What type of buyer are you?
It might sound obvious, but understanding what type of buyer you are will help you navigate through the complexities of the home loan market and find the best loan for your needs.
Investor vs. owner occupier
Do you want to buy a property as an investment or as a place to live in? This fundamental question is crucial in selecting both a property and a loan to suit your needs. For example, as an investor you might be looking for an in-demand apartment in a high-growth property area, while if you are an owner-occupier, you’re probably looking for a home in a specific area with features that match your lifestyle. Your lender will also want to know whether you intend to live in your property as an ‘owner-occupier’ and many will charge you a lower interest rate if you do. This is because owner-occupiers are seen as more stable customers who have a vested interest in keeping hold of the roof that’s over their head.
A refinancer is someone who switches from one home loan to another, either with the same lender or with a different one. People refinance for all sorts of reasons. You might be changing from a fixed to a variable rate, borrowing more money for renovations or simply switching to a more competitive rate. Refinancing can potentially save you thousands which is why it’s worth keeping an eye on your rate throughout the year and reassessing your loan every few years. Home loans might be long-term financial products but the market is continually evolving and improving so there’s every chance there are new features available that don’t exist in your loan if it’s been a while since the ink dried on your mortgage.
Tip: If refinancing, try not to extend the overall length of your loan term. Doing this will actually increase the amount you pay for your loan, and could negate any savings you might make from a lower rate, or worse still, put you backwards.
First home owner
A first home owner is someone who is buying a property for the first time, whether it’s as an investment or to live in. If you are going to live in the property, you may be eligible for the first home owners’ grant or a stamp duty tax exemption to help you get a leg up into the property market provided you meet a range of criteria.
First home owner grants
First home owner grants began in 2000 but are increasingly hard to come by due the continued tightening of eligibility criteria. To start with, you need to be over 18 and an Australian citizen or a permanent resident. The grants are only for newly-built or substantially renovated properties, or properties that have never been occupied before. You can’t have owned a property prior to 2000 or applied for a first home owners grant previously, and you need to live in it for a minimum of six months, within the first 12 months of owning it. The size of the grant varies from state-to-state, as does the cap on how much the property costs. An outline is below but it’s worth reading your state-specific grant information carefully.
First home owner grants and exemptions
|State||Grant amount||Stamp duty concessions|
|ACT||Up to $10,000||A concession applies to new or substantially renovated homes. The concession is based on a sliding scale, according to property value, provided buyers meet the eligibility criteria.|
|NSW||Up to $10,000||First home buyers purchasing new properties valued up to $550,000 are exempt from paying stamp duty while properties valued at between $550,000 and $650,000 will receive a partial concession, if they meet the FHOG eligibility criteria.|
|NT||$26,000||Concessions on stamp duty are available for people buying a new build or a substantially renovated property of up to $7000. Similar concessions are available to eligible senior citizens, pensioners and carers however neither are applicable if you are eligible for the FHOG.|
|QLD||$15,000||The QLD government provides a range of stamp duty concessions for people buying either their first home, their principal place of residence or a vacant block on which they intend to build. The concession and eligibility criteria ranges for each one.|
|SA||$15,000||Concessions on stamp duty only apply to people buying off the plan apartments. The concession offered is dependent on when you entered into the contract.|
|TAS||$10,000||No duty exemptions.|
|VIC||$10,000||First home buyers purchasing a property valued at $600,000 or less may be entitled to a reduction of up to 50%. The discount is regardless of whether your home is new or established but buyers to need to meet the FHOG eligibility.|
|WA||$10,000||There are a range of stamp duty concessions for eligible first home owners including for established dwellings. The concessions are provided on a sliding scale according to property value. The full criteria is on their site.|
Renovator or builder
Planning to buy a vacant lot and build your dream home? Or perhaps you are in the market for a renovator’s dream? Either way, if you intend to carry out major building work before you move in to your home then a construction home loan could be a good option. A construction loan is structured to release money in stages, when certain milestones in the building process are reached, the advantage being that you only pay interest on the money you’re actually using. Construction loans are typically interest-only loans which are then be transferred on to a normal home loan when the house is complete. While they are primarily designed for people building a home from scratch, some lenders will offer them to renovators as well.
