Everything you ever wanted to know about loans, explained in simple terms.


A

AAPR: Also referred to as a Comparison rate, the Average Annualised Percentage Rate reflects the total cost of your loan by taking into account costs other than the advertised interest rate. This is then expressed as a total cost to you over an average loan term. So basically it is the combination of the interest rate and any compulsory fees that are charged to the loan (and this is key) expressed as a percentage of the actual loan amount. Initially devised to show up those horrid honeymoon rate loans that had super low introductory rates and then jumped up extravagantly once you were locked in; the issue with comparison rates is the lenders can get around allowing for fees by charging them to a different account - remember its only fees charged to the loan which are included - and they don’t talk about incalculable fees like redraw fees which can add up dramatically but can’t be estimated upfront (who knows how many times you might redraw and therefore how many to include). The thought was good but in practice they fall down a little.

Acceptance: To agree to the terms and conditions of an offer contract. Sign on the dotted line and return – usually with an expiry date. Usually referred to as “signing your life away”, but actually that’s the mortgage…

Additional Repayment: Additional funds paid off your loan which exceed the minimum monthly repayments. All loans have a natural balance that drops as you make repayments – that’s how they get paid off – and anything about this amount is called “additional repayments” and in most cases can be accessed via “redraw”, or transfer back out of your home loan (for emergencies and other worthwhile purposes. Because interest is calculated on the current daily balance these additional repayments both put you ahead and save you loads of interest. This typically makes it a perfect place to stash your spare money & save interest & of course you can still access it if you need to.

Amortisation: To pay off principal and interest under a loan over a period of time. Amortisation is the actual function of repaying your loan and its pretty cool to graph. Basically, your typical principal and interest repayment is made up of the interest due on the outstanding balance, and an amount calculated to repay the principal over the balance of the loan term. Next repayment the interest is less (because the balance has dropped from the amortisation) and more goes to principal and so on and so forth until it’s all paid off.

Application fee: A fee paid by a borrower to cover the costs of establishing a loan. These days most loans have low or no application fees, a couple of hundred dollars at best on average and for pro-pack loans just a small charge to cover legal costs. Its important to note that the application fee often covers the valuation and legal fees for one loan and one property.

Arrears: Overdue payments which are due to be paid. Uh Oh, lets not get in arrears ok – but if you do, ask for help as soon as you can. Most lenders have excellent programs for hardship situations if you communicate with them early and often. Arrears will accrue interest and if they continue beyond 60 days they can attract additional penalty interest rates.

Assets: Items of value which you own. Eg Property, Cash, Furniture & Fittings etc. The big stuff generally. Banks ask you to list your assets and liabilities on your home loan because it gives them a picture of your financial life, you know, do you have more assets that you have loans? Do you have an appropriate “balance sheet” (the list of assets and liabilities” for your age and income? This gives them a very very rough view of the way you run your financial life.

B

Balance Sheet: A financial statement confirming assets, liabilities and capital. What you own on the left, what you owe on the right. Hopefully the left hand column adds to more than the right hand column – this would show you’re reasonably good with your money & going places. Lenders like to use this as a very very rough guide to your appetite for loans and accumulating assets.

Balloon Payment: A final payment finalising a debt in which the amount paid is substantially more than previous instalments. Usually applicable in car or equipment finance, you might choose to have a larger balloon payment where you plan to sell the asset in 5 years (for example) and you want to reduce your repayments along the way to make it more affordable. The key is ensuring the asset is worth more at the end of the loan term that the residual balloon payment. If not, we call this ‘negative equity’ – or “upside down on a can of coke”, not an industry term.

Borrower: An entity or person/s borrowing money. This one is pretty clear. If you’re looking for a loan you’re the (potential) borrower.

Breach of Contract: To break the conditions of a contract which have previously been agreed to. Like any contract, there are provisions for what can happen if you break the agreed terms, which can include a financial penalty. Remember, you don’t have to sign anything you’re unhappy with & you must read and understand everything that you sign. The flip side of this is most contracts are written in language which most of us don’t understand, and, most loan contracts are long and other than the interest rates and fees, fairly standard – which both means they should be very consumer safe in legal terms, but equally, if you don’t like the terms you probably are not going to find much different elsewhere. The one point I would highlight right here is to treat a fixed rate like entering into a contract and see more about Break fees which are a specific breach of contract for a fixed rate term.

