AAPR or Comparison Rate of a Loan
The AAPR or comparison rate is a rate which includes both the interest rate and fees and charges relating to a loan, reduced to a single percentage figure. It takes into account honeymoon periods, revert rates and any upfront or ongoing fees that is ascertainable when the comparison rate is disclosed. It is essentially the effective rate of the loan.
Amortizing or Principal & Interest (P&I)
Amortizing is another word for loans that are gradually being paid off. Borrowers with an amortizing loan have to make set repayments each month of both principal and interest so that over a certain period of time their loan is paid out. This is sometimes referred to as P&I. Other options are interest only or interest capitalization. The opposite of an amortizing product is a revolving line of credit.
Break costs are also known as economic costs. They are charged by an institution to recoup interest lost through a borrower refinancing with another institution or paying their loan out early. Break costs are normally only charged on fixed rate loans where the amount of interest the institution would receive is easily calculable. It can also be charged well into the variable portion of a honeymoon or introductory rate home loan. Some institutions also charge a flat fee on top of their break cost charge. They may refer to this fee as a "deferred establishment fee".
Bridging finance allows a borrower to "bridge" the gap between the sale of one property and the purchase of another. This can be useful if you are looking to upgrade from one property to another and the proceeds from the sale of the first property are not enough to cover the purchase price of the second. It is also used if the settlement date of the new property purchase takes place before the sale of the original property settles. If these two transactions are, say, a month apart, bridging finance can help fill that one month gap. Bridging finance can be expensive.
Sometimes referred to as a "controlled rate" home loan, a capped or tunnel loan sets parameters on the movement of a variable interest rate. With a capped loan, an upper limit is set on how high the loan rate can go while no limit is set on how low it can go. This gives some measure of protection if rates rise. With a tunnel structure, limits are set on both how high and how low a rate can go, creating a tunnel in which the loan rate can fluctuate.
Conveyancing fees (legal fees on the purchase) vary from state to state and will generally be between $400 to $1000 depending on the complexity of the transaction. If you elect to do the conveyancing yourself, the cost of the certificates and other documentation will still be required.
Everyone who wants to take out some form of housing finance needs to go to the bank with a certain amount of money set aside as a deposit. The amount of deposit you need depends on several factors including the LVR the bank lends at, what your other expenses are likely to be in the first few months of your loan and whether or not you want to reduce the borrowing amount as much as possible. The best way to determine the size of the deposit you'll need is to look at the actual price of the property you wish to purchase and deduct the LVR the bank lends at before charging mortgagee insurance. This will give you a percentage of the house's purchase price that you need as a basis of your deposit. After paying this deposit, you'll need to be sure you will still have enough money left over to pay your upfront expenses such as any solicitors fees (conveyancing), stamp duty, and any upfront loan fees. This can be $6,000 to $10,000 but ranges from state to state. If you don't have that much money left over, don't panic. You can ask the bank to lend to you at a higher lvr and pay them mortgagee insurance (approximately 1% of the loan). You'll still need the $6,000 to $10,000 but your deposit will be smaller.
Fixed Rate Loans
Fixed loans generally allow a borrower to lock in an interest rate for a particular period of time, normally 1-5 years. Customers who choose a fixed rate get assurance that their repayments will be set for the fixed period and that if interest rates rise, their rate will remain the same. However if interest rates drop, a fixed loan will keep a borrower at the higher rate. Customers who want the assurance of a fixed rate but want to take advantage of rate drops, should consider splitting their loan. Fixing a portion of a loan does mean a flexibility trade off. The fixed rate portion of a loan generally has more restrictions than a standard variable. Most fixed rate loans do not let you make extra repayments or pay out the loan (refinance) during the fixed period. Features such as redraw or mortgage offset are usually not allowed during the fixed period of a loan.
Interest capitalization is rarely used in personal lending because it involves the loan interest pushing the loan balance past the amount originally borrowed. For a certain period of time, no interest or principal repayments are required.
