When it comes to home loans there are five key areas you need consider:
- Loan type: What type of a buyer are you?
- Interest rates: What type of rate do you want?
- Fees: Uncover hidden costs and learn how to minimise them
- Features: Do you need a flexible home loan?
- Loan size: How much should you borrow?
Loan type: what type of a buyer are you?
Owner occupier, renovator, or investor?
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.
Not sure of the difference between investor loans and owner occupied, or whether you can qualify for a First Home Owner Grant? Wondering if your best bet is to grab a block of land and look for a construction loan instead? Download RateCity's 2020 Home Loan Guide to find out this and more!
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 to avoid extending the overall length of your loan term. This can actually increase the amount you pay in total interest on 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 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. 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 $7000||A concession applies to the purchase of a new home or a block of vacant residential land. 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 $650,000 are exempt from paying stamp duty while properties valued at between $650,000 and $800,000 will receive a partial concession, if they meet the FHOG eligibility criteria.|
|NT||Up to $26,000||Concessions on stamp duty are available for first home buyers (up to $23,928.60, though not if they’re eligible for the FHOG), non-first home buyers purchasing or building a new home (p to $7000), or seniors, pensioners and carers (up to $10,000).|
|QLD||Up to $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||Up to $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||Up to $10,000 (up to $20,000 until 1 July 2019)||First home buyers of established homes and pensioners downsizing to new homes may be eligible for duty concessions, depending on their settlement dates and other eligibility criteria.|
|VIC||Up to $10,000 (in regional Victoria, up to $20,000)||First home buyers purchasing a property valued at $600,000 or less may be exempt from duty, while htose buying a property of $600,001 to $750,000 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||Up to $10,000||When a home buyer is eligible for theFirst Home Owner Grant, a concessional rate of transfer duty will apply if the value of the dutiable property is below certain thresholds.|
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.
Key milestones in a construction loan:
- Lock up
Interest rates: what type of rate do you want?
Fixed, variable, split... what does this all mean?
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 interest on a daily basis so that the interest compounds.
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
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. 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.
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.
TIP: If you opt for a fixed rate loan, find out what variable rate the loan will revert to afterwards before signing up. You might find it’s a lot higher than competitive rates on the market.
Variable home loan
A variable home loan has an interest rate that can and will change over the course of your loan. The rate is determined by your lender, not the Reserve Bank of Australia (RBA), so while thecash ratemight 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 rate 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 can be 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, as 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 percentage of your loan that you didn’t fix.
‘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 principal amount you owe the bank.
Conversely, by paying down the principal on your loan, your 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 onto 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.
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 most of a loan’s fees and charges to help Australians understand its overall cost, and make a more balanced comparison of home loan products.
Comparison rates are 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 discounted rate that reverts to a higher rate after the promotional period is over. It’s important to go through the fine print of any loan for yourself.
Many mortgage holders don’t realise that the frequency of your mortgage repayments can make a noticeable impact on how much you’ll pay your bank in interest over the life of your loan. Banks calculate your interest 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 arates half of your monthly repayments, but because there are more than four weeks in most months, over the course of the year you’ll effectively end up making one extra monthly repayment (fun fact – in a 52-week year, there are 12 months, but 26 fortnights). Ultimately this means you’re tricking yourself into making higher repayments, but it’s often a trick worth playing because it could 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|
Fees: uncover hidden costs and learn how to minimise them
How much extra will you pay on your home loan?
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 some of the most common fees in the home loan market:
Tip: Avoiding fees outright isn’t necessarily the best financial fix – you may find that a loan with moderate fees but a lower interest rate still comes out ahead, or that paying a monthly fee for an offset account is better than having no offset at all. Make some calculations and consider getting financial advice before signing any agreements.
An ‘upfront’ or ‘application’ fee is a one-off expense your bank may charge when you take out a loan. The average start-up fee is over $570,however there are many 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 may be surprised by what your bank will agree to when they want your business.
On-going fees are any regular payments charged by your lender in addition to interest, including annual fees, monthly account-keeping fees and offset fees.
The average annual fee is close to $250, however there are many home loan products that don’t charge an annual fee at all.
