Demystifying loan jargon

Many people struggle to understand loan terms and the multitude of acronyms used by bankers and mortgage brokers.

Although you may seek advice from your local bank or mortgage broker, having a basic understanding of these terms will ensure increased confidence before signing on the dotted line.

Loan to Value Ratio (LVR)

This is the amount of loan you are borrowing compared to the value of the asset, expressed in percentage terms.

For example, if you are borrowing $400,000 on a $600,000 home, your LVR is 66% ($400,000/$600,000). The bigger your deposit, the lower the LVR will be.

Lenders generally place high importance on the LVR when assessing loan applications. The higher the LVR, the more risky the loan is for the bank.

Lender's Mortgage Insurance (LMI)

Generally, lenders prefer a maximum LVR (Loan to Value Ratio) of up to 80%. If the LVR is above 80%, lenders may ask you to pay Lender's Mortgage Insurance (LMI).

Lenders Mortgage Insurance is a one off premium that you can pay upfront or as part of your loan. Essentially, LMI protects the lender if you are unable to pay for your loan in the future and is calculated based on the size of your deposit and how much you need to borrow.

Fixed and variable interest rate

A fixed interest rate is a loan where the interest is set for the duration (term) of the loan, allowing the borrower to know exactly what their repayments will be.

In contrast, a variable interest rate may move up or down according to current economic conditions.

Guarantor

A Guarantor is a third party who enters into an agreement to pay your loan if you can't. If you default, the bank can recover any outstanding amount from them.

Principal and interest repayments

Most loans consist of principal and interest repayments. This means you are paying down both the principal balance (borrowed amount) as well as the accrued interest on the loan.

Interest only repayments

With these types of repayments, you are paying only the interest component for a certain period. The benefit of this is the initial repayments are far lower as you are not yet repaying the principal amount.

Offset account

This type of account is a transaction account linked to your home loan. The balance in this account offsets your loan amount, reducing the interest component.

For example, if your outstanding loan is $500,000 and you have $20,000 in this account, you will pay interest on $480,000.

An offset account can save you considerably in interest repayments over the life of your loan and help you pay it off sooner.

Redraw facility

With this facility, any extra repayments you make on your loan can be accessed at a later date.

For example, if your minimum monthly repayments are $2,000 but you repay $3,000, you can access (redraw) the $1,000 if you need it. Some people may choose to redraw money for large expenses such as a home renovation, while others may choose to retain the additional repayments to reduce the interest and term of the loan.

There are many terms and acronyms in your loan application journey and it can become quite overwhelming. When meeting with your bank or mortgage broker, along with asking about your borrowing power, be sure to also ask how some of the above terms impact your situation and if they may be suitable for you.