What Is a Mortgage and How Do They Work?
A mortgage is a loan, just like a car loan or a personal loan, that you take out in order to buy property or land. The amount of money that you borrow is much larger than for a car or personal loan, so most mortgages will have a term of around 25 years.
During this time, you’ll make payments on the loan until you have repaid the money that you have borrowed.
‘Mortgage’ is an old French word that was adopted into late middle English. It literally means ‘dead’ (mort) ‘pledge’ (gage).
This refers to the fact that the pledge - the security of the land title pledged to bank during the loan term - ends when the loan is repaid. At this point, the security the lender has registered over the property is released.
Usually, you’ll provide a deposit towards the purchase price of your new home. The lender will then supply the difference between your deposit and the purchase price.
The amount of money that you borrow is the principle of the mortgage. Having a larger deposit give you access to a wider range of home loan products with different features, and also means that you can access lower interest rates.
If you need to borrow more than 80% of the purchase price of the property, you’ll need to pay Lender’s Mortgage Insurance to provide the security for your lender in the place of the equity you would purchase in your new home if you had a larger deposit.
The equity in your home is the amount that you own - that you have paid for with your deposit or paid back through repayments on the mortgage.
When you take out a mortgage, the lender registers the mortgage with the title to the property until the home loan is repaid. Once you pay out the mortgage in full, the lender removes the mortgage from the title registration. You then own 100% of the property.
How Does a Mortgage Work?
The home loan or mortgage is secured against the property that you are using it to purchase. If you can’t make the mortgage repayments when they are due, the lender can sell the property in order to recover the money owing on the loan.
Just like a car loan or a personal loan, you are charged a fee for access to the money you’ve borrowed. This is expressed as a percentage of the total amount borrowed, and is referred to as 'ínterest'.
The ‘principle’ is the total amount of money that you owe to the lender. The amount of interest that you repay with each payment will depend on the total amount you have left to pay back, and on the rate that your lender sets based on the cash rate set by the Reserve Bank of Australia.
Depending on the type and structure of your mortgage, you may repay only the interest, or both the interest and the principle. You can read more about different types of home loans to find out what your options could be.
If you pay back only the interest on the loan, the principal on the loan will be repaid to the lender when the property is sold.
If you’re repaying both interest and principle, in the early years most of your payment will go towards interest, with a small part of reducing the principal or loan balance. As time passes a greater proportion of your repayments will go towards reducing the balance of the loan, so that at the end of the loan term, you will have repaid the full amount of the loan.
If you want to reduce the amount of interest (the costs of borrowing the loan money) you can make extra repayments in order to pay back the loan sooner. Even $200 per month extra can make a big difference to the amount of interest that you’ll pay over the lifetime of the loan.
How do you apply for a Mortgage?
You can apply for a mortgage with a bank or another home loan lender. You can also apply for a mortgage with a mortgage broker.
There are some advantages to at least speaking to a mortgage broker, even if you decide to get your home loan from your local bank. A mortgage broker can compare mortgages from a spectrum of home loan lenders.
They may find a suitable loan that isn't offered through retail home lending, and they can quickly and easily present the options that are available to you with an explanation of the benefits and features of each option. There's no obligation to arrange a mortgage with them, so if you decide to go through your bank, you'll have the peace of mind that you've researched all the options and found the best value.
When you are ready to apply for a mortgage, you will be asked a range of questions about your financial situation and the purpose of the purchase - whether it’s your first home, an investment, or land you intend to build on.
To complete a mortgage pre-approval you will need:
- proof of income (payslips, BAS statements, ATO Tax Return Statement)
- proof of 3 months worth of genuine savings
- Residential history
- employment history
- details of any loans or credit cards you might have
- proof of identity
If you don’t have much of a credit history, you might consider taking out a small credit card, and make sure it’s paid off at the end of every month.
If you do go to a mortgage broker, then they will perform a credit check before they do the loan application, with creating a hit on your credit file. With this information, they can make sure that they will only put you forward for a mortgage that you should be eligible for.
It’s a good idea to find out what your credit score is before you apply for a home loan - if there’s any issue with your credit file, you’ll have an opportunity to repair it before you apply, giving you a better home loan options.
Having a clean credit record, steady savings history and stable residential history will put you in a stronger negotiating position and give you access to better rates and a wider range of loan features.
A mortgage pre-approval will make it easier when you are ready to make an offer on a property. It shows the vendor that you can definitely afford the property and you are seriously interested.