Common home loan terms and what they mean

Even though it’s something hundreds of people do a day, buying a house is intimidating. Not only does it involve a lot of money, but it also uses a lot of confusing, very specific terminology that you don’t normally hear. When everyone acts like they know what these mean, it becomes harder to ask questions.

We thought we’d explore and explain some of the new terms you might need to learn when buying a property, and how they relate to each other.

Loan pre-approval

Loan pre-approval is when a lender agrees that they are willing to lend you money. It’s not a promise to lend, but the lender suggesting that it’s likely you’ll be able to work together. Pre-approval is a way of making sure someone is willing to lend to you, and should also give you an idea of how much you can borrow. This amount is calculated based on the information that you have given to the lender, which they haven’t verified yet.

Pre-approval means that you’ll be in a position to start looking at houses, as you’ll have an idea of how much you can borrow. Note that this is different to conditional approval. Speaking of which…

Conditional approval

When you’re closer to making an offer or a purchase, you will need conditional approval from the lender. Conditional approval is the next step in the process and it confirms the amount that you’ll be able to borrow. It’s calculated once the lender has checked and verified the information that you gave to them, and after they’ve performed a credit check. Once conditional approval is granted, more information is requested in order to grant unconditional approval, which means that the lender has successfully completed all of their checks and will lend you the money.

Lenders mortgage insurance

Lenders mortgage insurance (often shortened to LMI) is a fee charged by a lender to help protect them against loss if you default on the loan. Many people assume that LMI is there to protect the lender against a loan default, but this isn’t the case. LMI specifically protects the lender against the property selling for less than the unpaid value of the mortgage in the case of a default. This means that if your house has to be sold to pay the home loan, and it doesn’t sell for enough, the lender can claim on the LMI policy.

LMI can often be avoided with a large enough deposit: 20% is usually enough but it depends on the lender. It is a non-refundable fee as well, so if you change lenders, it’s possible they may require you to pay the LMI premium again.

Loan to value ratio

The loan to value ratio (or LVR) is pretty much what it says on the box. LVR is the value of the loan expressed as a ratio of the total value of the property. Lenders use this calculation to assess the riskiness of a loan. The closer to 100 the LVR is, the riskier the investment is for the lender.

LVR is used for certain calculations, including whether or not the borrower should pay LMI. If you have a 20% deposit, your LVR is 80%, which is typically good enough to avoid paying LMI. Lenders prefer a lower LVR because it makes it easier for them to recover the value of the loan if you default.

Offset account

An offset account is a second account connected to a loan account. It’s named this way because it helps to offset the interest earned on the mortgage but it does so at the expense of earning interest on the balance.

For example, if you have a loan of 100k and an offset account with 20k in it, you’ll only be charged interest on the 80k balance. It does, however, mean that you won’t be earning interest on the 20k. As interest earned is always less than interest charged on a loan, this is a smart way of managing your loan while maintaining financial flexibility. If your focus with your mortgage is paying it off sooner rather than trying to amass savings that are working for you as well, an offset account is a good way of achieving this.

Bridging finance

Bridging finance is a short-term loan that’s used to ‘bridge the gap’ between when you purchase a new property and when you sell your old property. This can be helpful if the sale of your property falls through, or if you’ve found the right property but need a little more time to organise finances. It’s only intended to be used for a short period of time (generally only up to twelve months) as the interest is much higher and calculated differently to normal home loan finance. While it may not be part of your initial home buying strategy, bridging finance can save a lot of headaches if things don’t go to plan.

Hopefully we’ve helped demystify some common home loan terms. While it’s a lot to understand, knowing what banks are looking for, and which options are available to you, can help you make better decisions that will help you in the long-term. An afternoon spent reading about your options can help to shave years off of your home loan, so it’s well worth your time to do your homework.

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