Interest only means simply that no principle repayments are required. You only have to pay the interest portion. Borrowers can't have more of their loan outstanding then they originally borrowed so interest repayments are required to keep the loan balance below that amount. Theoretically, the loan need never be paid out as long as interest payments are made. Some loans can be split with an interest only portion to reduce the repayments necessary in the early years of a loan. However, most people treat their revolving line of credit loans as an amortizing product in that they make their normal repayments. Interest only is common in fixed rate loans where the ability to calculate future interest means interest can be paid in advance.
Introductory or Honeymoon Rate Loan
Introductory or honeymoon rates were so named because they give the customer a low rate honeymoon period before they revert to the reality of the 30 year marriage. These products offer customers a special reduced rate for the first year that can be either fixed or variable. They generally revert to a standard or special variable rate and can sometimes have higher upfront or ongoing fees. The benefit of the 1 year introductory rate is that repayments in the first year are lower and can give first home buyers some breathing space. But honeymoon rates can have hidden traps. Often the rate they revert to after the first year is higher than the standard variable rate and the loan often has increased fees. Ask the institutions for their AAPR - the effective rate of their loan. This will show if taking out a loan with a "teaser" rate makes you better off overall. Honeymoon rates are sometimes referred to in advertising as "guaranteed" or "discounted".
If you're considering an introductory rate, there are some questions you should ask any institution you're considering:
- What is the effective rate of the loan or the AAPR?
- Does the initial low rate revert to the standard rate or to a special higher rate after one year?
- Are there higher upfront or ongoing fees?
- Can you pay out the loan (through refinancing) after the one year period or will you be charged a break cost? (Some loans will charge a break cost up to 5 years into the loan).
Lender Mortgagee Insurance
Mortgage Insurance is insurance for the institution rather than the borrower, even though it is the borrower who pays the premiums. If a borrower defaults on a loan that had mortgage insurance, the lender recoups all its money because the insurer guarantees the amount of the loan.
Loan to Value Ratio (LVR)
The Loan to Value Ratio (LVR) tells you exactly how much money an institution will lend to you. Finance companies never lend the total value of a property because they need to know they can get their money back if they sell it. They generally specify a particular percentage of the value of a house that they will lend up to. This is called the LVR and it is normally expressed as a percentage. If a house is worth $100000 and the institution only lends up to 80% LVR, they will lend you $80000 and you have to pay the extra $20000 yourself. This is called a deposit. These days, many institutions lend up to 95% LVR but require insurance for the loan. This is called mortgagee insurance. Most will lend up to 80% LVR without requiring the insurance.
Mortgage offset is another way to reduce your mortgage by attaching an account to the loan and using the balance to reduce interest. A mortgage offset account replaces your personal transaction account. Money can be deposited and withdrawn from the account in the same way as any other account. For this reason, it can be used to set up an "all-in-one" or salary loan. You have your salary paid straight in to an account that is linked to your mortgage but not a part of it. You can access your money in the same way you would if you still had your normal savings accounts - ATM, Eftpos, Cheque, and more recently, telephone and internet banking. 100% mortgage offset and redraw are close relatives in that they essentially achieve the same thing. You pay extra money in, allowing you to decrease the balance of your mortgage that is being charged interest. Then you can get it back again. Mortgage offset works by reducing the amount of interest charged on a loan. With 100% mortgage offset, every dollar deposited into the account means that same dollar in the loan is not charged any interest. Mortgage offset is tax effective because the account itself earns no interest thereby legally minimizing taxable income. If an account is 100% offset, this means that for one dollar in your offset account, you are effectively paying no interest on that same dollar in your mortgage. Mortgage offset does not have to be offset 100%. In these cases, it may be referred as a "Loan Reducer" or "Mortgage Reduction" facility.
If considering mortgage offset, there are a few questions you should ask any institution you're considering:
- Is it 100% offset? If it isn't, this means the interest on your mortgage is being reduced but not negated by the money in your offset account.
- What sort of access do I have to my account? Remember, to make mortgage offset fully effective your entire pay should be credited to this account. If you can't get it back again easily, this could create problems.
- Is there an ongoing fee on the mortgage offset account that is separate from and on top of any ongoing loan fees?
- How many free transactions do I have?
- How much does a transaction cost?
- Do I have to withdraw a minimum amount each time?