What type of rate do you want?
The interest rate on your mortgage is the rate at which the bank will charge you interest on the amount you have borrowed. The rate is expressed as an annual percentage, but lenders calculate the interest on a daily basis so that the interest compounds (see breakout box).
A range of factors can affect the amount you repay your bank including:
- Fixed vs variable rates
- Principal and interest repayments
- Advertised rate vs. comparison rate
- Frequency of payments
Fixed vs. variable interest rate
Before you decide on a home loan, it’s a good idea to decide what type of interest rate you want to pay. In the Australian mortgage market, there are three main options:
- Fixed rate loan
- Variable rate loan
- Split loan
Fixed home loan A fixed home loan is a loan where the interest rate is set for a certain amount of time, usually between one and 15 years. The advantage of a fixed rate is that you know exactly how much your repayments will be for the duration of the fixed term. There are some disadvantages to fixing that you need to be aware of. Some products won’t let you make extra repayments, or offer tools such as an offset account to help you reduce your interest, while others will charge a significant break fee if you decide to terminate the loan before the fixed period finishes. Variable home loan A variable home loan is one where the interest rate can and will change over the course of your loan. The rate is determined by your lender, not the Reserve Bank of Australia, so while the cash rate might go down, your bank may decide not to follow suit, although they do broadly follow market conditions. One of the upsides of variable rates is that they are typically more flexible than their fixed rate counterparts which means that a lot of these products will let you make extra repayments and offer features such as offset accounts. Split home loans A split loan lets you fix a portion of your loan, and leave the remainder on a variable rate so you get a bet each way on fixed and variable rates. A split loan is a good option for someone who wants the peace of mind that regular repayments can provide but still wants to retain some of the additional features variable loans typically provide such as an offset account. Of course, with most things in life, split loans are still a trade-off. If the variable rate goes down, for example, the lower interest rates will only apply to the section that you didn’t fix.
Advertised rate vs. comparison rate
Ever wondered why banks display two different interest rates when advertising a home loan? The first rate is typically the bank’s ‘advertised rate’ which is the percentage of interest they will charge you on your loan. The second rate, known as the ‘comparison rate’ factors in the majority of a loan’s fees and changes to help Australians understand the true cost of a loan and make a more balanced comparison of home loan products. The rate is calculated using an industry-wide formula based on a $150,000 loan over a 25-year period which all lenders are legally required to display alongside their advertised interest rate. Products that have a significantly higher comparison rate compared to their advertised rate are likely to include extra costs such as high application fees or an interest rate that increases over time, such as a 1-year low rate that increases by a percentage point or more after the fixed period is over, however it’s important to go through the fine print of any loan for yourself.
A lot of mortgage holders don’t realise that the frequency of your mortgage repayments can have a noticeable impact on how much you’ll pay your bank in interest over the life of your loan. Banks calculate the interest owing on a daily basis, so if you opt to pay fortnightly instead of monthly, that means for two weeks of each month you’ll be charged slightly less interest because you’ve already paid off part of your monthly repayment. It will only amount to a few cents at a time, but add it up over 360 months in a 30 year loan and it starts to turn into dollars. There is, however, another much bigger trick to paying fortnightly. Many lenders calculate fortnightly payments as half of your monthly repayments, but because there are more than four weeks in every month, over the course of the year you’ll end up making one extra repayment. Ultimately this means you’re tricking yourself into making higher repayments, but it’s a trick worth playing because it will save you thousands in the long run.
|$500,000 home loan at 6%||Fortnightly (half of the monthly repayments)||Monthly|
|Total interest paid over 30 years||$455,131||$579.191|
Tip: If you opt for a fixed rate loan, find out what variable rate the loan reverts to afterwards before you sign up to the loan. You might find it’s a lot higher than competitive rates on the market.
