Jumping the home loan hurdles

Jumping the home loan hurdles

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.

 

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Learn more about home loans

What happens to my home loan when interest rates rise?

If you are on a variable rate home loan, every so often your rate will be subject to increases and decreases. Rate changes are determined by your lender, not the Reserve Bank of Australia, however often when the RBA changes the cash rate, a number of banks will follow suit, at least to some extent. You can use RateCity cash rate to check how the latest interest rate change affected your mortgage interest rate.

When your rate rises, you will be required to pay your bank more each month in mortgage repayments. Similarly, if your interest rate is cut, then your monthly repayments will decrease. Your lender will notify you of what your new repayments will be, although you can do the calculations yourself, and compare other home loan rates using our mortgage calculator.

There is no way of conclusively predicting when interest rates will go up or down on home loans so if you prefer a more stable approach consider opting for a fixed rate loan.

What is a low-deposit home loan?

A low-deposit home loan is a mortgage where you need to borrow more than 80 per cent of the purchase price – in other words, your deposit is less than 20 per cent of the purchase price.

For example, if you want to buy a $500,000 property, you’ll need a low-deposit home loan if your deposit is less than $100,000 and therefore you need to borrow more than $400,000.

As a general rule, you’ll need to pay LMI (lender’s mortgage insurance) if you take out a low-deposit home loan. You can use this LMI calculator to estimate your LMI payment.

How can I calculate interest on my home loan?

You can calculate the total interest you will pay over the life of your loan by using a mortgage calculator. The calculator will estimate your repayments based on the amount you want to borrow, the interest rate, the length of your loan, whether you are an owner-occupier or an investor and whether you plan to pay ‘principal and interest’ or ‘interest-only’.

If you are buying a new home, the calculator will also help you work out how much you’ll need to pay in stamp duty and other related costs.

What is an interest-only loan? How do I work out interest-only loan repayments?

An ‘interest-only’ loan is a loan where the borrower is only required to pay back the interest on the loan. Typically, banks will only let lenders do this for a fixed period of time – often five years – however some lenders will be happy to extend this.

Interest-only loans are popular with investors who aren’t keen on putting a lot of capital into their investment property. It is also a handy feature for people who need to reduce their mortgage repayments for a short period of time while they are travelling overseas, or taking time off to look after a new family member, for example.

While moving on to interest-only will make your monthly repayments cheaper, ultimately, you will end up paying your bank thousands of dollars extra in interest to make up for the time where you weren’t paying off the principal.

Who has the best home loan?

Determining who has the ‘best’ home loan really does depend on your own personal circumstances and requirements. It may be tempting to judge a loan merely on the interest rate but there can be added value in the extras on offer, such as offset and redraw facilities, that aren’t available with all low rate loans.

To determine which loan is the best for you, think about whether you would prefer the consistency of a fixed loan or the flexibility and potential benefits of a variable loan. Then determine which features will be necessary throughout the life of your loan. Thirdly, consider how much you are willing to pay in fees for the loan you want. Once you find the perfect combination of these three elements you are on your way to determining the best loan for you. 

What are the pros and cons of no-deposit home loans?

It’s no longer possible to get a no-deposit home loan in Australia. In some circumstances, you might be able to take out a mortgage with a 5 per cent deposit – but before you do so, it’s important to weigh up the pros and cons.

The big advantage of borrowing 95 per cent (also known as a 95 per cent home loan) is that you get to buy your property sooner. That may be particularly important if you plan to purchase in a rising market, where prices are increasing faster than you can accumulate savings.

But 95 per cent home loans also have disadvantages. First, the 95 per cent home loan market is relatively small, so you’ll have fewer options to choose from. Second, you’ll probably have to pay LMI (lender’s mortgage insurance). Third, you’ll probably be charged a higher interest rate. Fourth, the more you borrow, the more you’ll ultimately have to pay in interest. Fifth, if your property declines in value, your mortgage might end up being worth more than your home.

What is a variable home loan?

A variable rate 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.

How do I take out a low-deposit home loan?

If you want to take out a low-deposit home loan, it might be a good idea to consult a mortgage broker who can give you professional financial advice and organise the mortgage for you.

Another way to take out a low-deposit home loan is to do your own research with a comparison website like RateCity. Once you’ve identified your preferred mortgage, you can apply through RateCity or go direct to the lender.

How can I get a home loan with bad credit?

If you want to get a home loan with bad credit, you need to convince a lender that your problems are behind you and that you will, indeed, be able to repay a mortgage.

One step you might want to take is to visit a mortgage broker who specialises in bad credit home loans (also known as ‘non-conforming home loans’ or ‘sub-prime home loans’). An experienced broker will know which lenders to approach, and how to plead your case with each of them.

Two points to bear in mind are:

  • Many home loan lenders don’t provide bad credit mortgages
  • Each lender has its own policies, and therefore favours different things

If you’d prefer to directly approach the lender yourself, you’re more likely to find success with smaller non-bank lenders that specialise in bad credit home loans (as opposed to bigger banks that prefer ‘vanilla’ mortgages). That’s because these smaller lenders are more likely to treat you as a unique individual rather than judge you according to a one-size-fits-all policy.

Lenders try to minimise their risk, so if you want to get a home loan with bad credit, you need to do everything you can to convince lenders that you’re safer than your credit history might suggest. If possible, provide paperwork that shows:

  • You have a secure job
  • You have a steady income
  • You’ve been reducing your debts
  • You’ve been increasing your savings

What are extra repayments?

Additional payments to your home loan above the minimum monthly instalments, which can help to reduce the loan’s term and remaining payable interest.

What is the difference between fixed, variable and split rates?

Fixed rate

A fixed rate 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 rate

A variable rate 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 rates 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.

How do I refinance my home loan?

Refinancing your home loan can involve a bit of paperwork but if you are moving on to a lower rate, it can save you thousands of dollars in the long-run. The first step is finding another loan on the market that you think will save you money over time or offer features that your current loan does not have. Once you have selected a couple of loans you are interested in, compare them with your current loan to see if you will save money in the long term on interest rates and fees. Remember to factor in any break fees and set up fees when assessing the cost of switching.

Once you have decided on a new loan it is simply a matter of contacting your existing and future lender to get the new loan set up. Beware that some lenders will revert your loan back to a 25 or 30 year term when you refinance which may mean initial lower repayments but may cost you more in the long run.

What is a fixed home loan?

A fixed rate 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.

How do I calculate monthly mortgage repayments?

Work out your mortgage repayments using a home loan calculator that takes into account your deposit size, property value and interest rate. This is divided by the loan term you choose (for example, there are 360 months in a 30-year mortgage) to determine the monthly repayments over this time frame.

Over the course of your loan, your monthly repayment amount will be affected by changes to your interest rate, plus any circumstances where you opt to pay interest-only for a period of time, instead of principal and interest.