Mortgages Explained

A summary of the usual differences is set out below. Please note that this is a general guide, and that differences between lenders may arise with specific products.

These discount periods can range from 6 months to 24 months, after which the interest rate reverts to the Standard Variable Rate.  In order for the Lender to ensure that they recoup the cost of the discount and to discourage borrowers from continually changing from introductory products of various lenders, most have introduced penalties should the borrower repay the facility within a specific time.

Traditionally lenders have offered terms of between 1 – 5 years for fixed rates, however some Lenders may offered terms of up to 10 years.

Fixed Rate term loans normally require the loan to be renegotiated at the conclusion of the fixed term, thus a 5 year fixed term loan would normally be required to be repaid in full at the end of year 5. However most Lenders have the ability to arrange for the facility to revert to the Standard Variable Rate after the Fixed Rate term has expired. Thus a loan facility can be established for a 25 or 30 year loan term with the first 5 years, fixed at a specific interest rate.

Fixed rate loans are popular with borrowers that want to take a conservative approach to borrowing, as they guarantee that the loan repayment will be the same for the Fixed Rate period. Many property investors have also found the Fixed Rate loans attractive products due to the product offering the comfort of guaranteed repayments.

Borrowers who take fixed rate loans need to understand that they are committing to a contract with the lending institution for the fixed rate term, and that should the contract be broken or the term changed, the Lender may charge the borrower substantial fees to cover the costs of breaking the contract.

These ‘break costs’ and can be very expensive. The break costs are determined by many factors, such as the term remaining, the current interest rate environment and the amount of the outstanding balance. They cannot be estimated when the contract is taken out.

In addition to the potentially prohibitive break costs, many Lenders also restrict the amount of extra repayments that can be made on the loan during the fixed rate period.

The restrictions vary from lender to lender, and if you are thinking of taking a fixed rate loan, these restrictions may be a very important factor to consider.

A line of credit loan allows the borrower to establish a credit or facility limit, and then draw from and pay down the loan without restriction. The borrower has the ability to use the entire limit at any time and does not have to comply with an amortised repayment schedule.

Most Lenders who offer these loans require that the monthly interest charge be the minimum payment required to maintain the account. That means that the borrower can determine, how much if any, principal repayment they wish to make.

The credit or facility limit is normally determined by two factors:

• borrowers ability to repay, and
• level of equity in the property being offered as security.

These facilities have the benefits of allowing the borrower to utilise as much or as little of the credit facility for whatever time frame they require, while still only being charged interest for the outstanding balance. The facilities even allow for the balance to move from a credit balance to a debit balance. Most Lenders will also allow for the borrower to operate their loan account as their transaction accounts, as an ‘all in one’ account.

Important Note: Line of credit loans are not suitable for people, as the facility allows for the original limit to be reused. Without proper discipline, it is possible to never pay down the loan at all with this kind of loan.

A reverse mortgage allows the borrower to borrow funds for any purpose or for day to day living expenses, secured against the equity in their property.

The main difference to this product to standard home loans is that the lender does not require the borrower to make any principal or interest repayments during the loan term. The debt instead capitalises. The debt is traditionally repaid once the property securing the loan is sold.

Due to the nature of the facility, with interest capitalised until the full payment of the debt, lenders restrict the amount that they will advance against the value of the property. Usually lenders will only lend up to 20% of the value of the property, depending upon the age of the borrower.

The borrower has the option of repaying the facility through normal means, however its not a requirement of a loan, allowing the consumer to maintain their current standard of living.

An additional requirement of these facilities is that the consumer will be required to obtain independent legal and financial advice, as the nature of the facility diminishes the borrower’s equity in the property.

Generally the terms offered by the Lenders are between 1 –5 years but some lenders may offer up to 10 years. After the initial interest only period, the loan will revert to the normal amortised repayments over the remaining term of the loan.

For example, and loan with a 30 year term may have a 5 year interest only term, followed by a 25 year principal and interest term.

Most Lenders will offer ‘100%’ offset, which means that any credit balance in the account will offset the outstanding balance of the loan facility. The mortgage offset account itself does not earn any interest. However, benefit in that the interest on the loan charged is calculated on the net outstanding balance, after reducing the outstanding balance by the amount deposited in the offset account.

For example, if a borrower had a loan with a balance of $100,000, and an offset account with a balance of $10,000, then interest is calculated on the net balance of $90,000.

As mortgage offset accounts are regulated by the Financial Services Reform Act, providing advice on these accounts to consumers may only be done by via the holder of an Australian Financial Services License (AFSL).

If a consumer requires a mortgage offset account, the lender who offers the product will provide the consumer with a Product Disclosure Statement which contains all relevant information.

For example, if a borrower has been paying an additional $500 per month of their loan, after 12 months, the borrower would be able to redraw $6,000.

The redrawn funds can be used for any purpose. Lenders may charge a fee to redraw extra payments, with costs typically varying from nil to $50 per redraw.

The LMI policy protects the lender against any losses where:

• the borrower default on their loan;
• the lender sells the security property; and
• There are not adequate funds to cover the outstanding loan and any fees and charges that may have accrued.

LMI is usually taken by the lender when the value of the loan requested exceeds 80% of the value of the security property.

The LMI premium is based upon a sliding scale depending upon the loan to value ratio (“LVR”) – the higher the LVR, the higher the premium. LMI premiums can be substantial, and must be factored into the overall cost of borrowing to ensure that there is not a shortfall of funds when it comes to settle a loan transaction.

LMI will normally not cover penalty interest, early repayment penalties, LMI premium, physical damage to property and fees and charges not directly related to costs incurred by the lender in order to recover the debt.

LMI companies may refund a portion of the LMI premium if the facility insured has been fully repaid within 12 months of advancement of funds.

LMI is available for both owner occupied & investment loans. In addition to the borrower needing to satisfy a lender’s criteria, they must usually also meet the requirements of the mortgage insurer.

In many cases an application may meet the lending guidelines of the lender, but fail to meet the mortgage insurer’s guidelines, in which case the lender will decline the loan.

Some Lenders may allow borrowers to add the LMI premium to the loan amount, which in effect allows the applicant to borrow in excess of the stated LVR.