So you’ve had your home loan for years and you’re not confident that it’s still the best deal for you. However, it was a long and arduous process, and you really don’t want to go through it again. It doesn’t have to be this way! And it is actually relatively simple to switch from your old, crappy home loan to new and better home loan.
There is plenty of home loan jargon out there and lucky for you, I have collated everything you need to know below!
When a borrower decides to switch from one lender to another, essentially the new lender pays the old home loan out with the original lender, and creates a new home loan. Borrowers typically refinance to get a more competitive rate, secure better features or release equity for investment and lifestyle purposes. For example, in certain circumstances, you could refinance your home loan to achieve a 0.50% better interest rate and access equity of $120,000, which could then be used as deposit for your next property.
Principal is the amount of money you borrow from the bank. As you pay off the principal, you will create more equity in your home. As you pay down the principal amount you owe on the home loan, you create more equity in the property. For example, if you borrowed $500,000 from the bank and at the end of the year you owed $490,000, you would have paid off $10,000 worth of principal from your home loan.
Interest is calculated on the principal amount outstanding on your loan. Many people refinance their home loan to secure a more competitive interest rate. This is how the banks make money and is considered the cost of your mortgage. For example, if you have a $500,000 home loan with an interest rate of 4%, you would pay $20,000 in interest to the bank over a 12 month period.
The interest rate on your home loan will determine how much interest is charged. There are a huge number of variables that affect the interest rate of a home loan. Borrowers typically strive to secure the most competitive interest rate possible to ensure they don’t spend more money on their home loan than is absolutely necessary. For example, if you were to refinance your $500,000 home loan from a 4.5% interest rate to a 4.0% interest rate, you would save $2,500 annually in interest costs.
When you have a variable rate home loan, the interest rate of your mortgage will fluctuate in line with market movements. Variable rates provide a lot of flexibility for the borrower, however some borrowers can feel uncertain with a variable rate. To give you an example, variable rates increase or decrease based on decisions made by both commercial banks (CBA, NAB etc) and by the Reserve Bank of Australia.
Fixed rate home loans lock in the interest rate for a predetermined period of time, typically from 1 to 5 years. Fixed rates provide a lot of certainty for the borrower, however lack the flexibility of a variable rate. To give you an example, if you locked your interest rate in for a fixed period of 3 years at 4.0%, your interest rate would remain at 4.0% for the next 3 years, after which it will revert back to the standard variable rate.
A split home loan will be part fixed and part variable. Perfect for those who would like both the certainty of a fixed rate and the flexibility of a variable rate. For example, if you had a $500,000 home loan, you could fix $250,000 at 4.0% for 3 years and leave $250,000 variable at 4.5%. This means that you have the certainty that for half of your loan the repayments won’t change for the next 3 years, however you still have the flexibility to make extra repayments on the variable part of the loan if you choose to do so.
Principal and Interest Repayments
When you make principal and interest repayments, your regular repayment will contain an element of principal and an element of interest. This means you are chipping away at the loan with every single repayment. For example, let’s assume that you had a home loan of $500,000 with a $2,000 monthly repayment. In this scenario, your interest for the month might be $1,500 which means that $500 will be paid off your principal, therefore meaning the home loan at the end of the month is now $499,500.
Interest Only Repayments
When you make interest only repayments, you pay only the interest costs each month, and no principal. This is great for cashflow, however you are not reducing the loan amount when you make interest only repayments. For example, assuming you had a home loan of $500,000 with a $1,500 per month interest repayment, during the month you will make a repayment of only $1,500, however the debt will remain at $500,000 at the end of the month and throughout the entire interest only period.
Depending on the type of loan and the lender, principal and interest loans can oftentimes nominate weekly, fortnightly or monthly repayments. Interest only repayments can only be made monthly. For example, instead of making a monthly repayment of $2,000 on your home loan, you may be able to make a weekly repayment of $500 instead. This is a handy tool for managing your household cashflow.
Owner Occupied Home Loan
This is the term used when the property used as security for your home loan is actually your home. These days, owner occupiers can typically secure more competitive interest rates than investors. For example, if you take out a home loan to buy your own home, this would be considered an ‘owner occupied’ home loan.
Investment Home Loan
This is the term used when the property used as security for your home loan is an investment property. These days, investment loans are more expensive than owner occupied loans. For example, if you take out a home loan to buy an investment property, this would be considered an ‘investment’ home loan.
The asset that is being used to secure the home loan. Every home loan needs an asset linked to it, and typically this is property. For example, if you were taking out an owner occupied home loan to buy a house, the bank will use that house as security. If you were taking out an investment home loan to buy a factory, the bank will use that factory as security.
The difference between what your home is worth and how much you currently owe on it. There are 2 ways to gain equity in your home, either through paying the principal amount down or having the property increase in value.
The length of time you have to pay the home loan off. A 30 year loan term is standard, however in Australia the real average length of a home loan is a little of 4 years, as people sell the property and pay off the mortgage, refinance their home loan to a better rate or pay the home loan off ahead of time. For example, even if you take out a 30 year loan term, if you make extra repayments or keep cash in offset, you will pay the home loan off quicker, say in 15 years in some cases.
An offset account is just like a regular transaction account, however it is linked to your mortgage to reduce the amount of interest you pay. A great idea, as for every dollar you keep in an offset account, you will pay no interest on the equivalent amount on your home loan. I love offset accounts and personally keep all of my cash holdings in offset accounts. For example, if you have a home loan of $500,000 and keep $100,000 in your offset account, you will only pay interest each month on $400,000, not $500,000.
A redraw facility will ensure you have access to any additional funds you contribute towards the mortgage. Great idea for a rainy day fund or to save for lifestyle goals. For example, let’s say the monthly repayment on your home loan is $2,000, however you have chosen to make repayments of $3,000 every month. At the end of the year, you will have saved $12,000 in your redraw facility which you can then use any way you please.
Settlement of a refinance is when the original loan and original lender is paid out in full, and the new lender establishes your new home loan. From this day forward, repayments will be made to the new lender. For example, when you go through the refinance process, the settlement is typically the final step and the day you get your new and better home loan.
Loan to Value Ratio
More commonly known as LVR, the loan to value ratio describes the amount owing on the home loan compared to the value of the property. Typically, the lower the loan to value ratio, the stronger the application is for the banks and the better the deal that can be negotiated. For example, a $400,000 home loan on a $500,000 property will have a loan to value ratio of 80%.
Lenders Mortgage Insurance.
More commonly known as LMI, lenders mortgage insurance is a premium that is charged to borrowers when the loan to value ratio of a loan is above 80%. Remember, lenders mortgage insurance protects the lender, not the borrower, and this is one of the biggest misconceptions that tricks property buyers. To give you an example, if you buy a $500,000 property with a $450,000 home loan, you will have a loan to value ratio of 90%, and will likely need to pay a lenders mortgage insurance premium of circa $10,000. Please note that in most cases, lenders mortgage insurance can be capitalised into the home loan.