The very basic guide to home loans
Confused? Nervous? Start with the home loan basics. And if you're unsure how a home loan works, don't worry. You're not alone.
A home loan - sometimes called a mortgage - is simply a long-term loan. You get one through a bank, credit union or other financial institution. Although it is likely to be the biggest loan you ever have, it is designed to be paid off slowly through manageable monthly or fortnightly repayments.
You choose how long you need to pay off the loan. Terms of 30, 25 and 20 years are most common. The lender will use your house as collateral against the loan.
How a home loan works
A home loan is made up of principal and interest. Principal is the amount you borrow. Interest is what you pay to borrow the money. At the start of the loan, your repayments largely consist of interest, with a small amount going towards the principal. As you reduce the principal, your interest charges fall until eventually the loan is paid off.
Case Study: If you took out a $100,000 loan at seven per cent over 25 years, you would end up paying a total of $212,100: $112,100 in interest plus the $100,000 principal.
What's in it for the lender
Home loan lending is the core activity of many banks and financial institutions. They make their money from:
- Interest on the loan
- Loan establishment fees
- Ongoing fees and charges
These charges reflect the cost of money as set by the Reserve Bank, the risk associated with the home loan, the cost of administering it and the need for all businesses to make a reasonable profit.
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