ANSWERS: How much do you know about buying a home?
Note: This article includes answers to yesterday’s quiz. Please see ‘Quiz: How much do you know about buying a home?’ to view the questions.
Q1: What is Loan Mortgage Insurance (LMI)?
- a) Insurance taken out by borrowers if they think the lender is insecure.
- b) Insurance protecting the lender from borrowers not being able to repay their loan.
- c) Insurance protecting the borrower in case their property decreases in value.
LMI is a type of insurance designed to protect lenders in the event the borrower is unable to meet their loan repayment obligations.
Nobody plans to default on a loan, but unforeseen circumstances can arise. For example, unexpected job loss or you or your partner become too ill to work. LMI is a one-off cost and is usually required if the borrowed amount exceeds 80% of the property’s value.
Q2: What is a split mortgage?
- a) It’s when you split the mortgage interest rate between fixed and variable.
- b) Used when purchasing multiple properties. The loan is split between the properties.
- c) There is no such thing as a split mortgage.
Splitting your mortgage allows you to fix the interest rate on part of your loan, and keep the remainder at a variable interest rate. It can be a savvy tactic in times of interest rate volatility by removing some of the risks of potential interest rate rises.
Generally, loans can be split by any ratio, e.g.: 50/50 or 70/30, etc. and conditions may apply, so it’s important you seek professional advice before making any decisions around whether loan splitting will work for you, and if so, what ratio would be best.
Q3: How much interest would you expect to pay on a $400,000 loan at 7% over 30 years?
- a) Approximately $710,000 over 30 years
- b) Approximately $275,000 over 30 years
- c) Approximately $550,000 over 30 years
Over the course of 30 years, you would pay around $557,595 on a $400,000 loan at 7%.
The calculation to work this out took into account the following assumptions:
|Interest rate||7% per annum||This is the standard rate that the Australian Prudential Regulation Authority (APRA) requires banks to use when ‘testing’ a borrower’s suitability.|
|Repayment frequency||Fortnightly||Payment frequency can significantly affect the overall amount of interest you pay.|
|Loan duration||30 years|
|Fees||0||All loans have fees and charges. Ensure you understand what costs are associated with your loan before signing up. If in doubt, ask!|
This calculation was based on a standard, variable loan where no changes were made to the loan structure, including additional payments, during the lifetime of the loan.
Q4: What is a secured loan?
- a) When a borrower’s loan application has been approved (secured) and the contract can proceed.
- b) When a borrower puts up an asset as security over a loan.
- c) A loan is considered ‘secured’ when all parties involved have signed the contract.
When you borrow to purchase a property, the property is generally used as security. This is, in fact what having a mortgage means – it’s when the lender lends money in exchange for holding the title of the property until the debt is repaid in full.
Conversely, an unsecured loan is where there is no asset being held as security, e.g. a credit card, but the trade-off is in much higher interest rates than for a secured loan.
Q5: The lender is only interested in how much you have owing on your credit cards when applying for a loan.
Lenders focus on the totally of your credit card limits more than the balances. This is because even though you may owe nothing on your cards, there’s nothing to stop you waiting to have your loan approved then buying up big, maxing out your cards and placing your ability to service a loan in jeopardy.
Bottom line, if you have, say, two credit cards with a $1,000 credit limit on one and $5,000 on the other, the lender will assume you owe $6,000 when you apply for your loan.
Q6: What is an offset account?
- a) An account linked to your mortgage to help reduce the amount of interest payable.
- b) An account that enables you to consolidate credit cards and personal loans with your mortgage.
- c) A partitioned account used for loan-splitting. One part is the inset, the remaining part is the offset.
An offset account is a transaction account linked to your mortgage. Cash saved in mortgage offset accounts is an effective way of paying your mortgage off faster because it helps to reduce the amount of interest payable.
The figures look like this:
|Without offset||With offset
|Loan term||30 years||26.5 years|
|Total interest paid||$557,595||$446,335|
|Total overall cost of loan (capital + interest)||$957,595||$846,335|
As this example demonstrates, with only a $20,000 balance in a mortgage offset account, it’s possible to pay a $400,000 mortgage at 7% interest off more than 3 years earlier and save over $110,000!
This example hasn’t considered fees or your personal circumstances so it’s best to speak with a licensed adviser before making any decisions.
Q7: Can you repay your mortgage earlier?
- a) No, never. In this competitive world, lenders want to keep your business as long as possible.
- b) Yes, always. Lenders prefer you to clear your debt as soon as possible.
- c) Generally yes, but conditions may apply.
Most lenders will allow you to make additional payments and/or pay off your mortgage earlier but you’ll need to check your mortgage contract or ask your lender to be certain.
If you’re considering paying your mortgage out earlier, and your mortgage contract allows it, you must discuss your personal situation with your lender as there may be terms and conditions, including early payout fees that influence your decision.
Q8: Your first loan application has been rejected due to insufficient deposit, what should you do?
- Try a smaller lender; their rules are more flexible, and if costs are higher it’s worth it in the end.
- Reconsider how much you want to borrow or wait until you’ve saved a better deposit.
- Ask a relative or friend for a loan to increase your deposit.
Lenders have a responsibility to ensure you can comfortably repay your loan. It’s not in their interest if you cannot meet your repayments as their strength and growth relies on the regular income from their customers.
For this reason, it’s not uncommon for lenders to deny loan applications if the deposit is too small – most lenders want a deposit of at least 20% of the sum to be borrowed.
In these circumstances you can:
- Compromise: consider a different property and work your way up to your dream home
- Continue saving – there is a variety of savings accounts structured to help you achieve your savings goals
- Investigate the government’s First Home Super Saver Scheme (FHSSS). If you’re a first home buyer, this may be a solution but you’ll need to seek professional advice to make sure it will work for you.
So, how did you go?
Borrowing money to purchase a home has always been a complex business, cluttered with jargon and fraught with pitfalls.
When applying for a loan, it’s imperative you know what you’re getting into. Read the contract thoroughly – including the fine print! Ask questions of your lender, conveyancer and even the local government. Do the sums and, more importantly, seek the advice of your financial adviser.
Be smart and be informed!