Confused About Types of Mortgages and Settlement Terms? Here’s Some Helpful Definitions

Mortgage Types and Other Terms

There is a lot of terminology used to describe home loans. If you’re new to the property game, here are some definitions to get you off to a flying start:

Bridging Finance
A bridging loan provides funds to buy your next home before you’ve sold your current one. It covers the deposit and other buying costs, such as Stamp Duty. Once you settle on your old home, the proceeds of sale are paid as a lump sum to reduce your interest repayments on the bridging loan.

Capital Gains Tax
Capital gain on an asset is the difference between what it cost you and what you sell it for. Tax is payable on capital gains. Personal assets, such as your home, car and furnishings are exempt from capital gains tax. Depreciating assets – such as business equipment or fittings in a rental property – are also exempt from capital gains tax. Capital loss on a taxable asset can be used to reduce any capital gain in the following year.

Deposit Bond
A deposit bond is an alternative to paying the deposit from your own immediate funds. Deposit bonds can be issued for all or part of your deposit, usually up to 10% of the home purchase price. Once you’ve settled, the deposit bond amount is paid back to the lender. The fee for a deposit bond is usually less than the fees for breaking fixed term or similar to get access to the cash you need. Equity is the difference between the value of your home and the amount you owe on it. For example, if your home is worth $900,000 and you owe $500,000, your equity is $400,000. As you pay off your home loan, your equity increases. You can borrow against the equity in your home to buy an investment property or another asset.

Fixed Rate
The interest rate of a fixed rate home loan is locked in for a specified period, often a number of years, regardless of changes to interest rates. This is a great option if you would like to know the exact repayments and are happy with the current interest rates being offered. When interest rates look like they may increase, it is a perfect time to look at this option. Most lenders will offer the option of switching from a variable to a fixed rate, however some will charge for this change. Also, something to bear in mind is if you want to pay out your loan or change to another lender in this fixed term, the bank fees and charges may be quite high.

Interest Only
An ‘interest-only’ home loan requires a borrower to pay only the interest component of the loan. This structure requires the repayment of the original borrowed amount in a lump sum when the home loan period is complete or the property is sold. Most interest-only home loans revert to a principal and interest loan after a set initial period. Interest-only home loans are more widely used by investors, who are attracted by the tax saving aspects and are usually not likely to hold the property for the term of the home loan.

They are not ideal for owner occupiers who are more focused on building equity in their property, as the underlying home loan debt is not reduced with interest-only. Be aware though that with an interest-only home loan, there is still the potential for the property to increase in capital value as real estate prices rise, which will have a positive impact on the borrower’s equity. An interest only home loan works well for investors who want to use the property to generate rental income and capital gains.

Loan Portability
Loan portability means transferring the loan on your current home across to purchase a new property. Some home loans offer this as a feature, so you don’t need to refinance when you upgrade to your next home. Bringing your old home loan with you works if you’re selling and buying at the same time. While you have the convenience of staying with your current home loan, and you don’t need to pay for bridging or refinancing, there are normally fees attached to using this feature. If you’re sure the home loan you already have is the best deal for you, then loan portability may be worth exploring.

Mortgage Offset
Mortgage offset accounts allow borrowers to use their savings and income to reduce the amount of interest they pay on their mortgage. This works by using the interest that would usually be paid to them on their savings to instead be deducted from (“offset” against) the amount of interest they owe on their mortgage. Furthermore, under this arrangement, as you don’t actually receive any interest on your savings in your hand (that interest is offset against your home loan debt rather than being credited to your savings account), no tax is payable on it.

You get the full, tax-free benefit of the savings interest in reducing your home loan debt. This often operates best when your mortgage offset account is used as your primary bank account – for savings, lump sum payments and salary payments. Note that offset accounts are more common with variable rate home loans, and are not always available on fixed rate home loans. To demonstrate how a full mortgage offset account works, we’ll take a $200,000 mortgage as an example, on which you pay interest.

Let’s say you also have $20,000 savings in an offset account, earning interest. When the $20,000 in the savings account is offset against the $200,000 owing on the mortgage, you will only be charged interest on a home loan debt of $180,000 ($200,000 – $20,000 = $180,000). It’s important to get professional advice to ensure this product suits you and your circumstances.

Also check the interest rates for both your mortgage and the offset account – they can be different (the interest rate you earn on your savings can often be less than the interest rate you pay on your home loan). Some home loans will offer the same rate of interest on the mortgage and the offset account and these are known as full offsets. Mortgage offsets can be very effective if used correctly, but bear in mind that lenders often charge a higher than average rate on the mortgage, usually up to about 0.15 per cent, or may charge additional monthly fees, for the privilege of having this feature. It is important to do your sums, as it might not suit your circumstances, especially if you have a large mortgage and little savings to put in the offset account.

Principal and Interest
‘Principal and interest’ and ‘interest-only’ home loans are designed to give borrowers a choice in the way they make their repayments, and how much and when they repay. Both will suit different borrowers’ needs and circumstances. A principal and interest home loan requires borrowers to make payments on the interest accrued on the mortgage, as well as repay a part of the principal. In this way, repayments on principal and interest home loans actually reduce your debt. Repayments are calculated and spread out so that the last scheduled payment fully pays out the home loan.

