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to switchbanks.
Please
note, the information contained
on this site is meant as a general
guide only. We make no guarantee
at Switchbanks that the information
provided is accurate or up to
date, and people using the information
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Principal
and Interest Loans
Inertest Only Loans
Variable Rate Loans
Fixed Rate Loans
Split/Combined Loans
Loan Value Ratio
Debt Servicing Ratio
Basic Home Loans
Early Repayment Theory
Standard Variable Rate
Introductory or 'Honeymoon' Rate
Loans
Redraw Facility
'All-in-one' Account Loans
100% Offset Account Loans
Partial Offset Account Loans
Interest Offset Loans
Professional Packages
Construction Loans
Bridging Loans
Consolidation Loans
Lines of Credit/Equity Loans
Reverse Mortgage Loans
Compulsory Comparison Rate (CCR)
Legislation
Australian Federal Privacy Act
2004
Financial Transactions Reporting
Act 1988
NSW Finance Brokers Contract (FBC)
Survival Tips
Principal
and Interest (P&I) Loans
Every loan, regardless
of which product or loan type,
is made up of two elements; principal
and interest. The principal is
the actual amount of money borrowed,
and the interest is the extra
money a client has to pay back
on top of the loan for the privilege
of borrowing it. This is, the
fee they pay for the use of that
money (think of it as money being
just another commodity that can
be bought and sold, and the interest
paid is the fee for using that
commodity).
A
Principal and Interest loan is
probably the most utilised loan
of all. This type of loan allows
a client to make regular repayments,
which consist of two portions.
One portion of the repayment is
paying off the principal, and
the remainder is servicing the
interest that has accrued on the
balance of the principal (what's
left to pay off). Basically it
means that the client is paying
off the loan as well as servicing
the interest on that loan. It
looks like this:
A
P&I loan allows a client to
build up equity in the property
by paying off the loan (the principal)
as well as servicing the interest.
The equity is that portion of
the property value that has no
money owing on it. For example,
if the security property was worth
$200,000 and the client owed $150,000
on it, they would have $50,000
equity in their property. This
type of loan is particularly useful
when purchasing an owner occupied
property, as it will allow a borrower
to build up equity to use later
on if they want to cross-secure
(use more than one property as
security for the loan) a loan
to purchase an investment property.
You would generally give a client
a P&I loan on a property that
they don't intend to sell in the
immediate future, or if they were
taking a mortgage on their property
to pay off another type of loan,
say a car loan for example, which
would originally have had a higher
interest rate, and has had no
capital gain (increase in value),
when they sell the car.
P&I
loans are generally taken over
a term of 25 years to 30 years
(the term is the time that the
loan repayments are calculated
over, which will also be the maximum
time to pay off the loan if the
client just paid their minimum
monthly payments and nothing extra).
The longer the term the less the
minimum monthly repayment amounts
will be. If they are an older
borrower, or their loan presents
a higher risk for one reason or
another, some lenders may require
them to take a P&I loan over
a shorter term, like 15 or 20
years etc. Just because the loan
has a nominated term (say 25 years)
it doesn't mean that they have
to take that long to pay out the
loan. It simply means that the
repayments have been calculated
over that period of time.
Interest
Only Loans
As previously discussed,
all loans consist of two portions;
principal and interest. However
not all payments have to consist
of both elements. An Interest
Only (IO) loan will only make
payments that service the interest.
Repayments on these loans ONLY
SERVICE THE INTEREST AND DO NOT
PAY OFF ANY OF THE INITIAL AMOUNT
BORROWED. Basically an IO loan
looks like this:
An
IO loan is generally taken out
for investment purposes. This
is because the repayments will
be less than those of a P&I
loan for the same amount, as there
is no 'principal' portion in the
repayment, and the borrower is
relying on the capital growth
(increase in value) of the property
(or shares, or investment) to
result in an amount larger than
the initial borrowed amount to
gain a profit. An IO loan can
usually be taken out for a period
of 1 - 5 years, over a 25-year
term. You should always be very
careful when arranging an IO loan
for a client, and make sure that
the term allows the client enough
flexibility to pay back the loan
at a time convenient to them.
For example, if a client takes
a five-year IO out for a term
of five years, they will have
to pay the complete amount of
the initial borrowings back at
the end of five years. If they
take a 5-year IO loan out over
a 25-year term, it means that
they've got a maximum of 25 years
in which to pay back the principal.
After the initial 5 years (or
what ever period they had the
loan as Interest Only) the loan
will generally revert to the lender's
standard variable rate product
(explained later) or principal
and interest on the same product,
or they can renegotiate another
IO term of up to five years. Interest
only loans can usually be done
with both fixed rate and variable
rate products, depending on the
lender (please see below for Fixed
and Variable rates).