Break costs: A cost incurred for paying out a loan balance on a fixed term loan before the term has expired. In shorthand these are a complicated calculation ending in a penalty that you will pay for breaking the fixed rate early. The longer explanation is it’s a penalty that reflects the loss of income the lender will incur because of the fixed rate ending early, basically, if they had leant the money to you for 5% (for example) and you had a year to go, and now they can only get 4% from another borrower, they want you to cover the 1% difference for the balance of the term. In actuality lenders are borrowing the money themselves and agreeing to a fixed contract with their lenders that they have to honour, so they are passing on their loss to you. I can’t stress enough to you to treat a fixed rate as a contract and understand exactly what you are agreeing to (and for a lot of borrowers it’s a very good idea to fix at least part of your loan). Its important to note you can incur a break cost if you:

  • Sell your property

  • Switch to a different loan type or refinance the loan

  • And / or Repay more than the allowed repayments – pretty important to note.

Most lenders allow up to $10,000 per year in additional repayments during a fixed rate without penalty (can’t access them in most cases though) which is roughly $200 a week and usually not an issue. When considering a fixed rate you should think about your future plans, if you’re thinking about selling or if you’re expecting to be able to extra repayments then talk with us about how you can structure the loan to benefit from the fixed rate and still have the flexibility you need.

Bridging Finance: A loan taken where the purchaser wishes to buy a new property before selling their existing property. The lender will take security over both proper­ties until the initial property is sold. So very very handy when you don’t want to have to packup and move twice! OK, there are pitfalls, you have to have a tonne of equity in your home to qualify, interest can add up and you’re taking a risk if you cant sell your place, but honestly worth a look at. Bridging loans differ from regular loans because they generally test your “affordability” for the loan (whether the bank thinks you can afford it or not) based on what you’ll owe at the end and not the total loan on both places (which few people would qualify for), and, they usually have a function built in for saving you repayments while you sell your old home, like the ability to add the interest to the loan, or repayments based on only your “end debt” (what you will owe after the sale).

C

Capital: The current value of your assets. Eg Property, Cash, vehicles etc. The left hand column in a balance sheet. Your capital is different to your equity – which is the total capital value less what you owe.

Capital gain: The financial gain received when selling an asset for more than you initially purchased it for. This is what we’re aiming for when we invest in property. Imagine selling a property and making $100,000 or more – even after capital gains tax that sure beats paying off your loan with your after tax income every week! And ask me about capital gains tax and why its nothing to be afraid of.

Capped loan: A loan where the interest rate is set so that it may reduce, but not exceed a certain level over an agreed period of time. Not common these days sadly, but its like hedging your bets – a fixed rate loan which can drop if the market does but not exceed a ‘capped’ or maximum rate during the term. They appear to be more beneficial to the borrower than the lender which is possibly why we don’t see a lot of them on offer any more, but its more likely because of the way the lenders raise their funds.

Cash Flow: In relation to company accounts, reported net income plus amounts charged off for depreciation, amortisation and extraordinary charges to reserves. In business and consumer terms its what is coming in vs what is going out and the timing of this. Cash flow is king – no point in having a bucket of money coming to you if it’s too late to meet your commitments. Simple ways to improve your cashflow can be to align your repayments to your pay cycle, even better if you can get the repayments to come out a few days after pay day – and not to rely on lump sum money which isn’t paid regularly, like bonuses. Keep these for surplus rather than relying upon them.

Certificate of Title: A document which details the ownership of land and the dimensions or other details of a property as well as any restrictions that apply to it (also known as encumbrances or easements which can be rules about how and where and what you can do on the block). Also known as a CT. This is basically the record that shows who owns the place, and mortgages are recorded with the title at the lands title office in your state, generally there’s also a record kept of everyone who owned the property previously. Once you’ve paid off your loan the certificate of title is returned to you (make sure you put it somewhere safe). CT’s have just gone electronic which poses an interesting question – when you payout your loan now, what do you get? An email?

