mortgage

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Understanding Mortgage: Important Information You Need to Know

Introduction to Understanding Mortgage: Mortgage Definition

The first step to understanding mortgage is to know what the word means. Dictionary.com defines mortgage as:

  1. a conveyance of an interest in property as security for the repayment of money borrowed.
  2. the deed by which such a transaction is effected.
  3. the rights conferred by it, or the state of the property conveyed.

In everyday language, this just means that a mortgage (also known as a “deed of trust”) is a legal document that says the lender may take away your home if you don’t repay the loan you took out with them. Originally, that loan will be to buy the house in the first place. But that isn’t always the case, as you’ll see.

When you sign the mortgage documents, you’ll also sign a promissory note. This is where you make the promise to repay the money you’ve loaned when taking out your mortgage. A lot of people get confused between the two because they think the mortgage is where you make the promise to repay.

Understanding Mortgage Payments

Part of the reason some people get confused between their mortgage and their promissory note is that “mortgage” is also used to describe the payments you make. When it comes to understanding mortgage, it’s good to know what these payments are:

  • Principal – the principal balance is the amount of money you still owe on your mortgage. With amortizing mortgages (like a fixed-rate mortgage), some of your payment reduces the principal while some of it pays the interest.
  • Interest – your mortgage’s interest rate is what determines how much you pay the lender as an extra fee for loaning money from them.
  • Taxes – some lenders will pay property tax on your behalf. If that’s the case, they put part of your monthly payment into an escrow account until tax season.
  • Homeowner’s insurance – most mortgage lenders require you to pay homeowner’s insurance. They will use it to cover damages from accidents, fires, storms, and other catastrophes. (Confused by insurance terminology? Read our guide on understanding insurance!)
  • Mortgage insurance – if you can’t afford to make a downpayment of at least 20%, most lenders will ask that you pay for the premiums on mortgage insurance. This helps mortgage lenders against losing all their money if you default on payments. There are two types of mortgage insurance: Private Mortgage Insurance (PMI) and those required for government-backed loans.

The Second Mortgage: When Mortgage Gives Way to Mortgage Debt

Earlier, we said that mortgage isn’t always used for loans toward buying a house. A lot of people take out a mortgage debt in order to borrow money for something else, like your small business or college fees.

If you already have a mortgage on your house, then this loan is a second mortgage. Also called a junior lien, you only need to pay this loan after your primary mortgage.

Fixed-Rate vs Variable Rate Mortgage

When it comes to understanding mortgages, it’s important to know that there are two main types.

Fixed-rate mortgages have a set interest rate that remains the same.

Variable-rate mortgages, on the other hand, have an interest rate that changes over time. Many variable-rate mortgages have a lower starting interest rate than fixed-rate mortgages. But after an introductory period, the interest rate increases. Some variable-rate mortgages put a limit on how high your interest rate will go, but this is not the norm. Variable-rate mortgages tie to an index of interest rates. When that index increases, so do your interest rates.

That’s why it’s usually better to choose a fixed-rate mortgage if you have the option.

Do I qualify for mortgage loan in Australia?

With house prices increasing 412% over the last 25 years, many Australians still do not afford to buy a home. Major cities have seen a fall in the price of homes in the past few months. However, residents and nonresidents alike still struggle to qualify for a mortgage loan.

There is no easy way, to sum up, lending criteria from dozens of banks, credit unions, and non-bank lenders. Nevertheless, there are a few important things you need to check off in order to qualify for a mortgage loan.

Do you think you qualify for a mortgage loan? Consider these criteria: 

Personal considerations

You need to be a natural person over the age of 18 in order to qualify for a mortgage loan. You also need to be an Australia resident or citizen. Some exceptions can be made. If you have no benefit in the loan or a non-resident you might still get a  home loan if you build a strong case with the right lender.

A non-resident is any person without permanent residency status in Australia. Or any person who resides and works in another country. 

Income needed to qualify for a mortgage loan

All banks will accept a salary as eligible income (proven with payslips showing before and after-tax salary). If you are under a probation period, you might still qualify for a mortgage loan. Your financial position and the strength of your application are paramount in the mortgage loan underwriting process. If you have a second job, most banks will require that you have had it for at least 12 months.

Some banks will accept income from casual/shift work and bonuses. Provided you’ve been working for the same employer for a couple of years. If casual income is your only income, your loan application will be assessed on its merits and the strength of your overall position as a borrower.

If you are self-employed, you need to have at least 2 years of trading in the current business. Some banks will still consider you eligible even you only have 1 year trading in the current business. But you need to have worked in a similar field for 2 years as an employee.

Most banks will not accept the overseas income of self-employed applicants.

Permanent pensions and annuity and investment income are eligible at most banks. Rental income (present or future) is also eligible under certain conditions.

Different banks will require different proof for these income types so be ready to provide all the required paperwork.

Serviceability

To grasp your ability to afford mortgage loan payments, banks will analyze your current and future financial commitments. These include other financial products like credit cards, overdrafts, credit agreements, and loans, property and family commitments, pension payments, etc.

They will calculate serviceability using one of these methods: 

  • Debt Service Ration (DSR) calculates the percentage of a customer’s gross income that is used to pay for a debt. As a rule, loan applications that turn a DSR of more than 50% get declined. 
  • Net Disposable Income (NDI) or Uncommitted Monthly Income (UMI): this method calculates surplus income by subtracting tax, living expenses and fixed commitments from your net income (either monthly or annually).  If you have zero to 25% surplus, you stand the chance to be approved.

While the three criteria described above are important, don’t overlook these next three: 

Most banks will require you to have a deposit between 5% and 20% in order to qualify for a mortgage loan. The lower figure is generally applicable to the big four banks (NAB – National Australia Bank, CBA – Commonwealth Bank, ANZ – Australia and New Zealand Banking Group, WBC- Westpac). And generally so provided you have a strong employment history and are a consistent saver. Low-doc applicants (only available for self-employed) will only need to have 20% genuine savings.

Credit history

Most Australian lenders perform a credit check of a potential borrower. If you want to know if you qualify for a mortgage loan, you can request a credit report yourself, so that you can correct wrongfully data the credit reporting agency might have on you. Credit-reporting agencies collect information from banks, financial institutions, and other credit providers utilities and others.

The Property and property valuation

In case the borrower is not able to pay their mortgage, the sale of the security property is the only alternative to clear off the loan. Therefore, the banks need to sell it as quickly as possible. This means the property needs to be in a high demand location, in a good condition, have no or few selling restrictions and have a wide appeal to potential buyers. The property: 

    • Must be in a residential area and have power connected
    • Needs to be a house, villa, home unit, townhouse, duplex or vacant land.
    • Must have direct vehicle access.
    • must have at least 50 square meters area (or 40 square meters for high-demand areas).

Some lenders require a valuation of the property, while others might not. The lender’s system will determine what type of valuation needs to be ordered. 

Loan to Value Ration (LVR or LTV)

When you try to figure out if you qualify for a mortgage loan, you need to know one thing. The highest amount any lender will give you is limited to a certain fraction of the property valuation. LVRs may vary by product, loan purpose and the location of the security. The maximum base LVR is 95% or up to 97% including capitalized Loan Mortgage Insurance (LMI). To learn more about how LVR (sometimes referred to as LTV) head on here.

What’s next in your qualify for mortgage loan journey?

Now that you read this article, you might not be a mortgage loan expert just yet. But you definitely are in a better position to have your first chat about your loan with a bank rep or a mortgage broker. And if you hang out more on our website, you will surely find more articles related to getting your first mortgage loan, such as this one that helps you calculate the amount of money you can borrow.