Fixed interest rate
- Set repayments each month provide peace of mind
- Potentially saves you money if the variable rate increases during the fixed term
- Helps you plan for monthly expenses
- Potentially costs you money if the variable rate falls
- Break fee: you’ll be charged a significant fee if you get out early
- Less flexibility: some loans don’t allow additional repayments or include an offset account
- Can attract high interest rates after the fixed rate period
Variable interest rate
- Can save you money if your bank’s interest rate drops
- More flexibility: loans typically offer more options such as an offset account and a redraw facility
- Switch loans at any time with minimal penalty
- Repayments will go up if your bank’s variable rate rises
- Harder to budget for on a monthly basis
- Higher repayments can put people into mortgage stress
Which loan should I take out? Fixed or variable? Fixed vs variable is one those crystal-ball questions potential home owners grapple with before they take out their first loan. The answer is, there’s no right or wrong answer - it really depends on how you want to manage your finances. If you’re someone who likes the security of knowing how much you need to repay each month, then a fixed rate could be right for you. If you’d rather keep your options open and pay market rate, regardless of the inevitable fluctuations, then a variable rate could be more your cup of tea.
‘Interest-only’ vs ‘principal and interest’ repayments
Most banks will ask you to pay back both the amount you owe and the interest charged – known as ‘principal and interest’ repayments. However some lenders will give you the option of making ‘interest only’ payments for a limited amount of time. While interest-only payments are lower on a monthly basis, ultimately they cost significantly more in the long run because you aren’t reducing the principle amount you owe the bank. Conversely, by paying down the principal on your loan, you’re monthly repayments might start higher but they will reduce over time to a point where you’ll become mortgage-free one day and own your home outright.
Example: Jackie and James decide to move on to interest only repayments for the first five years of their $500,000 mortgage* while they take time out to travel overseas. Doing so reduces their monthly repayments from $2,684 to $2,083 – a ‘saving’ of $601. After five years however, their monthly repayments will increase to $2,923 for the remainder of their 30 year loan, which is $239 more than what they would have paid each month if they had kept paying principal and interest. As a result of the interest only period, Jackie and James will also pay their bank an extra $35,606 in interest.
Did you know? Two thirds of all investor loans are interest-only loans (source: ASIC)
Why go interest only? Interest only repayments are popular with investors who want to minimise the amount of equity tied up in a property. This frees their money up so they can invest it elsewhere while still benefiting from any capital gains the property might have. Negative gearing rules in Australia mean that some investors can write off the interest paid on their investment, if their investment is running at an overall loss, however anyone considering investing in the property market should do their research thoroughly and talk to a financial expert before committing.
Loan fees & hidden costs
Fees are much like death and taxes – they’re pretty much unavoidable and home loans are notorious for them. The good news, however, is that there are lenders in the market who have minimal or no fees – it’s just a matter of knowing what to look for.
Here are the most common fees in the home loan market.
Tip: Avoiding fees outright isn’t necessarily the best financial fix – you may find a loan with moderate fees but a lower interest rate still comes out ahead or that a monthly fee for an offset account is better than having no offset at all.
An ‘upfront’ or ‘application’ fee is a one-off expense you are charged by your bank when you take out a loan. The average start-up fee is around $600 however there are over 1,000 loans on the market with none at all. If the loan you want does include an application fee, try and negotiate to have it waived. You’ll be surprised what your bank agrees to when they want your business.
On-going fees are any regular payments charged by your lender in addition to the interest they apply including annual fees, monthly account keeping fees and offset fees. The average annual fee is close to $200 however there are almost 2,000 home loan products that don’t charge an annual fee at all. There’s plenty of extra costs when you’re buying a home, such as conveyancing, stamp duty, moving costs, so the more fees you can avoid on your home loan, the better. While $200 might not seem like much in the grand scheme of things, it adds up to $6,000 over the life of a 30 year loan – money which would be much better off either reinvested into your home loan or in your back pocket for the next rainy day.