Ongoing fees are charged periodically over the entire life of the loan and can have a significant effect on the cost of a loan overall. They can be charged monthly, quarterly, semi-annually or annually. Ongoing fees can either be added to the amount of your loan still outstanding and charged interest or they can be deducted from a nominated transaction account.
An overdraft is a loan that does not need to be paid off in regular, structured repayments. Unlike a loan, an overdraft can be brought into credit or linked to a transaction account that can be brought into credit. The loan facility is available permanently and be accessed at any time without having to make new applications. A revolving line of credit is often thought of a giant overdraft as it can be paid off and redrawn back indefinitely over the life of the loan. Some institutions market the product as a "lifetime loan" in that you may never need another facility.
Parental leave and repayment holidays are almost siblings although an institution may offer one but not the other. Some institutions allow you to take either a short break from your loan repayments or to reduce your repayments for a short period of time due to parenthood. The loan repayments still have to be made over the same term of the loan, so after the leave period is over repayments are normally increased by the amount of the reduction.
Portability means simply that you can pick up your loan and carry it with you when you move houses. In the past, a housing loan was secured by a particular property and if you wanted to sell that property and move, you had to take out a new loan secured by the new property. Portability means you can sell your old property and buy a new one while keeping the same loan. Naturally, the new property would have to be worth enough so that the LVR of your loan is maintained.
If you are building a home rather than buying, having the entire sum of the loan available on day one can be inconvenient. For these people, the ability to get small portions of the loan at each stage of building can help. A progressive drawdown allows a borrower to slowly gain access to the funds they've borrowed in small, lump sums at various intervals.
Redraw is the capacity to pay extra money into your loan to reduce the amount of interest charged while being able to withdraw it back if you need it in the future. Money can only be withdrawn up to the balance the mortgage would have been at that date if only standard monthly repayments had been paid. This is called your amortizing or reducing limit. As an example, if I was required to pay $1000 per month but paid $1100 instead, after six months I am only allowed to redraw the extra $600. This means the loan keeps decreasing over time. A flexible redraw facility can help a customer set up a salary loan where their entire pay is credited to the mortgage and then redrawn over time. If used properly, a redraw facility can save you on interest charges while allowing you easy access to the extra money you've paid in. If redraw is not offered by the institution you're initially chosen, they may have another feature that effectively achieves the same thing - mortgage offset or a periodical payment facility such as Westpac Smart Pay.
If considering redraw, there are a few questions you should ask any institution you're considering:
- Do I have to pay extra for the feature?
- Is there a minimum amount that I have to redraw each time?
- Is there a cost for me to redraw?
- Do I get a number of free redraws?
- Do I have to redraw a minimum each time?
- What sort of access do I have to my mortgage? eg ATM, Eftpos, Cheque. This is not important if you are considering making a limited number of extra repayments and making one or two withdrawals over the life of the loan. If considering paying your entire wage into your mortgage, not being able to access it easily could create problems.
Refinancing simply means that you take out a new loan to pay out an old one. Refinancing is normally with another financial institution.
The definition of a repayment holiday is pretty self-evident. When it is available is not as self-evident. Under the Uniform Consumer Credit Code, all financial institutions have to allow some form of "holiday" from loan repayments if a customer can prove hardship such as an unexpected loss of income. But some institutions allow these holidays as a feature of their mortgage. Repayment holidays are usually available on loans where you can make extra repayments. If those extra repayments are large enough, you may have paid enough money into your loan to simply stop making repayments for a certain period of time. Some institutions may place limits on how long or how often you are allowed to do this.
Revolving Line of Credit
A revolving line of credit is a different kind of loan rather than a feature and is sometimes referred to as a salary loan. It is essentially a giant overdraft where money paid in can be withdrawn again up to the original amount borrowed. If used properly, it can function as several new loans without the borrower having to take out new loans. A revolving line of credit is best for those people who want to use the facility several times, buying a house, then shares or a new car with the same loan. Technically, a revolving line is interest only. But most people make principle and interest repayments each month so they can redraw the money up to the original loan limit when they need the funds. Revolving lines of credit often have higher interest rates than ordinary variable loans and can be a trap for those who aren't good at budgeting. If you want the flexibility but would prefer the safety of set monthly repayments and a mortgage that is slowly being paid off, a standard variable loan with redraw or mortgage offset would suit you better.
