Home Loans Guide
Congratulations on making the decision to purchase a home loan! Whether you are a first home buyer or are purchasing a home for investment purposes, choosing the right mortgage is a major life-changing decision that shouldn’t be taken lightly.
As a result, RateCity has put together a home loans guide which runs through what you will need to consider when purchasing a mortgage and hopefully save you some money in the process.
What to consider when choosing a home loan
- Home Loans Guide
1. Loan amount
Working out how much you should borrow is very important because you don’t want to take the risk of under borrowing and limiting yourself on what you can purchase. You also want to avoid over borrowing as it will lead to higher interest and repayments.
When working out how much you should borrow the general rule of thumb is that your total 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
First of all you need to establish why you require the loan in the first place. Your motivation for acquiring the loan will affect your decision. There are certain features you may need and particular lenders might be best to service these requirements.
Do you require the 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
This is the big question that most borrowers face when deciding on their home loan, whether to choose a fixed or variable interest rate. So how do you know which type of loan is best for you? We list 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. Fixing also allows you to budget more accurately while the repayments are stable.
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 – A low doc or low documentation loan are types of loans available 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. This type of loan is great for people that own a business and can’t provide the usual required documentation to prove a steady income.
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’. They can be seen as higher risk to lenders, so they may ask you to provide other assets such as your car as 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?
The minimum deposit required will depend on the type of loan and the financial institution.
As a general rule of thumb, it is recommended that you should save approximately 20 percent of the value of the property that you wish to purchase. The bigger deposit you save the better your application will look to your lender, and the less you will need to borrow.
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.
5. Loan features
The next step is to consider what types of features and services you need from a mortgage. Ask yourself, do you want to pay the interest only or both? Do you want to be able to make additional payments without being charged? Do you want a home loan package? A split option, mortgage portability, or a 100 percent mortgage offset facility? You will need to consider all of these options when deciding what features you want. See below for a checklist of some common loan features:
- 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.
- Split option – Have part of your interest fixed and the other part variable.
6. What to consider before applying for a home loan
Before you apply for a mortgage, here is a list of things that you should consider to make sure you are set up to get the best deal possible for your needs:
- As a rule of thumb your loan repayments should be no more than 30 percent of your income
- 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
- 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
- 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
- You are aware of all the fees, charges and ongoing costs
- You’ve accounted for other costs incurred in purchasing a home, such as lenders mortgage insurance (LMI) and stamp duty
- You have read and understand the product disclosure statement.
7. Checklist of costs involved
When it comes to mortgages there are various costs involved in addition to the application fees. Below is a checklist that you can use to find out some of the fees and charges associated with home loans you are interested in. Before you take out a mortgage it is important that you are aware of these fees and charges, this way you can include them in your calculations and plans so you won’t be hit with a nasty surprise at settlement.
- 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.