Planning to apply for a loan but confused by the myriad of banking jargon? You’re not alone. 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)
Amount of loan you are borrowing compared to the value of the asset, expressed in percentage terms.
For example, if you are borrowing $300,000 on a $500,000 home, your LVR is 60% ($300,000/$500,000).
Lender’s Mortgage Insurance (LMI)
Generally, lenders prefer an 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).
The LMI premium is paid to protect the lender should you default on the loan, and the property sale does not cover its cost of lending you more than the standard 80%.
Fixed and variable interest rate
A fixed interest rate is set for a specified period. In contrast, a variable interest rate may move up or down according to current economic conditions.
A Guarantor is a third party (usually an immediate family member) providing security to the bank against your loan. If you default, the bank can recover any outstanding amount from them.
Generally, if you have a guarantor, the bank may waive any LMI cost.
Principal and interest repayments
With these types of repayments, you are repaying both the interest and the principal component (borrowed amount) of the loan.
Interest only repayments
With these types of repayments, you are paying only the interest component for a certain period.
This type of account is a transaction account linked to your loan. The balance in this account offsets your loaned 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.
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.
Pre-approval or conditional approval
Before applying for a formal loan, you can apply for pre-approval.
The lender will state how much they are willing to lend you, pending certain conditions (such as the bank’s property valuation or taking out home insurance). Pre-approval also lets the vendor know that you are serious about buying their property.
The importance of understanding basic banking terms cannot be understated.
For example, you sign an offer document on your dream home, thinking that your loan is approved. However, you later realise that you only have conditional approval, with a clause that you must first repay your credit card debt.
The bank then rejects or delays your loan approval until that condition has been met. As a consequence, the seller rejects your offer, and you lose out on your dream home! Devastating!
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, i.e., would an offset account or a redraw facility fit your situation?
You will come across so many terms and acronyms in your journey loan application journey. So, keep a curious mindset and most importantly, keep learning.