Example:Anna is tossing up between two different mortgage products. Both have the same variable interest rate, but one has a monthly account keeping fee of $20. By picking the loan with no fees, and investing an extra $20 a month into her loan, Josie will end up shaving 6 months off her 30 year loan and saving over $9,000* in interest repayments.
Break fees are charged when a customer terminates a fixed-rate mortgage. The amount is determined at the time you decide to break the loan and is based on how much your bank stands to lose by you breaking the contract. As a general rule, the more the variable rate has dropped, the higher the fee will be.
Exit and discharge fees
The Federal Government banned exit fees in 2011, removing one of the biggest barriers to taking switching home loan providers. Lenders can still legally charge a discharge fee, which is payable when you come to the end of your home loan, however these fees are relatively small at an average of $304 while 134 products don’t have them at all.
Redraw fees are charged by your lender when you want to take money you have already paid into your mortgage back out. Typically, banks will only allow you to take money out of your loan if you have a redraw facility attached to your loan, and the money you are taking out is part of any additional repayments you’ve made. The average redraw fee is around $19 however there are plenty of lenders who include a number of fee-free redraws a year. Tip: Negative-gearers beware – any money redrawn is often treated as new borrowing for tax purposes, so there may be limits on how you can use it if you want to maximise your tax deduction.
Features: do you need a flexible home loan?
When looking for the right mortgage, a loan’s features can sometimes be just as important as the interest rate, especially if you are planning to put extra money towards your mortgage at some point over the life of the loan.
Making extra repayments is the most common way to pay down your loan faster, but you can add money to your loan by making lump sum contributions or through tools such as an offset account.
We take a look at the most common features available in mortgages today.
Tip:Be aware that features often come at a price so it’s wise to weigh up your options carefully. For example, a loan with an offset account might include a monthly fee or a higher interest rate so you need to make sure the benefits of the account actually outweigh the costs attached to having it. Conversely, products with some of the cheapest interest rates might not allow certain features such as additional repayments so you end up paying the maximum amount of interest for the duration of the loan term.
Additional repayments are payments you proactively make into your home loan in addition to your set monthly or fortnightly payments. This extra money goes towards reducing the amount you borrowed and as a result, will significantly reduce the amount of interest you pay. While additional repayments don’t have to be regular, it is a good way of chipping away at your debt, saving you thousands of dollars and potentially stripping years off your loan term. Before you sign up to a mortgage, check that it allows you to make extra repayments – this can often make or break someone’s decision to take out a particular loan.
Example:Five years into his home loan, Alex gets a pay rise and decides to use some of the extra cash to help pay off his mortgage faster. By committing to paying an extra $200 a month into his $500,000 loan for the remainder of his 30 year loan Alex works out he will save a total of $50,126 in interest and slash more than 3 years and 2 months off his loan**.
Did you know: selecting a shorter loan term can dramatically reduce the amount of interest you pay your bank over the lift of your loan.
Lump sum payments
Lump sum payments are similar to additional repayments although typically they are larger sums of money, deposited into your home loan as a one-off. Like additional repayments, the lump sum goes towards the principal owing on your loan and works towards lowering your overall interest costs and loan term. People will decide to make lump sum payments for all different reasons – you may have received an inheritance from a long-lost aunt, or collected a surprise tax return that year. The earlier you make the payment, the greater the benefits as the bank will start charging you less interest as soon as you make the deposit which will have a significant compounding effect.
Example:Instead of making additional repayments, Alex decides to make a one-off lump sum contribution into his home loan of $60,000 but he’s undecided about when to do it. He decides to work out what the difference will be and is shocked by the results: putting the $60K in at 5 years will see him save $121,294 in interest repayments over the life of his loan, while putting the $60K in at 15 years will save him just $56,008 – a difference of over $65,000*.