Variable
Interest Rate Loans
There are two types
of interest rates available to
the educated borrower. The first
type we'll discuss is the variable
rate. As the name implies, this
rate will vary from time to time
as the market fluctuates (goes
up and down). Most lenders have
a suite of variable rate products,
with their most expensive one
called The Standard Variable Rate.
The Standard Variable Rate is
generally slightly lower than
the 2-year fixed rate, however
this varies from lender to lender,
and some lenders may even have
it lower than their 1 year fixed
rate. A variable rate loan has
many pros, and really just one
con. The con is that if interest
rates rise, then the loan interest
rate will rise along with the
loan repayments. The interest
rate is not 'locked in' for a
specific period of time, meaning
that as the interest rate market
changes, the repayments will change
with them. The good thing is,
that if the rates go down so will
the repayments.
A
variable rate loan's main benefit
is that it will generally allow
some options for making extra
repayments, which in turn allows
a borrower to pay off their loan
more quickly, saving them more
money. These loans generally have
the 'bells and whistles' options,
and will sometimes have discounts
attached. An example of what a
variable rate may look at over
the course of twelve months is
shown below:
Fixed
Interest Rate Loans
As the name implies,
this sort of loan allows a borrower
to fix their interest rate for
a set period of time. It's usually
between 1 and 5 years, however
some lenders will allow the clients
to fix for up to 10 years. The
benefits of this is that they
have the peace of mind knowing
exactly what their repayments
are going to be month in and month
out for the amount of time that
they have fixed their loan for.
What
happens when the fixed period
expires? There are a couple of
options. One is to renegotiate
another fixed rate at the then
current market rates, i.e., the
new fixed rate will probably be
different than the old fixed rate
as the market will probably have
fluctuated by this time. If a
client chooses not to re-fix their
interest rate, the loan will generally
rollover (turn into) to the current
standard variable rate product.
An example of what a 5 Year fixed
rate loan may look like over 5
years is shown below:
A
client can take a fixed rate loan,
fixed for a set amount of time,
over a specific period of time
or term. For example, a client
could take a four year fixed rate
loan over a 25-year term. This
means that the loan repayments
for a P&I loan would be calculated
at the interest rate that they
fixed at, over the term of the
loan. To look at it in slightly
more depth, a loan taken at a
fixed rate of say 7.85% for 4
years over a term of 10 years
will have greater repayments than
a loan fixed at the same rate
for the same time taken over a
term of 25 years.
Split/Combined
Loans
A split or combined
loan is a facility that allows
a client to take the benefits
of one or more types of loans.
For example, they may want to
hedge their bets with interest
rates, so may want to borrow a
portion of the loan under a fixed
interest rate and a portion of
the loan under a variable rate.
This means that if interest rates
rise, then portion of the loan
that is fixed will remain the
same for the duration of the fixed
period, however if the rates go
down, then only the variable portion
of the loan will go down with
it.
A
client can also split between
loan products.
Loan
Value Ratio (LVR)
When considering
a loan application the Loan to
Value Ratio (LVR) needs to be
determined. The LVR is also known
as a LSR or Loan Security Ratio.
It means the same thing, however
is basically a figure expressed
as a percentage or how much the
borrowed amount is in relation
to the value of the security property.
LVR
= LOAN AMOUNT
VALUE OF PROPERTY
The
Value of the Property is determined
as the purchase price or value
as determined by an independent
valuer appointed by the Lender
- whichever is the lesser.
The
LVR needs to be calculated for
all loans to determine:
Whether
the Lender can lend the amount
required.
Where required, the Mortgage Insurance
premium.
Some Lenders will lend up to 95%
of the value of a property if
it is to be used for owner/occupied
purposes. Those who do not lend
up to 95% will lend a maximum
of 90%. Lenders will generally
lend a maximum of 90% on investment
property.
These
maximum amounts may be reduced
depending on the quality of the
property and the applicant. The
maximum amount that can be lent
to a foreign investor, in most
instances, is 70%.
When
the loan amount exceeds $500,000,
mortgage insurance is generally
unattainable and a 20% deposit
therefore will more than likely
be required. Individual circumstances
may be considered, however, and
cover may be possible for a particularly
strong applicant. A reduction
in the maximum amount that can
be financed usually coincides
with an increase in the potential
risk to the Lender.