Commercial Property: Property intended for use or occupancy by retail and wholesale businesses (e.g. stores, office buildings, hotels and service establishments). Interestingly this can be a residential home that is presently being used as an office, or that has the capability to be used for commercial purposes, think a hobby farm that has a shed setup at the roadside to sell a few boxes of fruit. True commercial property is treated as a riskier proposition by lenders; sometimes finding tenants is harder than for residential property and therefore the terms of any loan involving commercial property are different and the interest rates are higher.

Comparison Rate: See, AAPR.

Consumer Credit Code: The Consumer Credit Code also known as the UCCC is parliamentary legislation which is designed to protect the rights of the consumer by ensuring all lenders adhere to the same rules of lending practice. This has largely been replaced by the NCCP (National Consumer Credit Protection act of 2009).

Conveyancing: A legal process to transfer ownership of property from the seller to the buyer. The work of conveyancing is both simple and complicated – simple in that it involves a few forms being completed and submitted to the lands title office & you can technically do it yourself – and complicated in that it’s a very long document to read through and understand and there are checks that should be done as part of the process, like, are there proposed developments, roads, schools which could make living in your new place awful. Is the strata fund healthy or are you looking at a big bill to cover repairs? Are there disputes with neighbours that could impact on you? The experience of a conveyancing professional makes all the difference and its money well spent. I always choose a conveyancer or solicitor who is available when you need them - no good using a trial lawyer who will be unavailable if you need advice quickly.

Contract for Sale: A contract used in the transfer of property, which documents the conditions for the sale of the property. These vary from state to state but typically have a set format and will include documents that show a summary of the title and any restrictions. Often they will include letters from council which detail the rules of use of the property, the flood rating and hopefully a topographical survey. The contract is what you sign when you buy the property and it will have terms like the timeframe you have to settle on your purchase.

COSL: The Credit Ombudsman Service Limited. Like any ombudsmen they can offer assistance if you have been unfairly affected by a credit contract. They are external to the lenders and borrowers and might act as a mediator to get a faster resolution.

Credit Limit: maximum preset amount a borrower can use on a loan account. The amount that you cant go over. The limit drops along with the amortisation of the loan until you’ve paid it off completely.

Credit Reference or Credit Report: In order to approve a loan, a lender will require a credit report on the borrower to confirm previous loans applied for or credit difficulties recorded. Credit reports are prepared by authorised credit reporting agencies, such as the Credit Reference Association of Australia. The Lender obtains the borrower’s permission in writing to proceed with a credit report. Your credit report shows your last 5 years history so treat it like gold – a ‘busy’ credit report can prevent you from borrowing money and anything nasty on your credit report will almost certainly lock you out until it disappears off of your file. New legislation means credit providers can now report ‘positive’ credit history, in other words – always pays their bills on time & this can help some borrowers who may otherwise have been affected by hiccup on their file. The key in these cases if you have any issues is to communicate with the lender early and often, before it hits you file, and by all means don’t be a ‘credit junky’ making unnecessary applications. Shop around, but do it smart – use a broker, don’t sign privacy forms / allow credit checks, until you know you like what’s on offer.

Creditor: A party who is owed money, aka the lender. The creditor has a business in lending you money and they vary both in terms of what they offer and who they will lend to. In getting ready to borrow money it’s helpful to put yourself in their shoes, would you lend your money to someone who has your job history, your list of assets and liabilities, your credit report? Hopefully that’s a yes!

CRS: The Comparison Rate schedule which must be made available by each lender to confirm the annual percentage rate and its corresponding Comparison Rate for loan products offered. See AAPR explanation.

D

Daily Interest: Interest calculated on a daily basis. Interest is calculated daily but charged to your account typically monthly. This is why weekly and fortnightly – frankly any additional repayment – saves you interest, because it reduces the balance sooner and therefore the interest bill. It’s a self propelling method too – the less the interest is, the more goes off of principal, the less the interest is… etc. Here’s an exercise, take your current loan balance, multiply it by the interest rate, divide by 365 – that’s how much interest you’ll pay today, just don’t look at it too long….use it to motivate, not exhaust you!

