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Choosing the right home loan is one of the most important decisions a home buyer will make. With interest rates rising again in June as part of the Reserve Bank’s efforts to curb inflation, it is more important than ever to find the right loan. A home loan is a long-term debt, so even a small difference in the interest rate will add up over time.
There is a lot to consider when hunting for the best home loan rate. A top priority should be avoiding mortgage stress, which is when a household is spending more than 30% of pre-tax income on home loan repayments. The consequence of defaulting on a mortgage is serious. Along with incurring significant financial penalties, there is the possibility of losing the roof over your head and not being permitted to obtain another mortgage for several years.
For some people, a flexible loan that allows for faster repayments is important because the savings can be substantial. Peace of mind is also important, but these kinds of “extras” all come at a price. Weigh up whether these bells and whistles are worth the additional costs and always keep interest rates front of mind.
In the past the big four banks in Australia — ANZ, Commonwealth, NAB, and Westpac dominated the home loan landscape, but now the field is awash with a range of lenders, including online lenders Athena and Nano.
The ideal deposit is 20% of the total value of the home, because a lower amount typically requires Lenders Mortgage Insurance (LMI) to be taken out, and this increases total repayment costs.
It’s possible to obtain a loan with a smaller deposit, but this will increase the amount of interest to be repaid, and monthly repayments may be higher as well. Most lenders use a loan to value (LVR) calculation to determine the amount they are willing to lend. LVR is the amount of the loan as compared with the bank’s valuation of the purchased property. It is expressed as a percentage. If the bank is lending more than 80% LVR, the borrower will generally need Lenders Mortgage Insurance.
Make use of the Government’s MoneySmart home loan calculator to work out your LVR.
The First Home Owner Grant scheme is designed to help people get a foot onto the property ladder. It is a national scheme, but it is funded by the states and territories and each has its own set of eligibility rules and grant size, as outlined below:
Buying a house is a huge commitment that requires ongoing discipline to repay the mortgage. Saving for a deposit also takes time and most people find that having automatic deductions from their weekly or monthly pay into a separate savings account can help them save.
Once the savings have hit the target goal for the deposit, it is time to apply for loan pre-approval. This means that a lender has agreed, in principle, to lend a specific amount of money towards the purchase of a home. It isn’t full or final approval, but it provides a strong indication of the maximum available funds you can borrow.
It is an exciting part of the process that can also be useful in refining the search and being able to bid with confidence at an auction.
There are three types of home loans: basic, standard and package.
There are many different ways a homebuyer can structure the loan, depending on his or her needs:
As the name suggests, with principal and interest loans your monthly repayments go towards both the interest on the loan as well as the principal, which is the loan amount. Generally speaking, making extra payments toward the principal balance will make it possible to pay off the loan more quickly and reduce the overall cost of the loan.
A P&I loan is often the preferred approach of owner-occupiers, who want to be mortgage-free as soon as possible.
For an initial period, usually the first two years, your mortgage repayments will cover just the interest on the amount borrowed. This means that the debt is not reduced, you are merely chipping away at the interest. While repayments may be lower during the interest-only period, they will inevitably rise, so it is important to make sure that the loan will still be affordable once the interest-only period expires and you are paying off both the interest and the principal.
Many property investors take out interest-only loans because they don’t intend to pay off the home loan entirely. Instead, they flip the property for a profit in a few years’ time. This is, of course, a risky strategy that is entirely dependent on the property market rising year after year.
This is a home loan with an interest rate that fluctuates over time, usually as the RBA raises and lowers the official cash rate.
Pros of variable interest rates:
Cons of variable interest rates:
A fixed home loan is one that is set in stone for a fixed period of time. Knowing the exact amount of your repayments makes it possible to budget with certainty as homeowners will not be affected by RBA interest rate rises. The downside is not being able to benefit if rates fall.
Pros of fixing the rate:
Cons of fixing the rate:
An alternative to making the difficult choice between a fixed interest rate or a variable interest rate is the split loan, also known as the partly-fixed loan. Splitting the home loan is possible at any point during the life of the loan, and it means that a portion of the loan is set at a fixed interest rate and the remainder is variable.
There is a range of features to consider when comparing home loans, but among the most important are:
An interest rate is the fee charged for borrowing money of a lender. It is expressed as a percentage of the total loan figure and the goal is to secure the lowest possible interest rate that you can.
A comparison rate includes the interest rate as well as all the fees and charges associated with the loan being administered. The comparison rate provides a picture of the true cost of the loan to the borrower, and can be viewed as a more accurate interest rate in terms of the cost to you. The smaller the difference, therefore, between the comparison rate and the advertised interest rate, the better the deal, generally speaking.
This is the amount of money that you will need to pay to the financial institution or the bank each month. Spending more than 30% of pre-tax income on your home loan repayments may plunge a house into financial stress so aim for less than this amount.
If the home loan is tied to special discounts under a package home loan, the lender may charge an annual fee. Be sure that you are comfortable with this amount.
It is also a good idea to investigate what additional features you may benefit from, such as an offset account where salary and savings can be deposited to reduce the amount owing on the home loan, as well as whether you can make additional repayments without incurring a fee.
