the potential effect of an interest rate rise, while still maintaining the flexibility of a Variable Rate loan.
Lenders Mortgage Insurance (LMI)
Lender’s Mortgage Insurance is an insurance policy obtained by the lender, but paid for by the borrower. It is for the protection of the lender, and not the borrower. The LMI policy protects the lender against any losses where: the borrower default on their loan, the lender sells the security property; and there are not adequate funds to cover the outstanding loan and any fees and charges that may have accrued. LMI is usually taken by the lender when the value of the loan requested exceeds 80% of the value of the security property. The LMI premium is based upon a sliding scale depending upon the loan to value ratio (“LVR”) – the higher the LVR, the higher the premium. LMI premiums can be substantial, and must be factored into the overall cost of borrowing to ensure that there is not a shortfall of funds when it comes to settle a loan transaction.LMI will normally not cover penalty interest, early repayment penalties, LMI premium, physical damage to property and fees and charges not directly related to costs incurred by the lender in order to recover the debt. LMI companies may refund a portion of the LMI premium if the facility insured has been fully repaid within 12 months of advancement of funds. LMI is available for both owner occupied & investment loans. In addition to the borrower needing to satisfy a lender’s criteria, they must usually also meet the requirements of the mortgage insurer. In many cases an application may meet the lending guidelines of the lender, but fail to meet the mortgage insurer’s guidelines, in which case the lender will decline the loan. Some Lenders may allow borrowers to add the LMI premium to the loan amount, which in effect allows the applicant to borrow in excess of the stated LVR.