Debt Service Ratio: Lenders calculate the Debt Service Ratio (DSR) by taking into account a borrower’s expenses as a proportion of their income. Its just on of a number of methods of checking that your repayments should be comfortable. Generally you’re not allowed to exceed a certain percentage, say 35% of your income allocated to repayments.

Debtor: A party who owes money to another. Also known as a borrower, pretty straight forward.

Default: Failure to make a loan repayment by a specified date. This is really bad – we do not want to be in default. Basically the repercussions will be a black mark on your credit file, a penalty interest rate being applied to your loan & lots of unconformable phone calls. I will say again, if you see yourself getting into trouble – and it can happen for reasons beyond your control – then communicate with your lender sooner and often & you’ll find them very helpful.

Deferred Establishment fee: A penalty which may be charged when a loan is repaid by the borrower in full. Thankfully these have been outlawed in 2011 so you shouldn’t come across them in any new loan contracts and I am seeing the very last of them being active round about now. Basically this was a cost to offset the lenders costs when you paid out your loan within the first 5 years. Good riddance I say.

Direct Debit: A deduction of funds from a customers bank, credit union or building society account. In my opinion the simplest, less stressful way to pay your bills on time, every time, which is great with new positive credit reporting. Plus you don’t have to think about it. My advice is keep a good buffer in your offset account (it saves interest sitting there) and makes sure you always have enough should they all come out at the same time, and set everything to direct debit for an easy life. I still check my bills and my statements though – it doesn’t remove that responsibility.

Disbursements: Fees and charges which are usually imposed by the solicitor when establishing a loan. Disbursements might include excessive photocopying (note, the solicitor decides what is normal photocopying and what is excessive) and other items paid for on your behalf, like searches and inspections that they pay for, then you pay back to them at settlement. These are added to your bill and are in addition to your regular legal fees.

Discharge Fee: A fee imposed by the lender to process the discharge of a loan when it is paid out. Typically this is a couple of hundred dollars and represents their costs in getting the file out and having a solicitor look after the discharge.

Draw down: A draw down is the transfer of money from the lender to a borrower after the loan has settled. You start paying interest on any money that has been drawn down, as soon as it is paid to you. In the case of spare money in a loan (like a refinance where there will be surplus money) it could be a great idea to park this in your loan or your offset account until you need it, so you don’t pay unnecessary interest. In the instance of a construction loan, these are progressively drawn down as each stage of the building is completed, so again, you only pay for what you owe.

E

Early Repayment Penalty or DEF: If a loan is repaid before the end of its term, lenders may charge an early repayment penalty. See above on Deferred Establishment Fees, no longer allowed.

Equity: The value which an owner has in an asset over and above the debt against it. Eg the difference between the value of a property and the amount still owed on the mortgage. Ahhh this is a good one. Equity is that bit of the property that you own. Quite literally, what’s it worth – less what you owe = your equity. This is, however, different to accessible or useable equity, which you might want to access for future investment or a holiday – lenders wont generally lend more than 90% of the property value, so again, what is it worth, multiply this by 90% and take away what you currently owe and this is what you could potentially access.

F

Facility: A term used to describe a loan account. Would you like one facility or two? Just jargon, think of this as a loan or a loan split.

First Home Owners Grant: An incentive from the Federal Government giving a grant to first home buyers as a one off payment. Extremely helpful for those starting out and can also include stamp duty exemptions. There are conditions and terms attached to the grants which do change from time to time.

Fixed Rate: An interest rate set for an agreed term. Eg. for 2, 3, or 5 years. Fixed rates are akin to a contract – you agree to pay the lender than interest rate and repayment for a set period of time. This is convenient in that you know exactly what your repayments will be over the time but there is a payoff, most people believe that in the majority of cases the bank wins (I know I have certainly been glad of a fixed rate at times, so I’m in two minds about this) and you will lose some flexibility, so it’s important to consider your short and medium term goals in relation to fixing. Generally, if you have no plans or needs to change property or lender, and your budget is tight or its your