There are plenty of extra costs involved when you’re buying a home, such as conveyancing, stamp duty, and moving costs, so often the more fees you can avoid on your home loan, the better. While $200 per year might not seem like much in the grand scheme of things, it adds up to $6000 over the life of a 30 year loan – money which may 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 you are charged is determined at the time you decide to break the loan and is typically based on how much your bank stands to lose by you breaking the contract.
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, averaging at around $300, while many products don’t have them at all.
Redraw fees may be charged by your lender when you want to take money you have already paid onto 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 only the money from 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. Contact a tax accountant for more information.
Features: do you need a flexible home loan?
What is flexibility, and is it important to your mortgage?
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.
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 outweigh its costs. Conversely, products with some of the cheapest interest rates might not offer 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 (the principal) and as a result, can 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, potentially saving you thousands of dollars and stripping years off your loan term.
Before you sign up to a mortgage, check whether 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 potential benefits – 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 you’re charged.
An offset account is a transaction account attached to your mortgage. Money in your offset account is counted when calculating your interest charges e.g. if you have a $300,000 loan and have $10,000 in your offset account, you’ll be charged interest as if you only owed $290,000. 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 limit 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 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.
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.
Loan size: how much should you borrow?
More or less, it's the idea of borrowing "more" or "less"
Taking the time to understand each of the following factors can help clarify the home loan application process and enable you to properly allocate any additional expenses involved:
- 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.
Working these out is a bit like a chicken and egg scenario – it can be hard to determine which one comes first. 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 more 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.
Tip: Buying a home always comes with additional costs such as stamp duty and legal fees. If you choose to cover these costs using your home loan, Mmake sure you add these costs to your loan amount before calculating LVR. If you don’t, your LVR calculations will be out. The size of your deposit will help determine your 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. The higher your upfront deposit on the property, the lower the LVR on your mortgage.
LVR is your mortgage amount, divided by the value of the property.
For example, if 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. If you also choose to add $20,000 in additional cost (e.g. stamp duty) onto your loan.
Assuming an additional $20,000 in additional costs, your LVR will be $530,000 / $600,000 = 85%.
PROPERTY COST + EXTRAS – DEPOSIT = LOAN SIZE LOAN SIZE /PROPERTY VALUE = LVR%
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, and may need to pay Lenders Mortgage Insurance (LMI). You may also find that banks are less willing to give you a competitive interest rate.
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:
|Property value||Deposit||Stamp duty and other costs||Loan size||LVR||Estimated LMI|
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 are ones home buyers often forget to factor in: lenders mortgage insurance and stamp duty.
Stamp duty is a tax that Australia’s state and territory governments apply when a property is purchased. The tax is paid 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.
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.
Based on our Stamp Duty Calculator, Queensland is the cheapest place for stamp duty (excluding transfer fees), although it’s probably not wise to pick your future home based solely on these unavoidable taxes!
|$500,000||Stamp duty||Mortgage registration fee||Transfer fee||Total|
Based on a $500,000 owner-occupied, residential property.
Lender's mortgage insurance
Lenders mortgage insurance or ‘LMI’, is a type of insurance required by your bank if you have a deposit of 20% of the property value or less (an LVR of 80% or higher). This insurance covers your lender, not you, in the event you’re unable to pay your loan back.
Most banks pass the cost of LMI on to the borrower. The cost of LMI depends on the size of our loan compared to your deposit and the value of the property, and can climb as high as $10,000 or more if you’re stretching the budget to buy your home.
In addition to LMI and stamp duty, there’s a range of smaller costs that could 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 often 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 at the start of your loan, including application fees, documentation preparation fees and bank valuation fees. Check with your lender before you lock yourself in, and find out what you’ll pay in total for your upfront fees.
- 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 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 often 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 already tenants in the place. It takes time to find the right tenant, so you may not start receiving rental income straight away, and even then, a percentage of this income may be eaten up by agent fees.
Read other Home Loans guides
RateCity's must-read guides on all aspects of home buying selling refinancing and home loan essentials.
2020 Refinancing Home Loan Guide
Learn how refinancing can help shrink your mortgage repayments, pay off your home loan sooner, or put the equity in your property to use with the RateCity refinance home loan guide. Download the guide to understand the steps to refinancing and get advice from a mortgage expert about your home loan.
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