Lynne Blundell investigates the smartest strategies for securing a home loan.
September 14, 2009
What a difference a year makes. Just over 12 months ago interest rates were on the rise and banks were offering home loans for 100 percent of the value of a property. Then the global financial crisis hit, interest rates went into free fall and banks tightened up their lending requirements.
Right now interest rates are at their lowest level for decades. First-time buyers are back in the market following the boost to the federal government’s First Home Owners Scheme and there are signs that the housing sector is recovering. But banks are more cautious about lending and there is talk of interest rate rises.
It can be tough to qualify for a home loan but by having a strategy you can increase your chances, not only of getting the loan you want, but of meeting your payments if interest rates go up.
Deposit requirements are tougher
One casualty of the credit crunch has been the 100 percent loan. It is now pretty much impossible to borrow the full value of your home whether you are a first-time or repeat borrower. This can make things tough if you don’t have a savings history.
Most of the big banks now insist on a deposit of between 5 and 20 percent of the value of the property. Several major banks and some credit unions require a minimum of 10 percent.
If you want to borrow more than 80 percent of the purchase price you will need a deposit that consists of either equity in an existing property or what is referred to as ‘genuine savings’.
‘Genuine savings’ typically means:
• Money regularly saved over a minimum of three months in a bank account in your own name
• Term deposit in your name for a minimum of three months
• Share certificates held in your name for a minimum of three months
• Sale proceeds from a previous property you owned
• Accessible superannuation.
Most banks will also insist on lenders mortgage insurance (LMI) if you want to borrow more than 80 percent of a property’s value. This covers them if you are unable to pay your mortgage for any reason in the future and is one way of overcoming the need for a large deposit.
For example, Westpac specifies in its conditions that if you want a standard variable home loan to buy a $500,000 home you will need a deposit of at least $100,000 (20 percent deposit) without mortgage insurance and a minimum of $25,000 (5 percent deposit) if you have mortgage insurance.
Allowing for upfront costs
And don’t forget your upfront costs such as stamp duty, legal fees and loan establishment fees. According to Westpac‘s calculations, when you are borrowing 80 percent of the value for a $500,000 house, upfront costs would typically add up to $21,416.
If you are borrowing more than 80 percent of the value you will need to add mortgage insurance to these costs. According to Westpac, this will cost around $6,720, bringing the total upfront costs with mortgage insurance to around $28,336.
Factoring in future interest rate rises
When choosing your mortgage it is also important to factor in the likelihood of interest rate rises.
While the Reserve Bank of Australia is holding the official interest rate at 3 percent for the time being, once the economy shows real signs of recovery they are likely to rise.
Reserve Bank of Australia Governor Glenn Stevens told a recent parliamentary committee hearing that people taking out home loans should prepare for future interest rate rises by factoring in an extra 2 percent.
“It used to be the practice, I thought, that certainly banks test whether the borrower could cope with a two percentage-point increase,” Mr Stevens told the House of Representatives Economics Committee hearing.
“I’m not endorsing 2 (percent, but) … lenders should be applying that test.”
Even a 1 percent rise in interest rates would increase repayments on an average variable mortgage of $270,000 (from 5.15 to 6.15 percent p.a.) by more than $162 per month or about $1,944 a year.
One strategy is to split your home loan into part fixed and part variable interest. Another is to repay as much as possible on your variable loan while interest rates remain low.
If you added $160 to your monthly repayments to the average $270,000 home loan now for example, you could potentially save about $40,000 and reduce the loan by four years.
By planning your future and thinking of what features you will need for your home loan, you will be sure to find the best deal when it comes time to compare and apply for a home loan.