Equally, you may wish to look into whether the loan includes the option of a repayment holiday that allows home loan repayments to be paused during a period when it would be difficult to make them, such as job changes or a short-term injury. During the Covid-19 lockdowns, many banks offered repayment pauses to customers who needed it.
The term of a loan is typically 25 years or 30 years. Those five years can make a big difference to the amount that needs to be repaid every month. While it may seem advantageous to pay less each month, in the long run it actually adds up to more because you end up paying more in interest.
Choose the shortest loan possible without causing financial stress. That may be 15 years or it could be 25.
Perhaps one of the best tools in your home loan arsenal is a calculator, which will help you determine how much you can borrow, what your repayments will be and the difference paying off a little extra each month will have on your loan.
Visit the Federal Government’s Moneysmart site for their dedicated home loan calculators.
Fees that may seem small at the time of buying a property will add up over the lifetime of the loan, so make sure you’re aware of the true cost of all the fees. Some of the most common mortgage fees include:
A refinancer is someone who switches from one home loan to another. It could be a completely new lender or the same one, and the savings made can be substantial. It is worthwhile keeping an eye out for better options, because the home loan market is constantly evolving its products and features, and often offers a better deal to new customers than existing ones. It’s also important to ensure you’re not paying for loan features you don’t use.
There are many different reasons to refinance a home loan. It may simply be a way of taking advantage of a more competitive rate, or it may be to swap from a fixed to a variable rate, or to borrow more money to make home renovations.
ASIC offers some expert guidance on how to switch lenders, but before you do, it’s always worth contacting your lender and asking for them to lower the rate or match an introductory rate. You can make it clear that you are looking to refinance and ask the lending department for their best rate. They may be prepared to meet your needs rather than lose a valuable customer.
A person who is self-employed can obtain a loan by proving the stability of their income to a lender. Consistency in earning is sought by prospective lenders, who will require one or two years of tax returns and profit and loss statements to prove you have a solid financial track record. Be aware that a bank will be looking at your net income after deductions and expenses have been taken into account, not your overall revenue.
An offset is like having an accessible, high-interest savings account. Essentially, it is a transaction bank account that is linked to the home loan, and the amount in this savings account is deducted from the remaining principal before interest is calculated each month. For example, if you have a home loan of $300,000 and $30,000 in your offset account; in this situation, you’ll only be charged interest on a loan balance of $270,000. This allows money to be saved on interest without physically paying the funds into the loan itself. The good news is that you can access this money at any time, although the more money you have in the offset, the lower the amount of the loan you need to pay interest opn.
This is a question that only your bank or lender can determine according to their criteria. When deciding on a customer’s borrowing power banks take a number of factors into consideration, including the size of your deposit, income and employment, credit history and any debts, your monthly expenses and outgoings, as well as any assets you have. A mortgage broker can help you through this process, but make sure you check how many lenders they have access to and how they are remunerated by each lender. To get a rough guide to your borrowing power, you can try the Moneysmart site’s calculator as a starting point.
Thousands of dollars in interest can be saved by making extra payments on the principal loan balance each month. It helps to build equity faster and makes it possible to tackle other debts. Ideally, check that your loan allows you to make extra repayments before you sign on the dotted line.
Once you are ready to get the ball rolling on your home loan, you can take one of two paths: a mortgage broker or directly via a bank (either online or at the branch). There is no right or wrong way to apply, however, if you’re unsure of the documentation and would like someone to help you, then a mortgage broker could be the way to go. Be aware though that brokers are paid by lenders once you have signed on the dotted line so make sure you are offered a range of lending options and ask your broker whether he or she is paid the same commission for each loan.
Ideally? As much as possible. Australia has one of the highest levels of mortgage debt in the world, owing to our expensive real estate market, so the less debt you can take on the better. Lenders generally recommend a deposit of 20%, which is no small sum considering the prices of property in Australia.
With so many important decisions to make and a wide variety of lending options available, a mortgage broker can be a helpful advisor. They are required by law to act in the borrower’s best interests when making recommendations. Brokers are often paid by a fee or commission by the lender. Most often but not always, the buyer does not pay the broker anything. Some brokers receive a standard fee regardless of the loan that is recommended. Others get a higher fee for suggesting a certain loan. Some are employed by large brokering companies, such as AFG Home Loans and Aussie. The Financial Services Royal Commission recommended that broker commissions be scrapped, however the government did not adopt the measure and prior to winning government, Labor stated it would not scrap commissions either. Like everything related to getting a mortgage, it pays to shop around for a broker. And don’t be afraid to ask how they will be paid by the lender.
Investor loans are used by property investors, including mum and dad investors, to buy land, houses, apartments or commercial property. Income is earned through rent, but interest and property-related costs must be paid, such as council rates. The interest rates for investor loans are often higher than standard variable loans to owner-occupiers, and the criteria is often much tighter to be approved as the loans are considered to be much higher risk.
A bridging loan allows you to finance the purchase of a new property, while you await the sale of your current one. Think of it as a line of credit, hence the term bridge, that enables you to cover the gap of time between buying and selling. The loan is generally around six months for existing properties, but could be as long as 12 months if you are purchasing a new property. Bridging loans are not immediate: lenders will want plenty of evidence that you can re-pay the interest in the bridging loan and, therefore, you will need a healthy level of equity, potentially 50%, to qualify.