Do you find home loan and finance talk confusing? You are not alone. We've listed the five most common home loan terms you will hear and we will show you how they can help you save more.
According to a new financial literacy survey, a large number of Australians are not confident with financial literacy. The survey found that only 41% of Australians are confident they have the right home loan to suit their situation and just 15% of 18-29 year old home buyers feel confident.
Even commonly used terms, such as interest rates, some Australians have little knowledge on. Over a third of respondents were not sure if the RBA cash rate affected their mortgage repayments and one in ten thought it didn't affect their repayments at all.
Home loan features are a great way for mortgage holders to save money on their home loan, yet a large number do not understand some of the most common features. 55% of respondents didn't understand what an offset facility was, 40% had no understanding of a redraw facility and 38% did not understand how interest only repayments work.
While all of these terms may sound overwhelming at first, understanding what they are and how they affect your home loan can give you a great advantage and may even help you save money throughout the life of your home loan.
Listed below are the five most common home loan terms you will hear and we will show you how they can help you save more.
RBA cash rate
The RBA cash rate plays a major part in how much you'll pay on your home loan. The Reserve Bank of Australia (RBA) is the Australia's central bank and keeps track of the country's official cash rate. Each month, the RBA meets and discusses whether to raise, cut or hold the cash rate, depending on the current state of Australia's economy.
The cash rate is extremely important as it will help determine what interest rate your lender will charge and therefore affect your repayment amount. The official cash rate, along with the cost of funding, can cause your lender to raise or cut rates after the RBA makes a cash rate decision.
Comparing different home loans with different interest rates and different upfront and ongoing fees is difficult. When you see a home loan advertised, by law there needs to be two rates advertised, the interest rate and the comparison rate. The interest rate simply shows how much interest will be charged as a percentage of the loan, whereas a comparison rate is a standardized calculation of the interest rate if all the fees and charges were added in.
It is calculated on a loan amount of $150,000 over a loan term of 25 years and costs like setup costs, application fees, ongoing fees and discharge fees are added. This means that it is only a true indicator of the full cost if your loan amount and term matches this. If you go a bit further and get a personalized comparison rate it will do this. You can obtain this from most lenders by asking for a Key Facts Sheet. Some calculators will also give you a personalized comparison rate. By using this you are able to compare different home loans based on your loan amount and term.
Get your own personalized comparison rate on the State Custodians website by going to the Key Facts tab on our most popular loans or the Compare Home Loans calculator by clicking here.
An offset account is a savings account attached to your loan. It allows you to reduce the interest on your home loan without physically putting money into the loan itself. When the interest is calculated on the loan, which is usually daily, the balance of funds in the offset account is added to the loan. This means that the amount you are charged interest on is reduced by offset account balance. So instead of earning interest you are paying less interest on your loan and thus more of your repayment will be going to paying the principle and less towards interest.
When researching and comparing home loans, it’s worth looking at any possible fees or restrictions to moving money around that may be associated with the offset account. Some lenders may have minimum transaction amounts and withdrawal fees if you decide to redraw money from your offset account and these fees could end up costing you more than the interest you would save. Make sure you speak with lenders to understand how the offset account operates.
Redraw can be a very valuable tool to help you save in interest, significantly reducing your loan term, whilst still having access to your savings if you need it for other expenses. Some loans allow you to pay extra into the loan. Redraw is the ability to access those additional payments when and if you need them. The additional funds are paid into the loan itself and while ever they are left there, reduce the balance of the loan that the interest is calculated on. For example, if you have a $400,000 home loan, but have put $50,000 extra towards it, you will only be paying interest on $350,000.
If you are considering a loan with free redraw, you need to be aware of the terms and conditions the lender has in place. Some factors you will need to research include: if there are fees charged when you redraw, how you redraw (is it via a debit card, online or via branch), what is the number of free redraws per year, as well as the maximum and minimum redraw amounts.
An interest only home loan is when borrowers only have to pay the interest, as well as any fees, for a fixed period of time, usually five to 10 years. During this period, the repayments are a lot lower compared to a principal and interest home loan. Once the interest-only period ends, the home loan will revert back to a principal and interest home loan over the remaining term. For example, if it was a 30 year loan initially and 10 years interest only has passed, the new principal and interest repayments will be calculated over 20 years which could be quite a large increase in repayments. This can often catch borrowers off guard if they forget that the interest only period is expiring.
There are a number of reasons why borrowers may use interest-only repayments. Investors often take out interest only loans on investment properties so they can make minimum repayments on tax deductible debt, allowing them to direct more of their income to pay off the loan on their owner occupied property which is not tax deductible.
Some borrowers obtain an interest-only home loan so that they can ease into repayments and then have the time to financially prepare themselves before the interest-only period ends and they have larger repayments.
Now that you have an idea about what these terms mean and how they work, it may be a great time to look back at your home loan and see whether it is still working for you. Regularly reviewing your home loan gives you the chance to keep up to date with the latest products and interest rates on offer.
State Custodians offers very competitive home loans, with a broad range of features and we have a team of Lending Specialists ready to answer any questions you have. Check out our home loans here or call on 13 72 62 to chat to a lending specialists about your home loan options.