The Home Loan Jargon
Gone are the days when the only home loan on offer was a principal and interest arrangement, paid by the month over 25 years. Now, home buyers face a bounty of borrowing options, designed for different needs. Choosing the right one for your situation starts with understanding the jargon. Here’s our guide to what all the home loan terms mean.
VARIABLE LOAN: This is pretty much your stock standard principal and interest loan and still the most popular way for Australians to pay off their mortgage.
Repayments are calculated so that over the term of the loan — usually 30 years — both the original amount borrowed (the principal) and the interest payable over the term of the loan — are repaid in full by the end of the loan’s term.
The interest rate charged usually varies according to the movements of the official cash rate, which is reviewed monthly by the Reserve Bank. Until very recently, lenders tended to move rates up or down in step with the official rate announcements, but since the global financial crisis, some have been a little more greedy when passing on rate cuts in full, especially the big banks – make sure you speak to us about the lenders who do right but their customers when it comes to interest rate movements.
Variable loans usually allow for extra payments and, if interest rates dip, you benefit from the savings. On the flip side, if rates rise, you will face higher repayments. If taking out a variable loan, it’s always best to leave some padding in your budget to cover any rate hikes.
FIXED RATE: This is where the interest rate is fixed for a period of time — usually one to five years. The main benefit for the borrower is certainty.
The downside is being locked into a rate that may end up above the market if interest rates fall. Fixed rates are often favoured by borrowers who face a change in circumstances, such as having children.
INTEREST ONLY: Interest-only loans have their place in the market, especially among property investors. As the name suggests, you only pay the interest on the loan, a maximum of 5 years at any point in time – with any further periods requiring acceptance from the lender after that.
Property investors looking to maximise their tax deductions often opt for interest-only loans for the first few years after purchase because they can’t claim principal payments (we recommend you seek independent tax advice if you wish to explore how to maximise your tax deduction). There are many restrictions on Interest-only arrangements these days – set bu the regulators. Which means lenders are particular when decided whether to approve interest only.
Usually you must have equity – at least 80%, but the more the better (also affects your rate). And lenders are less likely these days to allow interest only on your home, except in certain circumstances – like self employed or significant equity.
You also have to demonstrate you can pay off your loan inside a shorter term – if your loan is 30 years, with 5 years interest only, you'd have to demonstrate you can pay it off inside 25 years.
SPLIT LOAN: A split loan allows you to have an each way bet on interest rates. You can choose to take part of your loan at a variable interest rate, which will move up or down in line with interest rate movements, and the remainder at a fixed rate, giving you certainty.
If rates increase significantly, part of your loan and budget is shielded from the volatility. On the other hand, if they drop over time, you will still have to pay the fixed rate on your nominated portion.
BASIC/NO FRILLS: These are generally loans with a lower variable interest rate than standard variable loans.
The trade-off for the discount is less flexibility and fewer features. For example, no offset and no redraws.
HONEYMOON/INTRODUCTORY: Aimed squarely at first homebuyers, honeymoon loans offer a discount for a limited period, usually 12 months.
Borrowers are usually offered a discount on the standard variable rate for the honeymoon period, which means their rate will move up or down with the variable rate, or a discounted fixed rate, which stays fixed for the agreed period.
OFFSET: An offset account is essentially a savings account that is linked to a loan account. Instead of earning interest on your savings deposit, the funds are used to offset the principal of the loan account.
For example, if you have a home loan of $100,000, plus $10,000 in an offset account, the lender will offset your loan balance with your offset account balance, meaning they would only calculate interest on $90,000.
Your loan repayment remains the same, but more of it is used to pay off the principal, reducing the life of your loan.
REDRAW: A redraw facility simply allows you to make extra repayments on your home loan and then access those funds if needed.
Like an Offset, the extra funds you pay into your home loan reduces the monthly interest you'll pay. For example, if you have a home loan of limit of $200,000, but $20,000 in redraw, your balance would be $180,000 which is what the interest is calculated on.
CONSTRUCTION LOAN: These loans allow new home builders and renovators to get on with their projects without borrowing and paying interest on the full amount up front. Instead, progressive payments are made directly to the builder.
Construction loans are generally provided for one to two years before reverting to a standard home loan.
LOW DOC: The name gives the impression there are no forms to fill in, but it actually refers to the fact these loans are for borrowers who have trouble providing documents to verify their income.
Low document loans are often sought by the self-employed, casual employees or home buyers with a poor credit history.