A large number of Australians have admitted they don’t know as much about home loans as they probably should. A new study (conducted in March 2021 by online researcher YouGov) has found that 54% of Australians take an active interest in controlling their finances. But despite this, 84% of non-homeowners say they need to know more about mortgage finance, and almost 30% confessed to knowing almost nothing about home loans (with no idea where to begin!).
But it’s not just the non-homeowners who are in the dark when it comes to understanding mortgage finance. A high number of Australian homeowners have also admitted they have “little or no knowledge” about many common home loan terms, such as Loan to Value Ratio (51%), offset accounts (38%), negative gearing (37%) and Lenders Mortgage Insurance (41%).
Demystifying Home Loan Terminology
In an effort to demystify home loans for Australian buyers, the team at Borro have put together a comprehensive list that explains common home loan terminology:
- Lenders Mortgage Insurance: Commonly abbreviated to LMI, Lenders Mortgage Insurance is an insurance policy designed to protect lenders from high-risk borrowers (those at a higher risk of defaulting on their repayments). If your deposit is less than 20% of the purchase price, you’ll typically be required to take out an LMI policy. Instead of paying a monthly insurance premium, you’ll have the total cost of the insurance policy added to your home loan.
- Loan to Value Ratio: Usually referred to as LVR, this is a formula used by lenders to determine the ratio of the home loan compared to the total value of the property. You calculate your LVR by dividing the total amount you want to borrow by the total value of the property and then multiplying this figure by 100. For example, if you want to borrow $600,000 and the property is valued at $750,000, your LVR would be 80% (600,000 / 750,000 x 100 = 80). To avoid paying LMI, you’ll need an LVR of 80% or less.
- Refinancing: Refinancing is when a homeowner (with an existing mortgage) switches to a new lender or a new loan with the same lender. The new loan pays out the balance of the existing loan, and the borrower then begins making repayments on the new loan. Most homeowners choose to refinance to lower their interest rate or so they can get access to more useful loan features (such as the ability to make additional repayments).
- Redraw: Redraw is a mortgage feature that is available with some home loan products. If your home loan has a redraw facility, it means that you can make additional repayments (paying more than the minimum amount required) and then withdraw these funds at a later date. This feature can be great for homeowners who are planning a future renovation.
- Offset Account: An offset account is another type of home loan feature available with some lenders. It functions like a transactional bank account (so you can use it to deposit your salary or pay bills, buy groceries, etc.), but it is linked to your mortgage. When your monthly interest is calculated by the lender, they will first deduct the total value of your offset account from your mortgage balance. For example, if you had a home loan balance of $350,000, and $50,000 in savings in your offset account, the lender would only charge you interest on $300,000. For homeowners with sizable cash savings, an offset account could lead to a significant reduction in how much interest you’ll pay over the life of the loan.
- Equity: Equity is the difference between what your property is currently worth and the remaining balance of your home loan. So, if your property is worth $600,000 but your remaining mortgage balance is $450,000, you have $150,000 worth of equity. Equity can be accrued by paying down your mortgage Principal, by making additional repayments or when your property value increases over time. When refinancing a home loan, you may be able to access the equity in your property to fund a renovation, pay for a new car or even as a deposit on an investment property.
- Negative/Positive Gearing: These are terms that generally relate to investment properties. Positive gearing refers to an investment property that makes a profit over the course of the financial year (when the rent you receive is worth more than the combined costs of owning the property, including interest paid, maintenance bills, council rates, etc.). An investment property is negatively geared if it costs more to own the property than you receive back in rent. This may sound like a bad thing, but negative gearing can reduce your taxable income for the year (making it an attractive prospect for some investors).
Mortgage Finance Doesn’t Have to be a Mystery
The more you understand about home loan finance, the easier it will be to make good decisions that support your future financial goals. So, if you’ve got more questions about home loan terminology, contact the friendly team at Borro today on Ph: 1300 1 BORRO or via the chat function on our website.