Firstly, I know this is very unusual for me (and DCE in general) but I have to give a disclaimer! This article is general in nature and does not take into account your personal financial situation. For personalised information go see someone who sells loans and is qualified to talk to you about them…like me haha. Anyway.. every day I meet people and help them get loans and more often than not they have no idea how they work, or what is involved. This is a very brief snapshot into the mystical world of Banks and lending…
So in the average persons life you are likely to come across a few different types of loans and lending. Most easily they are divided into:
- Mortgages – Secured loans (things that the lender takes security over while you pay them off) – most commonly home loans
- Personal Loans – Can be secured or unsecured but for this article, I’ll focus on secured.
- Credit Cards – A different type of unsecured loan, often referred to as evil and the most likely to get you in trouble.
The Big Ones – Home Loans
So firstly (and most complexly) are home loans. No awards for guessing what these are for.. Every lender will be different and have different policies, but the core products are similar. Basically, you borrow the money to buy a house, the bank lends you that money then charges you interest on it while you pay them back. You’ll need a deposit, and how much deposit you have usually dictates what kind of loan you can get and what fees are involved. LVR is loan to value ratio. You’ll hear that thrown around a lot. Basically it’s the percentage of the value of your property that the loan pays for.. really simply if your house is worth $100,000 and your loan is $50,000 the LVR is 50%. To avoid extra costs you want to aim for an 80% LVR (20% deposit).
Most loans are set up initially over a 25 or 30 year term which gives your your minimum payment amount. Interest is generally calculated daily and added monthly, so basically each day they work out how much you owe them and add it up. Again, really simply, if you have a $100,000 loan at 5% interest, you pay $5,000 a year or $13 per day in interest. This then gets added to the balance of the loan as you pay it down. You might hear the term ‘principle and interest’ which means you are paying off the minimum payment plus interest. After one year your would owe approx $98,500 after interest. Some investors will pay ‘interest only’ which means you’d just pay the $13 per day. This means at the end of a year you’d still owe the $100,000 and will have just paid interest.
The Medium Ones – Personal Loans
A car is generally the second biggest-ticket purchase anyone makes (not including boats/caravans etc). Because of this, a lot of people borrow money for them. A secured car loan is essentially a small home loan just with a different security (called a goods security agreement instead of a mortgage). Concept is the same, the financier takes security over the car while you pay them back. Again all different lenders will have different policies but you don’t generally need a 20% deposit to avoid extra costs. Interest should be worked out the same way but the loan term is more likely to be 4-7 years instead of 25-30.
The Tricky Tricksters – Credit Cards
Credit cards are unsecured loans and are generally pretty easy to obtain. While I see their value in some circumstances, lots of people get themselves into trouble with them. Interest rates can vary from 10-25% depending on the card, and if you don’t keep on top of them they can cause you pretty serious issues. That being said they do have perks, some have frequent flyer or bonus points, just be mindful that often you need a lot more ‘points’ to buy an item than if you just paid for it outright.
A lot have a ’55 day interest free period’ which is ‘up to’ 55 days. To be safe, just pay it off every month.
There are a few pretty nifty strategies to gain points and use your credit card for daily purchases, the key is to pay it off in full every month to avoid extra fees and charges. Maybe speak to an accountant of financial planner if you want some expert advice…
So being realistic..if you haven’t already been exposed to some kind of lending in your life, chances are you will. Be smart with it, not everyone that tries to help you is going to have your best interests at heart. Where you can (and not be charged for it) make as many extra payments as possible. Fast forward 30 years into your home loan, and if you have been making minimum payments only, you have basically paid off the initial loan twice! $100,000 over 30 years at 5% you end up paying a total of $193,000. The key is to try and make regular extra payments as often as possible. As little as an extra $20 per week could save you $25,000 in interest!! A little bit goes a really long way.
Be very aware of application and ongoing fees, just because someone advertises a 0% interest rate, doesn’t mean you actually pay 0%! Ask for a comparison rate and if that isn’t 0%, you’re paying interest somewhere. For more info on what a comparison rate is, read the small print haha.
Also in my experience, anyone (who isn’t a qualified accountant or financial planner) that is overly keen to tell you what you should do or how to do it, is probably full of shit. My opinion only.