Offset accounts and redraw facilities
Offset accounts and redraw facilities are tools you can use to put extra money into your home loan to reduce the amount of interest charged. While on the surface these two features appear to be quite similar, there are some differences you need to be aware of. An offset account is a transaction account attached to your mortgage which allows you to make instant and unlimited deposits and withdrawals without charge. Some banks will only allow you to partially offset your mortgage, so ideally look for one that enables you to offset 100% of the interest, rather than just a portion which can significantly reduce your savings. A redraw facility allows customers to take money out of their mortgage that they have already deposited as additional repayments. The extra money is actually kept in the loan, rather than a separate account, and there are often limits on how many redraws you can make or fees attached to making a redraw.
|Offset||Instant and unlimited deposits and withdrawals||Requires diligence to refrain from ‘dipping in’ to the account|
|Money reduces the amount of interest you are charged||Can include an offset account fee|
|Can include ATM access||Often attracts a higher interest rate|
|Redraw||Money goes towards the amount owing on your loan||Lenders can limit the amount and or frequency of withdrawals|
|Extra repayments are seen as more permanent||Withdrawals are usually not instant|
|Focus is on paying off your mortgage sooner||Redraws can attract fees|
|Potential tax implications for negative gearers.|
Example:Jessica decides to set up an offset account with her $500,000 mortgage and puts $50,000 into it. After 10 years, Jessica calculates she will save approximately $32,350, if her interest rate remains unchanged at 5%. If she leaves it there until the loan is paid off, she will save over $142,000 and reduce her loan term by over four years.
How much should you borrow?
Taking the time to understand each factor will help clarify the process and enable you to properly allocate for the additional expenses included in the standard home loan:
- Deposit size
- Additional mortgage costs
- Property value
- Ability to repay
Determining how much you need to borrow is often not as straight-forward as you might think. After you’ve worked out where you want to buy, you’ll need to work out how much you can put forward as a deposit, how much you can afford to make in monthly repayments and how much you need to borrow overall.
Deciding each of these factors is a bit like a chicken and egg scenario – which one comes first is hard to determine. Your loan size will affect how big your deposit needs to be, while your ability to meet regular repayments will affect your loan size.
When buying a property, your lender will ask for a cash deposit as security on the loan. The bigger the deposit the happier they’ll generally be as it provides them with collateral, should the deal turn sour. It also helps prove to them that you are financially secure enough to have saved up this amount of money. The bank will assess this deposit as a ‘loan-to-value’ ratio, or LVR, which is the amount of money you borrow for your home loan vs the value of the property, expressed as a percentage. LVRs are used by lenders to work out how much equity you have in your home and help determine whether you are a risky borrower. Anyone with an LVR of under 80 per cent is generally seen as safe, while borrowers with high LVR’s of up to 95 per cent may find it harder to get a home loan. You may also find that banks are less willing to give you a competitive interest rate.
Example: Suzie has her eye on a $500,000 apartment. She’s saved up $100,000 for a home loan deposit, and is hoping that’s just enough to ensure she has the 20 per cent deposit needed to avoid paying lenders’ mortgage insurance i.e. $400,000 / $500,000 = 80%. However Suze’s forgotten to include additional extra costs such as stamp duty and legal fees, which add an extra $30,000 on to her borrowing amount. Re-doing her sums she’s now only got an LVR of $430,000 / $500,000 = 86%, which means she either has to come up with an extra $30,000 in savings somewhere, or face the prospect of paying $5K in LMI.
