General Home Loan Terminology Explained

Home Loan Terminology Explained

This article is to help you understand some of the common home loan terminology used. Reading this will help get you ready for our future conversations on suitable loan types and facilities.

After you have read this document, please let us know of any questions you may have. If we do not receive any feedback from you on this terminology, we will take it that you have read this and understood it. We will also cover this off together when we further refine your loan and facilities.

LVR (Loan to Value Ratio)

Loan to Value Ratio is a financial measure that can have a significant impact on your borrowing power. Your LVR is calculated by dividing the loan amount by the value of the property. The lower the LVR the better, as it usually means you have more equity in your home. Your LVR is considered high if the loan makes up more than 80% of the property’s value. In this situation there is a risk you could stretch financial resources and you are more vulnerable to financial changes such as a recession or interest rate rise.

The Reserve Bank has applied LVR restrictions to help protect highly indebted homeowners and investors from any sharp housing downturn. These restrictions on high LVR residential mortgage lending limit how much low-deposit lending banks can do.

If you have a high LVR, you will be faced with more stringent credit checks and you will be charged a Low Equity Premium. Lenders will also require a table loan, where you reduce the loan principal over time.

The advantages:  

  • The LVR restrictions are designed to protect borrowers from risk.

Things to consider:  

  • If you are building a new house, the 80% LVR restrictions do not apply so funding is more available.
  • If you have a high LVR you need to be able to show that you will have a greater amount of surplus cash after all outgoings (including loan servicing) than you would if you had a low LVR.
  • If you have an LVR of over 80% you will also be charged a Low Equity Premium. The cost of this depends on your LVR band (lower rates apply to the 80-85% band than the 90-95% band).

LVR restrictions for Lenders have recently been reviewed: 

From 1 March 2021:

  • LVR restrictions for owner-occupiers will be reinstated to a maximum of 20% of new lending at LVRs above 80%.
  • LVR restrictions for investors will be reinstated to a maximum of 5% of new lending at LVRs above 70%.

From 1 May 2021:

  • LVR restrictions for owner-occupiers will remain at a maximum of 20% of new lending at LVRs above 80%.
  • LVR restrictions for investors will be further raised to a maximum of 5% of new lending at LVRs above 60%.

Table Loans

By far the most common type of home loan, table loans involve structuring the term of the loan over a long period (up to 30 years with most lenders). Every week, fortnight, or month, you repay the same amount unless your interest rate changes. In the beginning, you are mostly paying off the interest. As you go on you begin paying more of the principal, which is the amount you initially borrowed. Table loans can be structured with either a fixed or a floating rate.

The advantages:

  • Certainty – you pay regular payments and you have a set date for when it will be paid off.

Things to consider:

  • Application fees for table loans apply. These vary significantly and can often be negotiated. Most lenders charge between $200 and $400.
  • If your income is irregular, making fixed regular payments may be difficult.

Floating Home Loans

Floating home loans are sometimes known as variable rate home loans. If you have a floating home loan your interest rate will fluctuate so your repayments will go up or down. The amount it fluctuates is driven by the Official Cash Rate.

The advantages:

  • You can make additional payments without any penalties.
  • You have the flexibility to move to a fixed-term loan as you please.
  • You can more easily absorb more expensive debt into your floating home loan.

Things to consider:

  • Floating rates are usually higher than fixed rates.
  • When rates go up so do your payments, which can put pressure on your cashflow.

Fixed Home Loans

With a fixed home loan, you pay an interest rate that is locked in for a specific period. This period could be anything between six months and five years and is called the loan term. At the end of the term, you need to re-fix it for a new term or move to a floating rate.

The advantages:

  • Certainty – repayments are always the same amount.
  • Lenders are competitive and you can often negotiate rates.
  • You can secure a low rate for a long period, which is good if rates are rising.

Things to consider:

  • If you lock in for a long term, there’s a chance rates may drop.
  • Some Lenders offer capped rates, where the interest rate cannot rise above your fixed rate, but it will drop if floating rates drop below the capped rate.
  • If you want to increase repayments or make extra payments, there can be additional charges.
  • If you want to break your term, you may be charged a ‘break fee’.

