Your need-to-know guide before applying for a loan
Telling you to do your research before applying for a home loan is just about the safest advice we could ever give.
Not only because you’ll be dealing with life-changing sums of money, but because you’ll also need to negotiate the all too perplexing real-estate jargon that lenders and property experts are fond of using.
To start you on your journey, here are the fundamental terms you need to understand:
The term ‘borrowing power’ can be used to describe how you look to banks and lenders when it comes to securing your home loan.
“[Borrowing power] determines the maximum loan amount a lender can provide that will not place applicants in hardship,” the head of lending operations at Bank First, John Spiteri, explains.
“It is calculated by using current permanent income, less living expenses and existing loan commitments to confirm that the surplus amount is enough to cover the new loan repayments.”
Lenders mortgage insurance
Lenders mortgage insurance (LMI) is a one-off fee you will pay to your mortgage provider if your home deposit is less than 20% of your home’s value. For example, if you have a 10% deposit on a $500,000 home, you will pay a fee of around $9,000.
If you have a higher deposit, you will pay less LMI or can avoid paying it altogether.
“Borrowers should note that LMI is to offset losses in the case where the bank is unable to recover its costs in a mortgagee sale,” John confirms. “It does not insure the borrowers in the case of inability to meet repayments. A borrower has other personal insurance options such as income protection insurance in the case of sickness or injury.”
Chances are you’ve heard this term floating around the news recently. It’s more relevant to property investors than owner occupier home buyers, but it won’t hurt you to understand the concept.
Basically, ‘gearing’ means borrowing money for the purpose of an investment. ‘Negative gearing’ is when the income from that investment (like the rental payments you receive from your investment property) amounts to less than your expenses (in this case, the interest accruing on your investment loan and other costs such as land rates).
It sounds like you’re making a loss, but here’s the catch: the loss can be used to reduce your overall taxable income.
“If the gross income generated by the investment is less than the cost of owning and managing the investment, the investor would be able to claim the loss on the negative geared investment as a tax deduction against other taxable income,” John detailed. “There is also capital gains tax that may apply once the asset has been sold.”
Principal & interest
There are two types of home loans: ‘principal and interest’ and ‘interest only’.
‘Principal’ simply means ‘the amount of the loan’. The ‘interest’ is a rate that everyone pays their lender, and is calculated as a percentage of your total loan amount. For example, you might have a principal of $450,000 with a 5% interest rate.
A principal and interest loan means you will pay back your loan total (in increments, of course), as well as interest at the same time.
Interest-only loans are when you only pay the interest portion of your loan repayments.
Interest-only loans imply you will pay a lower payment amount over the initial interest-only period but more over the life of the loan. You will still need to repay your principal – and the interest owed on that as well – after the interest-only period is over.
Which loan is best for first-home buyers? It is always best for home owners to make principal and interest loan repayments. This would reduce their principal and, therefore, cut down total interest payments over the life of the loan.