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Going over loan documentation can be really dull and confusing, even overwhelming sometimes, especially if you’re new to the experience. But as you’d expect, it’s really important to know what you’re signing. So how do you make it easier? How do you make sure you’re not missing anything?
Well, there’s really just one thing to do first – and that’s get clear on at least the basic concepts you’ll encounter as you read through the details of any potential loan arrangement – the loan terms.
What are loan terms?
‘Loan terms’ is a phrase that refers to the various terms and conditions you agree to when you take out a loan. You’ll also hear them referred to as the ‘terms of the loan’.
Loan terms specify the lenders and borrower’s obligations and are typically included in the final loan or credit agreement. They can include details such as the repayment period for the loan, the interest rate, any fees or penalties you might incur, as well as any special conditions.
Key loan terms everyone should know
Loan agreements can be complicated but the most important loan terms are easy enough to identify and understand for those of us just starting out in property investment.
Repayment Period: The loan repayment period specifies how long you have to repay what you borrow. This is important as it will affect the amount you repay each month as well as the amount of total interest you will pay over the life of the loan.
Repayment Terms: The loan will typically include a schedule of repayments that sets out how much of each payment goes to paying off the principal (the amount you actually borrowed), how much goes to the interest, how your principal balance should decrease over time and the total amount of interest you will pay.
Ready for some jargon? This schedule is called an amortisation schedule.
Amortisation Schedule:
An amortisation schedule might sound tricky, but it’s really just a fancy word to explain how you pay back your home loan over time. Here’s how –
A schedule lists every payment you’ll make until the loan is fully paid off. It tells you how much of each payment goes towards the money you borrowed (called the principal) and how much goes towards the fee the bank charges you for borrowing money (called interest). At the start, you pay more interest and less principal. But as you keep on paying, more of your money goes towards the principal, and you pay less interest. Eventually, you pay off the whole loan!
In simpler terms, it’s like having a detailed plan that shows you exactly how you’re paying off your home loan bit by bit.
Interest rates: The interest rate is the rate of interest you will pay for the loan. This is essentially the cost the lender charges you for borrowing the principal (the amount you need to purchase your home).
There are different ways lenders can charge you interest. Usually, they will apply either a fixed rate where you pay the same interest rate for the life of the loan or a variable rate which changes your loan interest as interest rates rise or fall.
The type and amount of the interest rate will be stipulated and, as mentioned above, the amount you will pay over the life of the loan will be set out with the repayment details.
Interest rate calculations can be complicated (which is why home loan calculators are a great idea).
Loan-to-Value Ratio (LVR):
The Loan-to-Value Ratio, or LVR for short, is a way to measure how much money you’re borrowing compared to the value of the house you want to buy. Imagine the house you want to buy is worth $1,000,000. If you borrow $800,000 from the bank and put in $200,000 of your own money, your LVR would be 80%. This is because $800,000 (the loan amount) is 80% of the value of the house.
In simple terms, the LVR helps the bank decide how much they can safely lend you to buy a home. Diver deeper into understanding LVR here.
Fees and Penalties: These include the additional costs that will be charged over the life of the loan. While they vary, some common fees include:
- Origination fees – this is the cost required to start a new loan.
- Closing costs – the cost to finalise the closure of your loan period.
- Prepayment penalties – an administrative fee applied when you pay out your home loan early.
- Late payment penalties – paid if you don’t make your monthly minimum repayments.
- Annual fees – charged each year for the duration of the loan.
- Monthly fees – a fee towards servicing and administering the loan each month. They may include any charges for redraw facilities or prepayments.
- Additional repayment fees – a fee charged when you pay more than your monthly repayments.
- Exit fees – charged when your mortgage is repaid in full, these may include discharge and settlement fees.
There are a variety of fees and penalties, and they vary from lender to lender, loan to loan and depending on your decisions over the life of the loan, but as you can see there can be a significant number that will add up over the life of the loan.
Don’t let the complexity get to you
The terms of a loan offer can vary a lot, so apart from making sure you’re confident of your obligations under the loan, understanding the terms of the loan helps you decide if the mortgage you’re being offered really is the loan for you, or whether you need to negotiate, or even find another lender.
Also, as you can see, understanding the loan terms might lead to a whole lot of new and important questions. It really is in your best interest to get familiar with these terms before you sign anything.
As your knowledge of loan terms increases, remember not to let the new terms and your increasing awareness of what’s really involved in a loan agreement get to you. Stay confident, get clear on the details, and if you’d like more certainty, reach out to the professionals for support. When you’re new to property investment, working with people who know the loan world can make a huge difference to your home ownership journey.