Other mortgage costs: In addition to LMI and stamp duty, there’s a range of smaller costs that will add to your bottom line when buying a house. While some won’t be applicable to your circumstances, it’s worth checking off each one: Conveyancing / legal fees: While there are some DIY conveyancing kits on the market it’s a good idea to consider engaging a professional when it comes to managing legal documents. There are two types of professionals you can engage: a conveyancer or a solicitor. A conveyancer is likely to be cheaper however they are more restricted in the advice they can give you. Mortgage fees: there are a variety of upfront fees your lender might charge you at the start of your loan including application fees, documentation preparation fees and bank valuation fees. Check with your lender what the total upfront fees are before you lock yourself in. Inspections: There are a range of inspections you will want to consider before buying a property including a building inspection, a pest inspection and a strata report, if you are buying an apartment. These reports will help you determine whether there are any current or previous issues with the place you want to buy – information you’ll want to know before you secure the keys to your new home, rather than after. Council, water and strata rates: if the previous owner paid for these services a year in advance, you’ll be asked to refund them for the remainder of the year. Home Insurance: insurance is vital if you want to protect your new purchase. If you are moving into the place, home and contents insurance could be worthwhile, while investors who are renting the property will probably want to opt for landlord insurance. Moving costs: If you’re planning on moving into your new home, you might need a removalist. Professional removalists can be expensive, particularly if you have a large house or you are moving interstate. If you want a low cost alternative, online service forums such as airtasker.com can help you nab a competitive deal. Telecommunications: the relocation of phone lines, internet and any Pay-TV services can add up so make sure you factor in a few hundred dollars for this. These companies can also be booked for months in advance so it’s a good idea to call them early. Rental costs: If you’re an investor you won’t be looking for a removalist but you might need a real estate agent to find tenants and manage the property, if there aren’t tenants already in the place. If that’s the case, don’t bank on receiving the first couple of months’ rent. It will take you time to find the right tenant and then the agents fees can take up much of the remainder.
Determining LVR: LVR is your mortgage amount, divided by the value of the property. For example, say you want to buy a property worth $600,000 and you have saved up a deposit of $90,000, you’ll need to borrow $510,000, plus an additional $20,000 in additional costs. Assuming the lender has valued it at the same amount, your LVR will be $530,000 / $600,000 = 85%. Graphics: PROPERTY COST + EXTRAS – DEPOSIT = LOAN SIZE LOAN SIZE / PROPERTY VALUE = LVR%
Tip:Buying a home always comes with additional costs such as stamp duty and legal fees. Make sure you add these costs to your loan amount before calculating LVR. If you don’t, your LVR calculations will be out.
Additional mortgage costs
Taking out a mortgage has its own list of additional fees and charges from organising building inspection reports to legal fees. Two of the biggest expenses however are ones home buyers often forget to factor in: lenders mortgage insurance and stamp duty.
Lenders mortgage insurance
Lenders mortgage insurance or ‘LMI’, is a type of insurance required by your bank if you have a deposit of 20% or less than the total loan size. Be aware that the insurance you’re paying for covers your lender, not you, in the case that you might not be able to pay the loan back. The cost of LMI depends on how big your loan is versus how big your deposit is, and can climb as high as $10,000 or more if you’re stretching the budget to buy your home.
Example: Tom has a deposit of $80,000. He wants to borrow as much as possible but is determined not to pay LMI. Factoring in a buffer of $20,000 for additional costs, Tom can borrow $240,000 to buy a $300,000 property to give him a LVR of exactly 80 per cent. If Tom decides to buy a place for more, his loan size will increase, as will the stamp duty costs, putting his LVR well over 80 per cent, as illustrated in the table:
|Property value||Deposit||Stamp duty and other costs||Loan size||LVR||Estimated LMI|
Stamp duty is a tax that is applied by state and territory governments in Australia at the time of purchase of a property. The tax is paid for by the buyer in addition to a mortgage registration fee and a transfer fee. It’s fair to say stamp duty is probably not one of people’s favourite taxes, especially as it can be over 4% of the property price and comes at a time when most people are stretching the budget anyway. Queensland is the cheapest place for stamp duty, while South Australia is the most expensive, based on a $300,000 property, although it’s probably not wise to pick your future home based solely on these unavoidable taxes! In addition to stamp duty, most state and territory governments will also charge for the transfer of the title and the registration of the mortgage, however these are typically much smaller fees.
|$500,000||Stamp duty||Mortgage registration fee||Transfer fee||Total|
Based on a $500,000 owner-occupied, residential property.