Debt
Servicing Ratio and Surplus Income
When assessing whether a client
can service a loan, some lenders
measure the borrower's capacity
using a Debt Service Ratio (DSR)
calculation. The DSR is calculated
by dividing the applicant's financial
commitments (including the repayments
on the proposed loan) by the verifiable
income. A representation is below:
DSR
= Financial Commitments (annually)
Gross Taxable Income (annual)
The
Ratio should not exceed 35% and
the lower the Ratio, the stronger
the application. On occasion this
figure can be greater, particularly
when the applicants are on a high
income. This will normally mean
that their surplus income remains
high despite their commitments.
Their surplus income is calculated
as follows:
Surplus
Income = Gross Taxable Income
- Financial Commitments
Most
Lenders require a minimum annual
surplus income of between $12,000
and $15,000, however this is not
a firm requirement, and varies
from loan to loan and lender to
lender.
Basic
Home Loans
Interest rates
are very much 'you get for what
you pay for'. A client might get
a cheap variable rate for a very
basic home loan that offers limited
opportunity to pay off the loan
earlier, or they may go for a
little more expensive loan which
allows them to pay off their debt
quicker and over all save them
potentially thousands of dollars.
A
basic home loan is one that really
offers none of the extras that
will be discussed in the paragraphs
below. They will usually have
very low interest rates, and should
have little to no regular fees,
though usually won't allow a borrower
to pay any extra off the loan
or will only allow them to vary
your repayments once per year
or so. Because they are cheap,
the lenders don't make much money
from these loans, so may load
up 'deferred establishment' fees
etc - i.e., paying off their loan
early, say if they refinance for
example. (The Uniform Consumer
Credit Code [UCCC] does not allow
a lender to charge fees for repaying
a loan early, or charging 'early
repayment fees', however a lender
may charge 'Deferred Establishment
Fees' instead.)
These
types of loans are best suited
to those will never need or want
any flexibility with their loan,
aren't able to pay any thing extra
off their loan, or who may want
to use their extra income for
other investments etc.
Early
Repayment Theory
The idea behind
taking any flexible product should
be how it's going to allow a borrower
to pay their loan off early through
options for bringing down the
balance more quickly. The reason
a borrower should want to pay
a loan off as early as possible,
is that the earlier they pay it
off, the more money they will
save. By way of example, let's
say a client has taken a variable
'principal and interest' loan
for $150,000 over a term of 25
years. Let's also say that their
interest rate was 6.50%, and that
through some wonderful chain of
events, their interest rate didn't
change during the entire term
of the loan.
Upon
their 300th payment, which would
be the last payment they make
after 25 years of mortgage they
would have paid $150,000 back
of the principal, and approximately
a total of $153,843 in interest.
Lets say now, that they took less
time, and managed to pay pack
the loan in say 20 years. After
paying back the original amount
of $150,000, they would have paid
approx $118,406 in interest, which
would be a saving of approx $37,437
in interest repayments. To take
that even further, let's say they
only took 10 years to pay off
their mortgage. On top of their
initial borrowed amount of $150,000,
they would only have had to pay
back approx $54,487 in interest,
which would be a saving of approx
$99,356 than if they had taken
the full 25 years to pay back
the loan. Put simply, the sooner
a borrower can pay a loan off,
the more they will save in interest.
The
basic concept for putting more
into a loan to pay it off quickly
is simple. If interest rates didn't
change, neither would the repayments.
The only thing that would change
is the relationship between the
Principal portion of the repayment,
and the Interest portion of the
repayment. When a borrower begins
repaying a loan, a very small
portion of each repayment is paying
down the principal of the loan,
while the vast majority is servicing
the interest that's been calculated
on the balance of the loan. This
means that as borrowers pay more
and more off the loan, the interest
portion of the payment will be
less as the interest has been
calculated on a lesser amount,
which also means that the principal
portion of the repayment will
be greater. This means that a
borrower will be paying more off
the principal amount with each
repayment. Don't forget, repayment
amounts are calculated at repaying
the loan over 25 years. By owing
less, interest being calculated
is less, which means that each
repayment is paying more off the
principal, and thus reducing the
balance that is owed.
Standard
Variable Rate
Each lender will normally offer
a number of loan products. The
'all singing all dancing' product
is generally the one that is calculated
at the Standard Variable Rate,
and is usually the most expensive
of the variable rate products
(with the exception of a Line
of Credit). The loan product with
the Standard Variable Rate usually
has all the 'bells and whistles'
attached so is usually more expensive
than the more simpler variable
rate loans, and as such may be
the bench mark you use when comparing
how much margin each lender has
put on their loans.
Introductory
Rate Loans
Most lenders will
offer an Introductory Rate Loan.
These are also known as 'Honeymoon'
loans, due to the honeymoon period
of a heavily discounted rate.
