8 Finance terms property investors must understand

We’re not taught much about money and finance at school are we?

So when you start hunting down a loan for your new home or investment property you’ll probably come across some industry-speak and terms you’re not familiar with.

So here’s a few you should know:

1. Interest only or Principle and interest  

When borrowing from a bank the two standard loan options are principle and interest or interest only.

With an interest-only loan, you only pay the interest on the loan each month and none of the loan itself (the principle.)

This means your monthly payments are lower than if you were to pay down the principle (the main loan amount.)

On the other hand, a principle and interest loan means that your monthly repayments are made up of your interest payments plus you’re paying back a small portion of the loan as well.

2. Lenders Mortgage Insurance (LMI)

Lenders Mortgage Insurance (LMI) is usually paid when you have a deposit of less than 20 per cent, and is a one-off payment you pay to your lender to protect them if you default on your loan.

You can often add this sum to your loan balance, but it protects (insures) the lender – not you.

If you default on your loan the insurance company will pay the bank and come and chase you for the money.

3. Offset accounts

This is a separate transaction account that is linked to your home or investment loan and allows you to use any savings you put into this account to ‘offset’ the interest you’re accruing on your loan account. 

Rather than earning interest on savings, the balance in your offset account is theoretically deducted from the loan balance, which in turn, reduces the interest charged to the loan.

Another advantage is that the ATO does not consider this as earning interest income and so benefit is achieved without additional tax expense.

Further, an offset account can reduce the term of the loan and allows funds to be kept ‘at call’ and used for any purpose.

You may be interested in reading: Understand the difference between a line of credit and an offset account

4. Redraw facilities

A redraw facility allows home loan holders to access any additional payments they’ve made on their loan.

It is only available if you have paid more than the minimum amount required and not all home or investment loans offer this feature.

The facility can be used to your advantage if you regularly pay extra money into your loan, knowing you can withdraw it if necessary.

While the extra money is in your loan account, it will reduce the amount owing and therefore the interest payable on your mortgage.

5. Comparison rates 

Essentially, a comparison rate is a way to help consumers identify the true cost of a loan and today all banks and other lenders are legally required to display a comparison rate when advertising any loan.

It is a rate that includes both the interest rate and the fees and charges relating to a loan, combined into a single percentage figure.

The comparison rate can help you work the true cost of a loan by reducing the interest rate and most fees and charges to a single percentage figure and is therefore a useful tool for borrowers to compare the cost of different loans from different lenders, however it’s important for investors to consider all of a loan’s features and not just focus on the comparison rate.

6. Split loans

A split loan allows you to allocate a portion of your loan amount to attract a variable interest rate, and another portion to attract a fixed rate.

This means you can take advantage of the security of a fixed rate but with the flexibility of a variable rate, as well as reduce the impact on your loan repayments if interest rates rise.

The split doesn’t have to be 50:50, you can choose exactly how much of your total you want to assign to each loan type

This offers you a way to minimise your risk when taking out a loan for your home or investment property.

7. Break fees

Loan break fees or costs are the costs and fees associated with breaking a fixed rate loan contract. 

When you enter into a fixed rate loan for your home or investment property, the interest rate that you are charged is calculated based on the lending institution’s prediction of the likely interest rate movements over the course of that term (often 3 to 5 years.)

When you break the term of your contract (such as paying back your loan early if you want to change to a different loan product or maybe sell your property), the break cost is designed to compensate the financial institution for any loss of profit that has been factored in to the term of the contract.

Paying a break fee is sometimes worthwhile, if you stand to save more than the fee’s total on a lower interest rate

8. Equity release

Equity release allow you to access your property’s value by borrowing against (releasing) the equity in your property.

This is a common method used by property investors to get funds for the deposit of their next property.