Interest Only Loans

As the name suggests, this is when repayments cover just the interest calculated on the loan. You are not
repaying any of the principal, therefore you are not reducing the loan at all. Many use this interest-only
option for a short period when they need additional cashflow and then switch to a table loan.

The advantage:

  • Repayments are lower, so you will have more cash for other things.

Things to consider:

  • It ends up costing you more as your repayments are not actually making any dent in the loan amount.

Offset Loans

In most situations, interest is paid on the full amount of your loan. If you choose an offset loan set-up, the lender takes into account any savings or funds you may have in other accounts and deducts this from the loan total before calculating your interest. For example, if you have a $500,000 home loan and $25,000 in your savings account, you will only pay interest on $475,000. The interest is calculated daily, so the more money you have in your accounts the less interest you pay. Interest is calculated at the floating (or variable) rate.

The advantages:

  • Paying less interest means you can pay off your loan faster.
  • You have flexibility as there is usually no fixed term.
  • It is often possible to link many different accounts (partners, parents, etc) to generate more savings on interest.

Things to consider:

  • Any savings that are offset will no longer earn interest. (However, interest earned on savings is usually much lower than the interest paid on debt, so the offset will likely be worthwhile).

Revolving Credit Loans

Having a revolving credit loan is like having a really large overdraft. You have the one account that your pay goes into and your bills and loan repayments are deducted from this same account. The interest you pay is calculated daily based on the balance of your account. So the more money you have in the account the less interest you pay. You can make lump-sum repayments and redraw money up to the loan amount limit.

The advantages:

  • If you are disciplined, you can pay off your mortgage faster.
  • Adding any savings into this account (rather than a separate savings account) gives you bigger interest saves and avoids the tax on savings account interest.
  • There are no fixed repayments, which can be good if your income fluctuates.
  • Some lenders can reduce your credit limit each month, which can help you pay off your loan within a specific term.

Things to consider:

  • You need to have self-control and avoid the temptation to spend up to the credit limit – as this will keep you in debt for longer.
  • Application fees can be up to $500 and you may also be charged fees for day-to-day transactions.

Redraw Facility

A redraw facility can help you out if you need extra cash. It enables you to access funds from what you
have already paid into your home loan. The amount you can redraw is limited to the amount of principal you have paid on the loan.

The advantages:

  • You can access additional funds without taking out a new loan.

Things to consider:

  • This is generally not available with fixed interest rate loans.
  • You will end up paying more overall.

Reducing Loans

Reducing loans are sometimes referred to as straight-line mortgages. They are not that common in New
Zealand. With this type of loan, each week, fortnight, or month you pay the same amount of principal, but the amount of interest you pay reduces with each repayment. This means at the start of the loan term payments can be rather high, but they reduce over time.

The advantages:

  • You pay less interest overall than you do with a table loan because a higher amount of principal is paid during the early repayments.
  • It can be ideal if you expect your income to drop over time.

Things to consider:

  • With higher repayments at the outset, it may not be an affordable option.
  • If you can manage the higher repayments, it could be better to choose a table loan and pay the high repayments for the full term, therefore paying less interest.

Construction Loans

If you are building a home or renovating, a construction loan is a good option. These loans start as interest-only and allow you to make progress payments to your builder to a maximum limit. Once your build is complete your loan will be converted to a standard table loan (or another loan structure agreed to at the outset).

The advantages:

  • During construction you pay interest only, and only draw out the loan money as you need to. This can make it easier for you to pay for your expenses such as accommodation throughout the build process.

Things to consider:

  • If your loan is a high LVR loan, you will need a fixed-price contract from a reputable building company from the outset. This will need to cover the full cost of a ‘turn-key’ house at completion.
  • Your budget should err on the high side, as it is important you stick within this budget. If you end up needing more money, it will be very difficult to obtain extra funding if you already have a high LVR.

Repayment Holidays

Many lenders can offer borrowers a break from their repayments. During this repayment holiday you won’t
have to make any home loan repayments. However, you will still be accruing interest which will have to be
paid at some stage. This means you will need to increase loan repayments down the track or pay a lump
sum on return from the holiday.

The advantage:

  • If you are facing short-term challenges and you need extra cash, this can free up much-needed funds.

Things to consider:

  • Repayment holidays are only a short-term solution.
  • You will end up paying more overall as you are adding interest but not reducing the principal.

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