Generally lenders will offer a
very cheap rate for a period of
usually one year, though some
may do as little as six months,
while others may offer the discounted
rate for up to three or fours
years. The introductory rate can
take one of two forms, the first
being a fixed discount, and the
second being a discounted fixed
rate. The fixed discount is a
rate that will be variable, but
fixed at a certain level, or margin,
below the standard variable rate.
This means that for the introductory
period, the discounted rate will
move with the market. If the standard
variable rate rises by say, 0.50%,
so will the discounted rate, if
the standard variable rate drops
by 0.50% so will the discounted
rate. The discounted fixed rate
is a discounted rate, fixed at
that rate for the introductory
period. Regardless of what the
market does, the discounted fixed
rate will remain the same for
the introductory period.
Whilst
these loans are sometimes quite
popular, there are a number of
things to look out for. Most of
these loans will roll over into
the standard variable rate or
even a higher variable rate than
the standard variable rate (usually
the major lenders won't do this,
however some of the smaller ones
may…) after the initial
introductory period. This means
that any benefit a borrower may
have had by way of cheap rate
for the introductory period, may
be negated by the fact that they
are now paying the most expensive
rate in the lender's variable
suite. Some lenders may also 'cap'
or limit the amount of extra money
a borrower can pay off the loan
during the introductory period,
which in turn may limit the benefit
of having the introductory period
in the first place. You should
also check what sort of exit fees
a borrower might have after any
period of the loan, for example
they will more than certainly
have to pay an exit fee of some
description if they pay out the
loan or refinance at the end of
the introductory period. This
basically encourages borrowers
not to jump from honeymoon product
to honeymoon product, and allows
a lender to cover costs incurred
during the introduction period.
If
a borrower is considering a honeymoon
product, you should consider what
their financial goals are. This
will allow you to compare how
much they will pay over a set
time, and work out which is the
better deal i.e., you need to
work out how long they intend
to pay a mortgage for. Let's say
your borrowers get an introductory
rate loan that rolls over into
a standard variable rate. Work
out your average monthly repayment
over different periods of time
(say 5 years, 10 years, 15 years,
and 25 years). Now compare this
to the repayment amount the client
would be making if they took a
product with a lower interest
rate than the standard variable
rate (one that still meets their
requirements though) to see which
works out cheaper. Although they
might be making very small repayments
during the honeymoon period, they
will be making the maximum payments
afterwards. This will more than
likely work out more expensive
(especially as more time goes
by), than if they had taken a
product with a rate higher than
the introductory rate, but less
than the standard variable rate,
that remains relatively constant
(and consistent with the market
fluctuations) throughout the loan
term.
Another
suggestion you may want to make
to a client is that when they
take on an introductory rate loan
they may want to consider making
repayments at the roll over rate
(if their loan product allows
it) rather than at the introductory
rate, from day one. This will
allow them to get into the habit
of making repayments at the higher
amount, so they shouldn't have
to change their financial exposure
or disposable income when their
honeymoon period is finished.
It will also allow them to build
up equity in their property a
lot more quickly.
Redraw
Facilities
This type of loan allows a borrower
to put extra funds into the loan
to bring down the principal amount,
but also allows them to 'redraw'
those extra funds at any time.
Let's say they have a loan of
$200,000 and savings of $10,000.
The borrower could put their savings
directly into the loans redraw
facility, and would then only
be paying interest that's been
calculated on $190,000.
Most
redraw facilities are fairly cheap
by way of interest rates and fees.
They are usually well below the
standard variable rate, and most
don't incur regular monthly or
annual fees. It is not unusual
however, for most lenders to have
a minimum redraw amount, usually
around $2000, though some may
be lower or have no minimum at
all. Most lenders will also charge
a fee whenever you redraw, usually
around $50 or so, but again this
varies from lender to lender.
Something you should be aware
of is an activation fee. This
may apply to a variety of facilities
attached to the loan depending
on the chosen lender, and is basically
a fee to 'switch on' or activate
a facility such as a redraw. A
client should only have to pay
the activation fee once for each
facility, however may still have
to pay a fee each time they use
the facility such as redraw etc.
The
redraw facility is probably best
suited for low to medium income
earners, who manage to put a little
extra away each month. You should
think of the redraw facility as
a savings account, not an account
for everyday transactions. It's
a good way of saving up for a
holiday, car, or other property
etc, while using these savings
to pay off a loan more quickly.
The clients only put in what money
they have left over at the end
of the month after their mortgage
repayment and living expenses,
or they can nominate to pay extra
each month if they are direct
debiting from their salary. If
they perhaps get a cash bonus,
a return from their tax, or some
unexpected windfall, they could
also consider putting this into
their redraw facility. By having
the money in
