Securing finance for your first property is an exciting and nerve racking time. The thrill of owning your first home can be offset by the stress of committing to a mortgage. Much of this stress can come from not understanding the mortgage market, an area that is often cloaked in mystery for those without a financial background.
We’ve got you covered. Learning the basics of how mortgages work starts with an understanding of the terminology used within the industry. Many fields have their jargon – the mortgage and lending sector is no exception!
Here’s a list of some of the key phrases and words you should know when you’re applying (it’s even worth a refresher even if you thought you knew!).
Fixed Rate/Variable Rate Mortgages – When taking out a mortgage you can choose between a fixed rate or variable rate loan (or a combination). A fixed rate means your rate of interest on the mortgage will not change for a specified period of time (1-5 years is most common). This provides you with a level of certainty when making your repayments. A variable rate means that your rate of interest on the mortgage will fluctuate with the market. You’ll get a better rate than a fixed rate, but you also take the risk of interest rates rising. If rates do start rising, the fixed rate will rise too. Variable rates tend to have more features on the loan (such as a redraw facility or offset account). Your suitability for which type of loan depends on your risk profile, and your ability to budget for any fluctuations.
Equity – This is the value of your property, less what’s owed to the bank. Over time your equity in the property will normally increase as the value of the property rises, and the amount you owe on your mortgage drops. A home owner with a property valued at $900,000 and a mortgage of $600,000 will have $300,000 equity in the property. If five years later the value of the property has increased to $1.1M and the mortgage, after repayments, has dropped to $500,000 then the equity will have doubled to $600,000. Sometimes you can borrow against this equity to make improvements to your property, such as a new bathroom or pool.
Refinancing – From time to time your finance needs may change and it may be in your best interest to replace your existing mortgage with another alternative. This can happen when you want to unlock equity from your property or spread your repayments over a different timeframe. Refinancing is the process of remortgaging your property with a new mortgage under more favourable terms. A good example of this is moving to another lender.
Closing costs – Whether you are taking out your first mortgage or refinancing there will always be costs involved in doing so. Application fees, solicitor’s costs and stamp duties are many of the more common ones you may encounter as part of the process.
Debt to income ratio – A lender’s primary focus is their risk – your ability to repay their loan on time. To assess this, they will look at how much you are borrowing relative to your income, or ability to pay the loan back.
Loan to Value Ratio – Aside from your ability to service the loan (make repayments), the lender will also be interested in the risk should you not meet the repayments. The mortgage document will give them the right to sell your property and recover their funds – a scary thought. Therefore the ratio of loan to the value of the property will be important to them as they need to ensure they can recover the loan amount from the value of the property under these circumstances.
Deposit – Few lenders will be prepared to lend 100% of a property’s value. The amount you will need to contribute is your deposit. Most lenders will require around 20% for a deposit but they will allow 10%, or sometimes less, in certain circumstances. In this case they will probably require you to take out Private Mortgage Insurance (PMI), a cost you will have to meet to insure their risk. It’s important you understand that although you will be footing the bill, the insurance protects the lender and not you. It ensures the lender is protected should you default (fail to make payments) on the loan.
There are numerous phrases used in the mortgage industry. The important thing is to educate yourself in their meaning and not feel intimidated by their use. Buying your first home is a happy occasion – as long as you’re educated and committing to what you can afford both now (with some wriggle room!) the process of borrowing money should be a good experience.
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The information in this article is general in nature and does not take into consideration your personal situation or circumstances. You should consider whether the information contained in this article is suitable to your needs and where appropriate, seek professional advice from a financial adviser or other finance professional.