Home Loans Guide
Congratulations you have just landed on the home loan Holy Grail! Whether you're a first home buyer, refinancing your home loan or purchasing an investment property, we understand that at times comparing and understanding home loan information can feel like trying to decipher Morse code.
With this in mind we’ve tackled the home loan process head-on and narrowed down the key points you should consider before applying for a loan.
What to consider when choosing a home loan
1. Loan amount
It’s important to seek the advice of lenders but where money is involved, there is only one person who knows what’s best for you – you! Working out the loan amount is an important first step towards home ownership so it’s imperative to work out how little or how much you can comfortably afford to borrow. The loan amount will dictate your regular mortgage repayments so it’s important you don’t borrow more than you can afford to pay off regularly.
To work out what repayments are affordable, begin by assessing your income and expenses. Once you have a handle on this, you should take into account any changes that might affect your income stream in the future, factor in interest rates rises and consider the type of lifestyle you want to live while paying off your home loan. As a general rule of thumb, your total mortgage repayments should be no more than 30 percent of your total income. Also, leave a buffer of around two percent to protect yourself in case interest rates increase.
2. Loan purpose
It sounds obvious but the first thing you need to establish is why you require the loan. The answer to this question will steer you down the right path to finding your ideal home loan. The reason for this is there are certain features you may need depending on the purpose of your desired loan and particular lenders who will be able to better tailor to your needs.
Is the purpose of your loan to:
Live in the property - This is for anyone including first home buyers that will reside in the property they wish to purchase.
Purchase an investment property - If you plan on purchasing a property to rent out or renovate and sell, then you may need to apply for an investment loan.
Line of credit - A line of credit allows you to access the equity in your home and use that money for whatever you like, from a holiday or renovations.
Reverse mortgage - If you are over 60-years-old, then you may be interested in a reverse mortgage. If you own your own home, this type of loan allows you to borrow money against the equity in your home and use as you desire.
3. Loan type
Borrowers experience many emotions when buying a home. Most of them are positive but one of the most common emotions is also fear. Fear of selecting the wrong home loan type is a common concern for most. So how do you know which type of loan is best for you?
We’ve tried to take some pressure off your shoulders by laying out some pros and cons for all loan types to help with your decision.
Pros – Fixing your interest rate guarantees that your repayments will remain the same for a set period of time (usually from one to 10 years) and gives you protection against rate rises. The upside is that it will allow you to budget more accurately as your regular repayments will remain the same, instead of fluctuating with rate rises and declines.
Cons – If interest rates decline, you will miss out on the savings because your rate will not change. Fixed rates are also usually higher than variable rates because you are paying for the security that your rate won’t move for the set period of time.
Pros – Variable rates generally follow the Reserve Bank of Australia’s official cash rate. If the cash rate falls, your variable rate is likely to decrease and so will your repayments. Variable interest rates are also generally lower than fixed rates.
Cons - If interest rates rise, so will your repayments. Variable rate loans are harder to budget for as your repayments may differ from month to month depending on whether your lender increases or decreases your rate.
Pros – Do you own a business or have you just started a new job? A low documentation (low doc) home loan is designed for people who can’t provide the usual paperwork required when applying for a loan. Usually you don’t have to provide pay slips and tax returns however you must state your income and you must be able to prove that you can meet the repayments.
Cons – Usually with this type of loan the interest rate is higher than regular home loans. You may also be charged additional fees such as ‘risk fees’. Low doc loans are considered a higher risk loan for lenders so they may ask you to provide other assets, such as your car, for security against the loan.
Pros – This type of loan offers a lower interest rate for a specific amount of time, usually the first year. Targeted at first home buyers who are inexperienced in paying off a mortgage, intro loans can be used as a great way to ease them into the home loan market. Depending on the lender, you can usually choose between a fixed or variable interest rate at a reduced rate for a certain period.
Cons – After the introductory period ends, the interest rate reverts to a higher interest rate, which may not be the best deal on the market. You could therefore end up paying a lot more in interest over the entire loan term than if you chose a cheaper deal to begin with.
4. How much of a deposit is needed?
Saving for a home loan deposit and knowing how much to save is the first big hurdle home buyers face. The minimum deposit required will depend on the type of loan and the financial institution but there is an industry standard you should try to comply to.
In Australia it is recommended that you should save approximately 20 percent of the value of the property that you wish to purchase.
