Sometimes, with financial matters, it seems like you are having to learn a whole new language!
At Focus Financial Group, we are committed to discussing your financial requirements in simple, relevant and easy to understand, terms.
Following is a list of the most common terms - and products - that you will come across when looking at a establishing your loan.
Mortgage: This is where it all starts. You need to differentiate between a mortgage and a loan. When we borrow money to buy a property, you take out a loan secured by a mortgage over a property. While the term “mortgage” is commonly used to describe a property loan, it is – in fact – the legal instrument that records the security for the loan.
Types of Loans
Table Loans: Repayments that remain constant over the life of the loan. For the first few years, most of your repayment pays off interest and only a small amount is allocated to reducing principal. Over time, this changes so that later payments are mostly paying off principal.
A “Table Loan” is most suitable for people who require certainty in their budgeting. Worth remembering, however, is that over time, your personal circumstances and finances will probably change
Reducing Loans: Repayments change each payment period. Principal payments stay the same, while interest payments gradually reduce. So your payments start relatively high and reduce over time.
Transactional Loan: combines all your bank accounts in one - your savings and salary directly off-set your mortgage, reducing your interest. This type of loan commits you to loan balance reduction.
Revolving (Line of) Credit/ "Flexi Loan": Generally, a type of loan that works off an account into which all your earnings are paid. It is a bit like an overdraft and quite frequently includes a credit card. Like a transactional loan, all your accounts are combined in one. Unlike a transaction loan, however, there is no forced reduction in your loan balance.
This type of loan is good for those who re very disciplined with their finances; budget well; who may wish – or are able – to pay off regular lump sums. The temptation is to utilize the “leftover” balance at the end of the month rather than apply it to repayment of the debt. While revolving credit (or flexi) loans make it convenient to “draw down” on the loan for other purchases (eg. A new car, or holiday) they should not be regarded in this way (see Post on this topic “It’s On the House”)
Interest Only: As the name suggests, on this loan, you only pay the interest - not the principal. Usually an interim measure, for example as bridging finance while another home is sold. Very common among property investors.
Most lenders will allow you to make higher than minimum payments, but not all. Some will charge you extra. The early repayment possibilities vary greatly between lenders.
Fixed Rate: Best if you like to know exactly what your mortgage repayments over a set period. This is very helpful if your total lending is high compared to your income: you may need to limit your exposure to interest rate changes. However, the longer the fixed term rate, the more it can impact on you if the rates drop significantly.
Floating Rate: (or Variable Rate): Great for people who need the flexibility to make lump sum payments, or to repay the whole mortgage, without being committed to specific term or conditions. If you are likely to comfortably cover your mortgage repayments you may consider putting a portion of your lending on a floating rate. Balance that by keeping the remainder of your lending on a fixed interest rate term to avoid too much risk.
Capped Rate: Like a floating interest rate but have the security of knowing what your maximum rate is. So, if the floating rate drops below the capped rate, your interest drops too. And there's usually no penalty for paying off lump sums, repaying the whole loan, or for increasing re-payments.
Combination or Split Rate: Some people find this is the best of both worlds - the advantages of a fixed rate but with the option of making lump sum repayments if you want to.
Other Terms you may Encounter:
Break Fees: Are the costs applied by a lender to “break” the fixed term of a loan by repaying it early. Why do they charge this? When you fix a loan your Lender makes a commitment with their suppliers (or depositors) to secure those funds at an agreed interest rate for an agreed term: they budget for this and project the future income. In simple terms they themselves are locked in.
Due to some highly publicized, large break fee complaints, Lenders no longer charge (potentially) large penalty regardless of whether it is to their advantage or not. Today they look at the economic cost of breaking a fixed rate. Each Lender has its own formula for calculating the economic cost: Basically it is simply the difference between today’s rates and what you’re paying, times the number of days left to run, times the loan amount.
If you decide to break the fixed rate they need to find another borrower for the funds. Naturally the new borrower will only be prepared to pay today’s interest rate which means the Bank is now out of pocket for the difference. Effectively this is the amount that is passed on to you plus an administration fee (in some case which can be substantial).
Pre-Approval: Is an excellent way to avoid potential disappointment when looking to purchase. Pre-approval is based on documented and verified information. Credit history, employment history, income, equity and cash on hand are all used to determine a very realistic portrayal of a buyer's borrowing potential.
Pre-approval lets you know exactly how much you are able to spend and what conditions, if any, the lender may have.
Pre-approval is a very direct way for a homebuyer to tell a seller that they are serious about buying a home. If a seller is weighing multiple offers they may be inclined to sell to someone who has been pre-approved, even if the offer is not the highest one. Pre-approval is the next best thing to cash in the bank.
Pre- Qualification: Pre-qualification is basically an informal discussion between the buyer and a lender’s representative. They make an assessment of the buyer's borrowing potential. This assessment is based solely on what the borrower tells the lender, does not require verification and does not commit the lender in any contractual sense.
Low Doc / No Doc Mortgages: Who uses them? These can work well for people who are self employed, have fluctuating income/ cashflow or for investment property purchasers. Both options are relatively simple.
A Low Doc mortgage is where you self certify your income and borrow up to 85% of the property’s value or purchase price (whichever is lower). There is no need to provide payslips, tenancy agreements or financial accounts. The key here is that you must genuinely earn the income you state but you do not need to prove it.
With a No Doc mortgage you can borrow up to 70% and only need to sign a declaration that you can afford the loan.
These types of loans were very popular during the peak of the market. There are only a few financial institutions (generally second tier lenders) who actually offer this product at the moment.