Why home loans are like jeans & how to choose the right one in 4 simple steps
Looking for a home loan can be a pretty overwhelming process – there are so many choices out there and everyone seems to have an opinion on what you should be focussing on. Perhaps the most important thing to remember in the homebuying process is that home loans are like jeans, one size does not fit all, and you should shop around to find the right fit for you.
Buying a home or investment property is probably one of the biggest purchases you’ll make in your life, and in most situations people undertake the homebuying process all backwards. All their effort goes into trawling real estate websites and traipsing to open homes for months until finally finding the perfect property, only to have the loan they need to fund their purchase be a rushed after-thought. However, by spending time finding the right loan before you even locate your dream home, you could not only save money, but also understand the debt you’re taking on and make your loan structure work for you and your needs.
With a little research, finding the right home loan is more straight forward than you might think, there are 4 key steps to undertake to help you identify what home loan will work for you:
STEP 1. ASSESS YOUR SITUATION
When it comes to your life and finances, you are the only expert in the field. So, it’s important to assess your situation and needs so you can pick a loan that fits your unique circumstances. Some key factors to consider are:
POTENTIAL HOME COST
Your loan repayments will depend on the cost of the property, which can vary depending on what you’re looking for; a larger family home? Investment apartment to rent out? First home as a new couple? Using an online calculator, like our borrowing power calculator, can be a really useful tool to find out what you can afford.
Your credit history, the amount of deposit you have saved and any existing debt you have can affect your loan options. Take some time to get an overall picture of your financial situation; are you on a single income? Joint income? How much do you need to set aside for other upcoming commitments like a wedding or your kids school fees? Checking your credit score is also important so you know where you stand in the eyes of lenders. Bonus tip: you can check your Experian credit score for free with Credit Savvy right now.
FUTURE LIFE PLANS
Depending on your career or upcoming life events you might hold on to this property for one year or for decades. This might affect the home loan options you should choose, for example the longer you are planning on owning the property the riskier a variable rate loan could be.
STEP 2. CONSIDER THE OPTIONS OPEN TO YOU
Now that you’ve got an idea of your personal situation you’re ready to look at the loan options available to you and decide what features you want.
Generally speaking, the length (or ‘term’) of a home loan can be anywhere from 10-40 years, with 25 and 30 year terms being the most common. Selecting the loan term that is right for you is important because while the longer the term the lower the monthly repayments, conversely the greater the amount of interest you end up paying. Finding the balance that is acceptable to you and your finances is something you should put some thought into.
There are broadly two methods of repayment you can opt for when you take out a home loan:
Principal and interest – This means that your repayments reduce the amount of principal as well as paying off the interest that is amassing on the loan. These can be the smart choice if you are planning on living in the property long term, as the loan is designed to be repaid over the full term of the loan.
Interest only repayments – As the name suggests this means that your repayments only cover the loan interest set by the lender, therefore typically the property would have to be sold to repay the principal amount. Typically, these loans are aimed at investors as it enables them to hang on to a rental property, which over the course of the loan can generate them income or capital gains.
INTEREST RATE TYPES
Variable interest rate – The interest rate on the loan will go up and/or down depending on the changes the lender makes to their rates – typically this will be in line with changes to the official cash rate.
Fixed interest rate – The interest rate on the loan you take out will remain unchanged for the fixed period (usually around 1-5 years) after which your loan will revert to a variable interest rate.
Split loan – This is where a proportion of your loan is variable, and the other part is fixed.
To personalise your loan even further, there may be extra features that you could incorporate for extra flexibility, although be aware that sometimes, extra features can mean extra costs.
LMI (Lender’s Mortgage Insurance) – Traditionally lenders have required a 20% deposit when you apply for a home loan. If this isn’t achievable by the time you want to enter the property market (and depending on your lender) you may want to consider getting LMI in addition to your loan which can allow you to borrow a higher proportion of the property value – thus requiring a smaller deposit up front. Be aware though, LMI comes at a cost and can be several thousands of dollars – usually added to your home loan amount.
Offset account – This is a savings or transaction account that is linked to your home loan. The balance you hold in this account is taken off the amount you owe on your home loan, reducing the amount of interest you pay.
Extra repayments – Making extra repayments on your loan when you can afford it will save you interest and pay your loan down quicker, however some loans will limit the amount of extra payments you can make per year or may charge you fees for making extra payments.
Redraw facility – Having a redraw facility on your loan allows you to pay extra money off your loan when you can afford it and then gives you the option to take out (or redraw) that additional money later if you need it. However, there can be conditions or fees to redraw these funds so make sure you check what charges apply to your loan.
STEP 3. COMPARE LENDERS AND LOANS
Once you’ve assessed your situation and home loan needs and have a feel for the type of loan structure you’re looking for its time to put in some time and start shopping around. You might want to ask your friends or family for recommendations or experiences with lenders that they’ve had, but by far one of the most convenient ways to amass information on what is out there on offer is to use a comparison platform or online marketplace to help you compare interest rates and lenders.
Utilising these comparison platforms gives you insight into what is out there on offer, helps you understand your options and can give you negotiating power. If you have examples of what is on offer from other lenders, you might want to take it to your current bank or lender and see if they can match or beat the offer to retain your business – it never hurts to ask!
If this all seems far too overwhelming you might want to consider using a mortgage broker to help you research and source a home loan that works for you. A broker is an intermediary between you (the borrower) and the lender and can negotiate on your behalf and support you through the application and settlement process. Although a broker’s services are free for you the borrower they do work on a commission per loan paid by the lenders. (Read more about the positives and negatives of banks vs brokers here)
STEP 4. UNDERSTAND ALL THE FEES AND COSTS
When you’re comparing loans and lenders it’s not just about the interest rate and features, it’s important to make sure that you are completely across any fees involved with the loan also so you know exactly how much your loan is going to cost you. Different lenders charge different fees so make sure your lender is completely transparent about any fees you will be charged now (and possibly later), the same fees can also go by different names depending on your lender.
FEES TO ASK ABOUT:
- Establishment fees aka: ‘Application’, ‘up-front’, ‘start-up’ or ‘set-up’ fees – This is a one-off payment when you start your loan.
- Ongoing fees aka: ‘Service’ or ‘administration’ fees – These are fees that are charged monthly or annually for administrating your loan.
- Fees for breaking a fixed rate mortgage aka: ‘Break fee’ – If interest rates come down and you want to break or change your fixed rate loan you may be charged a break fee that could be very high depending on how much interest rates have dropped.
- Early exit fees aka: ‘Early termination’, ‘deferred establishment’, ‘deferred application’ or ‘early discharge’ fees – These may be charged if you pay your home loan off in full within a specified time period (e.g. the first 5 years). There are laws surrounding exit fees on loans now and lenders are not allowed to use them to discourage borrowers from switching lenders, only to recover losses for the lender that can be directly connected to the borrower exiting the loan early.
- Discharge fees aka: ‘Termination’ or ‘settlement’ fees – These may be charged when you pay your home loan out in full.
- Refinancing fees – If you’re looking to refinance your home loan, you can be charged a range of fees by your new lender including some of the above mentioned.
By law there is a limit to the amount of fees you can be charged by a lender (no more than 48% annually), however fees can add thousands of dollars to the average 25 year home loan so it’s important to know what you are in for before you commit to the loan.
Choosing a home loan is a big and complicated decision and involves more than just interest rates if you want to be happy with the fit for you. If you follow these 4 simple steps you should be in a good position to choose a home loan that fits you as well as your favourite pair of jeans.