Although you may find a home loan lender willing to accept less than 20 percent, you will save a substantial amount of money by saving a larger deposit. Put simply, the bigger the deposit, the less you need to borrow and less you pay in interest. Plus, your application will look more attractive to your lender.
Home loans also require a maximum loan-to-value ratio (LVR) which is the amount of money you can borrow as a percentage of the value of the property. For example, if the loan had an LVR of 90 percent, you will need to save at least 10 percent as a deposit. So if you wanted to purchase a property valued at $300,000, you will need to outlay a minimum of $30,000.
The downfall of saving less than a 20 percent deposit is that you may be stung with lenders mortgage insurance.
Lenders mortgage insurance (LMI) is a security cost which is required if you want to borrow more than 80% for a standard loan.
LMI is calculated based on the loan amount and the loan value to ratio (LVR), the higher the loan to value ratio, the higher the risk to the lender and the more you will pay for LMI.
5. Loan features
When you begin your search for a home loan there is a lot to take into consideration. It's not simply about finding the cheapest home loan rate, although this will play into your final decision, it’s about finding a loan with the right features.
We've put together a list of the most important home loan features and services to help you choose the right home loan for you.
- Redraw facility – This allows you to access extra money you have added to your mortgage.
- Additional repayments – Whether you are able to make extra repayments on a regular basis.
- Lump sum repayments – If you can make bulk payments on an ad hoc basis.
- Mortgage offset – A transaction account linked to your mortgage whereby the balance of the transaction account is offset against the unpaid balance of your loan to reduce the amount of interest payable. If it is 100 percent offset, it means that you are allowed to hold the entire sum of the loan amount in your linked transaction account.
- Mortgage Portability – Allows you to transfer your loan from your current home to a different property. This can sometimes reduce fees including establishment of a new loan.
- Interest only – If you are purchasing an investment property you may want to consider an interest only loan.
- Split option – Have part of your interest fixed and the other part variable.
6. What to consider before applying for a home loan
Want to know an easier way to spot a great home loan deal without having to study economics? Here is a list of things you should consider in order to get the best possible home loan for your needs.
- Repayments: As a rule of thumb your loan repayments should be no more than 30 percent of your income.
- Flexibility: When calculating how much you can afford to make in repayments, ensure that you allow for at least a 2 percent buffer for rate increases and changes to your financial circumstances.
- Deposit: You have saved a deposit and can show a proven savings history of at least three-six months by either depositing money into a linked savings account on a regular basis (at least once a month) or increasing your balance in your transaction account. Most loans require a deposit of at least 5 percent and you will also need to save for establishment fees and other upfront charges.
- Documentation: You have copies of all documentation required, such as pay slips to prove your income, bank statements to show your savings, bills or rental receipts to prove your credit history and identification.
- Fees and Charges: Do your homework so there are no expensive surprises. Be aware of all the fees, charges and ongoing costs.
- Extra Costs: You’ve accounted for other costs incurred in purchasing a home, such as lenders mortgage insurance (LMI) and stamp duty.
- Fine Print: You have read and understand the product disclosure statement.
7. Fees and charges checklist
When you begin an initial home loan hunt it can feel like a surprise party of added extras have come to meet you. No one likes hidden costs and this can make budgeting very difficult if you haven’t factored in all the fees and charges.
To avoid any nasty surprises we have prepared a list for you that details some of the fees and charges associated with home loans.
- Application fee/up-front cost
- Ongoing fee
- Additional repayment fee
- Late payment fee
- Break costs and exit fees
- Mortgage discharge fee
- Redraw fee
- Re-fix fee
- Switching fee
- Portability fee
8. Star Ratings
CANSTAR star ratings are a consumer-friendly benchmark that help you compare financial products based on their rates and features. We evaluate literally thousands of products from hundreds of finance institutions. Products offering superior value are awarded five stars.
Only the top 5% to 10% of products scored using the CANSTAR star ratings methodology are awarded the prestigious five star status. As a consumer, this is your guarantee of a high-performance product.
For more information on Star Ratings, check out our Star Ratings page
Now that you have determined your needs and loan features, you are ready to start shopping.
One of the most effective ways to find a great value mortgage is by comparing home loans online. This way you can search in your own time, in your own space and it’s very straight forward and simple to use. RateCity has setup a great system, so all you have to do is enter in details such as the reason for the loan, type of rate you want and the required loan amount and the search results will appear relevant to your needs. You can then refine your search further by comparing selected loans that best suit you. If you find a mortgage that you want, you can also apply online.