So, it has finally come. Crunch time. You have made the decision to use those savings for a down payment on a property. But now you must crunch the numbers. You will need a mortgage, but what can you afford? Is the most competitive rate suitable for your situation? Entering the world of home loans can be foreign and intimidating. Here we try to break down how to compare mortgage loans for you.
The best way to analyse home loans is to get key fact sheets from different lenders. A key fact sheet will give you the information you need in a set layout. It will tell you the total amount to be paid back over the life of the loan, including the repayment amounts, fees, and charges. It will also give you an individualised comparison rate that will assist you to measure the total cost of a loan compared to other loans. If you ask for a key fact sheet for a home loan, credit providers must give you one – unless you choose an interest-only or a line of credit loan.
You must consider many aspects before choosing a home loan. To get you started, below are some of the different ways you can compare them:
1. Compare Interest rate
‘Fixed’ and ‘variable’ and are the two interest rate options that lenders offer:
The interest rate on your loan will stay unchanged for the fixed period of one to five years, after which your loan will go back to a variable rate.
The interest rate on your loan may go up or go down, usually following a change in the official cash rate. However, lenders may make changes independently.
2. Repayment type
There are two loan options with regard to repayment type:
With this, you make regular payments against the amount borrowed (the principle), as well as pay interest. This loan is intended to be repaid in full over its term – 25 or 30 years.
Your repayment amount will only cover the interest. The principal amount you borrowed will not decrease except if you make extra repayments. However, going interest-only may cost you more in the long run.
3. Loan features
Carefully think about what features you actually need in a loan. If a loan has many components, it may have a higher interest rate or product fee. The following features can be valuable, but may cost you more:
Split rate option
The split rate option is where one part of your loan is fixed, and another part is variable. A split mortgage lets you to manage the risk of interest rate fluctuations during times of economic uncertainty with its fixed component while taking advantage of depreciating rates with the variable rate.
This is a savings account tied to your home loan. Your account balance is reduced from the amount you owe on your loan, lowering the amount of interest you pay. You must be prudent when calculating the probability of the advantage of an offset account. For example, the additional payments you may have to make if the balance of your offset account is low may outweigh any benefits you get from having it.
A redraw lets you to pay extra money into your loan that you can withdraw later if you need it. The extra money reduces your loan balance, which reduces the interest you pay. Lenders may enforce a fee or conditions for redrawing funds, so confirm what conditions and charges apply to your loan. Your loan is operating with a redraw facility if it grants you to have your whole pay credit to the loan account and pay bills or use EFTPOS to withdraw funds.
Some loans offer a repayment holiday for a short period of time – usually around six months. Sometimes you can only use this feature if you have made extra repayments, so check the conditions or you might have to make higher repayments after the repayment holiday to make up for it.
This feature makes your loan portable. You can transfer your existing loan from one property to another, helping a lender keep you as a customer and for you to save money on exit fees and application fees. Loan portability also allows you to keep loan features such as the interest rate and online banking by keeping the same lender and loan structure.
However, to transfer your loan from one property to another, both your sale and purchase properties must settle on the same day – a difficult thing to organise.
Most of the time portability is only a feature of variable rate loans. Check with your lender If you have a fixed rate loan, as they will probably involve break costs. Each lender has particular rules about loan portability, so make sure you understand them on whichever loan that you are considering. We also recommend that you also find out if there are more competitive loans on the market from other lenders.
4. Loan type
Now you will need to choose the home loan that will work best for you. You can choose from one of the following:
This is, as the name suggests, a basic, no-nonsense loan with a handful of features and a low interest rate. This loan may not suit you if you want a redraw facility that allows you to make extra repayments and access them later.
A standard loan offers more flexibility than a basic loan. For example, it has a redraw facility, it allows you to change over to a fixed rate, and it may give you the option to split the loan into fixed and variable portions. Most of the time, this loan also comes with a 100% offset account.
Home loan package
This is a standard loan that, depending on your loan amount, offers an interest rate discount of up to 1.2%. This can be cheaper than many basic loans. The package usually comes with a free transaction account and no annual credit card fee. However, up to $400 of package fees per year apply.
Line of credit loan
You can only spend up to a set credit limit with a line of credit loan. Normally, your wages will be paid into the account, as well as going towards your bills and other expenses. Appealingly, the credit limit is fixed and does not reduce as you repay the loan. Eventually, you will have to repay the loan in full by a specified date, which you will need to plan for. This type of loan suits someone who is disciplined and budgets carefully rather than someone who may have an irregular income.
This loan may be used to manage the shift between buying and selling properties. A bridging loan is typically used by people who buy a new house before selling their existing one. After assessing the capital available in your existing house, lenders may offer one of two types of bridging loans:
- A single loan taking both properties like a security deposit. They will give you a bridging period – six months to a year – for you to sell your existing property. You will only have to make interest payments during this period. Once the first house is sold, the earnings are put towards your overall debt and both this and the balance will either return to a principal-and-interest loan or a new loan will have to be entered into.
- The other is a separate loan that you will not need to make repayments on during the bridging period for the property being purchased. Interest will accumulate on the new loan, and you will still make the normal repayments on your existing home loan. When your existing property is sold and the original home loan is paid, you will need to renegotiate the outstanding debt on the new property.
Keep in mind when taking out a bridging loan: if you do not sell your existing property within the bridging period, you may have to take a price lower than the one you expected, leaving you with a larger end debt to repay.
You may need a construction loan if you are building a new house. With this type of loan, you can withdraw funds whenever you receive bills from tradespeople and suppliers. You will only pay interest on the funds you have used. Most lenders offer construction loans at a variable interest rate. The loan will revert to principal and interest repayments as soon as the construction is finished.
A plan, permits, and a fixed-price building contract are often required for the approval of a construction loan. If you are a building owner, it might be possible to apply for this loan without a fixed-price contract, but the lender requirements might be stricter and the loan amount less. You can obtain more information on building a home from your state’s fair trading or consumer protection agency.