These repayments will be higher than for an interest-only home loan, but they will help borrowers pay off their home loan. If you are planning to buy a property to live in long term, then it is likely a principal and interest loan will better suit your needs. Repaying both interest and the principal will allow you to gradually increase your equity in the property by reducing the size of your mortgage, and at the end of the loan term you will be the sole owner of your home.

Redraw
More borrowers are moving to include redraw facilities when establishing a home loan, and it is easy to see why. The ability to make extra repayments into the mortgage, instead of putting that money into say, a savings account, allows borrowers to reduce the interest on their home loan, which in turn helps reduce the term of the loan. It also provides borrowers with a safety net, as they can access the extra payments if required, down the track.

This is particularly suited to first home buyers who are not likely to have extra funds in the early stages of their home loan, but may in the future. Talk to us for the best redraw deals, as they vary between lenders. It is important to be aware of the costs involved, which may include set up, activation fees and redraw fees. There may also be limits on redraw withdrawal amounts (both maximum and minimum).

Refinancing
Refinancing means breaking your current home loan contract to take on a new loan with improved rates and features. It’s important to understand what’s involved, and that banks can on charge some fees to switch. If you currently have a fixed rate loan, then often the costs to break the term outweigh the benefits. On a variable rate, you may be surprised at how much you could save by switching. We recommend you talk to us every 2 years to reassess your loan and see what is best for you.

Settlement
Settlement is the official exchange of contracts for the sale of a house, conducted between legal and/or financial representatives of both the buyer and the vendor. Settlement takes place on a day and time agreed by both parties. The average settlement is 4-6 weeks, however both parties can negotiated shorter or longer settlement period, depending on their needs. SMSF A SMSF (Self Managed Superannuation Fund) allows you to take complete control of building your retirement wealth. The key difference between a SMSF and a standard superannuation funds is that SMSF members are also the SMSF trustees. As SMSF member/trustee you manage the fund for your own retirement benefit, and you are fully responsible for complying with superannuation and tax laws. Although the rules and regulations for SMSFs make them complex to set up, the control and flexibility of investment make them very attractive to many people. It’s a major financial decision and you need the time and skills to manage your own super fund effectively. Split Loan A home loan can be split to have one part at a variable rate, and the remainder at a fixed rate. It may be split 50% variable/50% fixed, or some other ratio such as 60%/40%. A split loan allows you to take an ‘each way bet’ on future interest rates.

Variable Rate
The interest rate on a variable rate home loan can change at any time, either up or down, in line with official interest rates set by the Reserve Bank of Australia. Market circumstances and competition between lenders can also lead to interest rate changes, which can affect the interest rate of your loan. This can be quite confusing as the cash rate could be 1.5% however the lowest home loan rate that the banks are offering is 3.74% at the time of print of this blog. Some lenders do pass on some of the cash rate fluctuations, but some keep their same rate.

Settlement
Settlement is the official exchange of contracts for the sale of a house, conducted between legal and/or financial representatives of both the buyer and the vendor. Settlement takes place on a day and time agreed by both parties. The average settlement is 4-6 weeks, however both parties can negotiate a shorter or longer settlement period, depending on their needs.

SMSF
A SMSF (Self Managed Superannuation Fund) allows you to take complete control of building your retirement wealth. The key difference between a SMSF and a standard superannuation funds is that SMSF members are also the SMSF trustees. As SMSF member/trustee you manage the fund for your own retirement benefit, and you are fully responsible for complying with superannuation and tax laws. Although the rules and regulations for SMSFs make them complex to set up, the control and flexibility of investment make them very attractive to many people. It’s a major financial decision and you need the time and skills to manage your own super fund effectively.

Split Loan
A home loan can be split to have one part at a variable rate, and the remainder at a fixed rate. It may be split 50% variable/50% fixed, or some other ratio such as 60%/40%. A split loan allows you to take an ‘each way bet’ on future interest rates.

Variable Rate 
The interest rate on a variable rate home loan can change at any time, either up or down, in line with official interest rates set by the Reserve Bank of Australia. Market circumstances and competition between lenders can also lead to interest rate changes, which can affect the interest rate of your loan. This can be quite confusing as the cash rate could be 1.5% however the lowest home loan rate that the banks are offering is 3.74%. Some lenders do pass on some of the cash rate fluctuations, but some keep their same rate.

Stamp duty
Stamp duty is a state government tax on the transfer of land or the sale of a property.  It is calculated either at a set rate or as a percentage of the total sale, depending on where the transaction took place. Stamp duty taxes differ from state to state, so you need to do your research. Many states have di􀁌erent rules and most o􀁌er concessions or bonuses on stamp duty, depending on the type of property purchased and the sale price.

Currently buyers can pay stamp duty of up to 5.5% of the purchase price in Victoria, depending on the concessions available. But in some states, the tax can effectively amount to nothing after stamp duty bonuses.

Research what stamp duty savings and concessions may be available in your state or territory by looking at these government websites:

Use our handy stamp duty calculator to estimate your stamp duty, based on the final sale price of the property or purchase price.

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