If you are considering a revolving line of credit there are a few questions you need to ask yourself and the institution:
- Am I really going to use the facility? A Revolving Line of Credit is best for those people who want to make large transactions, both deposits and withdrawals, on a regular basis for share trading or new purchases.
- How much does it cost to make a transaction on the loan?
- What kind of accessibility does the loan have? ie cheque, credit card, ATM, Eftpos, telephone and internet banking?
- If the transactions are not free and unlimited, how many transactions am I allowed free?
- What are the costs after the free transactions are excluded?
A salary loan was so titled because a customer's salary can be paid directly into the loan. This allows a borrower to use their mortgage as both a line of credit and a savings account. Although ATM, Eftpos, cheque books and other means of access are available, recent salary loans encourage borrowers to use a credit card for all their purchases and then pay the card off in one transaction from their mortgage. This allows the money to reduce interest for the longest period of time. Although traditionally associated with a revolving line of credit, amortizing products such as a standard variable now offer this flexibility at a cheaper rate.
Splitting a loan is a popular way to reduce the effects of interest rate movements. Nearly every person who has had a mortgage knows the effect market movements have on their mortgage repayments. Those who have left their mortgages variable are in a never-ending state of terror that the market will go up, while those who have fixed their loans for a certain period watch in horror as the market drops while their rate stays high. Splitting your loan can be an effective way to hedge your bets on interest rate movements. By dividing your loan into two portions, fixed and variable, you can watch the variable half of your loan drop when the market does but know that half of your mortgage is safe at a lower interest rate if the market goes up. Loans don't necessarily have to be split into two portions. You can split into thirds, quarters or even more. Most institutions require a minimum dollar amount in each split portion and some charge per split so you should investigate all costs beforehand. Split loans are sometimes called "combination loans".
If considering splitting, there are some questions you should ask any institutions you're considering.
- Can the loan I have chosen be split? For example, some basic variable loans can not be part of a split.
- How many splits can I have?
- What is the minimum dollar amount I am required to have in each split portion?
- Is there a fee for splitting my loan?
- If I split my loan, do I have to pay ongoing fees on each loan portion or just one fee for the overall loan?
Stamp Duty is a State Government duty on financial and some other transactions that is generally a small percentage of the amount borrowed. Stamp Duty is normally incorporated into your loan contract and deducted from the total amount the bank will lend you. This means a loan for $100000 could result in a cheque for only $99200 requiring the borrower to come up with the other $800 at settlement.
Switching involves moving from one loan type to another during the term of a loan. This could be from a standard variable to a fixed rate loan or any other combination. A switching fee is often charged. If a customer decides to split an existing loan they could be charged both a split fee and a switching fee for changing their loan type.
Upfront fees are all those institution charges to set up and process your loan application, value your property and assist with settlement. In modern banking, they can also cover securitization costs and outsourcing of services that larger institutions do in-house such as writing loan contracts that are legal. Although upfront fees can seem scary, compared to an ongoing cost such as the interest rate and any ongoing fees they have a marginal effect on the cost of the loan overall.
Variable Rate Loan
Most institutions offer a variable rate loan, often called their standard variable loan. The interest rate on these loans does exactly what the name suggests. It can vary with time depending on the market. Although this can sound scary, variable rates are based on official Reserve Bank interest rates and generally won't change unless there is an official change. Variable loans include basic, standard or revolving line of credit products and are traditionally the most flexible. These days, standard variable loans can offer a wealth of features. If used properly, these features can help to pay off a mortgage more quickly. Variable loans may allow you to offset your mortgage, make extra repayments and redraw. They also allow you to pay your loan out early. Many institutions offer basic or "no-frills" variable loans with a lower interest rate. In the past, these loans were rate based with little or no extras. Recent mortgage competition has seen these loans offering features as a way to distinguish them from other basic products. Make sure you find out if your institution has a basic product with the features you require as it could meet your needs at a lower rate.
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Kamran Sedghi - (Credit Representative Number 399750)
of BLSSA Pty Ltd ACN 117 651 760 (Australian Credit Licence 391237)