What to consider before taking a home loan
A mortgage is one of the biggest financial obligations you will undertake in your life. It could be with you for 30 years or more. Therefore, it’s critical that you make an informed choice about your home loan based on all of the information available to you. Here are the factors you should consider before committing to a loan.
Where do you want to live?
Before you apply for a home loan, one of the first questions you should ask is where you actually want to buy. This will determine a myriad of factors, including how much you will have to borrow and what size deposit you will need.
How is the public education system in your suburb of choice? Better Education can show you how each suburb ranks in terms of primary school education and secondary school education (see below). If you have children or are planning to have children, you can then use that information to inform your decision.
- New South Wales
- Western Australia
- South Australia
- Northern Territory
- Australian Capital Territory
Before you buy in a new area, you should thoroughly investigate the public transport infrastructure and roads. Figure out how you would get to work, your extended family, friends, shops and places of leisure. If the commute is long, have a frank discussion with your loved ones about whether your willing to sacrifice time for your dream home.
Find out what the crime rate is in your area of choiceandhow close it is to emergency services - including hospitals and police stations.
Visit your area of choice at different times of the day to find out how it is affected by local noises. Does it have planes flying overhead? Are there loud trains nearby? Is it close to a highway? And importantly, how important is a quiet life to you? Some people don't mind a bit of noise, for others, it's a dealbreaker.
The surrounding area
On your visits to the suburb, check out the local community scene and make sure it is to your liking. Are there plenty of places to get food? A good night life? Plenty of parks for families or pets? It could be worth coming up with a checklist of what you are looking for in a suburb and see how many boxes your potential suburb ticks.
Quality of Life
If you are going to take a mortgage that is higher than your current rent, you should consider the impact it will have on your quality of life. It is quite likely in this scenario that you will have to take shortcuts elsewhere, especially on discretionary expenses like eating out or holidaying. You must decide whether you are prepared to make these sacrifices.
It’s a good idea to create a chart and map all your expenses.
Your next step is to decide whether you can reasonably pay the extra amount a mortgage may require and what you will cut back on to balance your own household budget. This may involve mapping what items could increase when you take on a mortgage (bills, transportation), what could decrease (leisure, savings) and what will remain fairly consistent (insurance, education, food and groceries).
There are also other non-financial costs and gains associated with taking on a home loan. Your new residence may be closer or further from transport, better or worse equipped for families and feature more or less cultural benefits than your rental location. You need to consider how important these factors are for you.
Once you have weighed up the financial and non-financial costs, it is time to ask whether you are a suitable loan applicant.
Example of monthly expenses
- Food and other groceries
- Bills (e.g. electricity, gas, internet)
- Transportation (e.g. train tickets, petrol)
- Insurance (e.g. private health care, life insurance)
- Education (e.g. child care, books, uniforms)
- Leisure (e.g. movies,restaurants, trips)
- Savings for future expenses (e.g. car upgrades, tertiary education).
Non-financial questions to ask
- Will I be able to maintain friendships?
- Will my kids settle into the new school/area?
- Does the new area have the cultural benefits my rental area did, such as restaurants, cafes etc.?
- Is my new area equipped with the facilities I desire, such as good access to healthcare facilities?
Do you meet lenders' criteria?
There are several factors that reduce your eligibility for a loan, so before applying you should make sure you tick your lender’s borrowing criteria.
Most lenders require a deposit of at least 5 per cent, however borrowers with deposits between 5 and 19 per cent are often required to pay lenders’ mortgage insurance to cover the lender in the case they are unable to repay the loan.
Other criteria that can reduce your eligibility include a poor credit history or poor trail of documentation about your work history. These factors don’t always make you ineligible, but they may increase your rate of interest or insurance costs.
Changes that could affect you
In 2015, the Australian Prudential Regulation Authority asked the biggest lenders to improve their capital reserves, which led to the tightening of lending criteria. Find out how much you can borrow.
The RBA cash rate
On the first Tuesday of every month, the Reserve Bank of Australia determines the official cash rate.
The decision to cut, hold or lift the cash rate is determined by a number of factors, including the level of inflation, the employment level, the Australian dollar and economic growth. Broadly, the goal is to keep inflation within the target band of 2-3 per cent, keep the dollar stable and unemployment low.
Why does this matter for borrowers? Lenders use the RBA cash rate as a guide for their variable interest rates. Your interest rate determines the additional cost you pay on your loan amount in exchange for the loan. If interest rates are falling, chances are your variable rate will be on the decline too. However, if interest rates are rising, your variable rate may rise with the official cash rate.
The last cash rate increase was in August2016.
Say the RBA decides to cut its official cash rate from 1.5 per cent to 1.25 per cent. If a lender chose to pass on that 25 basis points cut in full, it would mean a borrower with a $500,000 mortgage, formerly at 3.5 per cent, would save around $7 a month on their repayments.
Other costs and barriers
When you get your mortgage, you may be relieved of paying rent, but you'll have a number of other costs that you would not have had before you owned a home.
It's worth writing down what these costs are and deciding whether you want to draw extra from your mortgage to fund them or can afford to factor them into your existing budget.
Added costs include:
- Council taxes
- Maintenance and repairs
- Advertising and agent costs if you're an investor
- Water bills.
Before you buy, get a builder's inspection report to determine whether any work needs to be done to the building. This will give you a guide of how much extra you may have to spend in the first few years - and whether the purchase is even worthwhile.
Time out of the workforce
There will be times in your life where you have to take a break from the workforce. Sometimes it's voluntary - like if youwant to have a child, or travel- or sometimes it's involuntary - like if you lose your job or get sick. It's important to have a plan for these scenarios.
Income protection insurance
Income protection insurance gives you a regular wage in the case of misadventure, such as illness or accident. There are several ways it can be purchased, including through your industry or retail super fund, through an adviser or directly through the insurer. The benefit of income protection insurance is that it will cover your repayments if something unexpected happens.
Many people have children and a mortgage, but before you take on a home loan, it's worth considering how time out of the workforce for parentalleave would affect your repayments. The rates of pay for theGovernment's Paid Parental Leave Scheme should beconsidered, as should the amount of time you wish to take out of work for parental leave.
Some lenders allow you to take a 'repayment holiday' for reasons they deem legitimate, such as parental leave. Repayment holidays allow you to pause the payment of interest and principal for a period of up to 12 months. Keep in mind, only some lenders offer this service, so it's worth asking about before you take on a loan if you are considering some time out of the workforce.
The purchase process
Buyers generally have two choices when it comes to how they purchase a property: auction or private sale/treaty. There are pros and cons to both methods.
For example, an auction allows the buyer to secure the property quicker than private sale negotiations may take, but auction buyers have no cooling off period, which means once they have committed, they are not able to easily change their mind. As a result, it's critical to do your due diligence before bidding at an auction.
Let’s say you have beenpre-approved from your bank to borrow $900,000 on an LVR of 90% (i.e. property value of $1,000,000).You then go to the auction and bid $1,000,000 and win. However, then, thebank than values the property for $950,000. This means your LVR is now 95% and the bank can cancel your pre-approval. If purchased at auction without a cooling off period, you would still be obligated to buy.
A property valuation is an essential part of the lending process. For the lender, it’s an insurance policy that the loan will be repaid in the case you are unable to. The amount of finance you are offered will depend on the valuation report. It takes into account a number of factors including property features and flaws, location and land size.