Buying your first home? Here are four things you need to watch out for

A growing number of first home buyers are rushing to join the property market, lured in by historically low rates. But they may not be looking at the whole picture.

New data from the Real Estate Institute of Australia (REIA)’s Housing Affordability Report, for the September quarter 2019, recorded the highest percentage of first home buyers entering the Australian marketplace in eight years.

REIA President Adrian Kelly said: “Although the average loan amount has risen, the increase in family income and the decrease in the interest rates have negated this rise.”

As a result of three Reserve Bank of Australia cash rate cuts in 2019, Australian borrowers have seen home loan rates plummet to record lows.

Lenders have also reduced their serviceability floors in response to lower market rates. Easing back on this part of the home loan assessment means would-be borrowers may find getting a home loan is a little easier. Plus, they may now be able to borrow thousands more.

These changes may have worked to create an ideal setting for first home buyers to take a bigger piece of the home loan pie. However, there are a few risks that first home borrowers should consider before they leap into this new mortgage environment.

First home buyer growth in Australia

In the September 2019 quarter, the number of new loans to first home buyers grew by 9,270 (13.6 per cent), and 6.8 per cent over the year.

According to REIA data, 29.4 per cent of all new loans in the September quarter (excluding refinancing) were to first home buyers, the highest percentage since December 2011.

State-based first home buyer figures

State Number of new FHB loans

(Sept. 2019 quarter)

Increase over Sept. 2019 quarter Increase from Sept. ‘19 quarter – Sept. ’18 quarter
New South Wales 8,246 20.6% 15.3%
Victoria 9,395 10.2% 9.0%
Queensland 5,589 16.8% 6.9%
South Australia 1,547 -2.7% 4.4%
Western Australia 3,817 9.9% 6.3%
Tasmania 502 1.4% 3.7%
Northern Territory 218 -20.4% 6.9%
Australian Capital Territory 662 61.1% 24.9%

Source: REIA Housing Affordability Report, September 2019 quarter.

The risks first home borrowers face

While taking advantage of low rates and easier loan assessment criteria can be beneficial, it’s important for first home buyers to be aware of the potential home loan traps.

1. Can you afford a 3 per cent rate increase?

Home loan rates are low now, but they could increase one day. Before applying for any home loan, it’s recommended you calculate whether you can afford a potential 3 per cent increase on your mortgage rates.

For example, a $500,000 30-year home loan on a rate of 3.20 per cent (excluding fees) would only cost $2,162 in monthly repayments. A hypothetical rate increase of 3 per cent to 6.20 per cent would see mortgage repayments shoot up to $3,062 per month. This is an increase of $900 a month could see the unprepared fall into mortgage stress.

Before applying for a home loan, consider if a 3 per cent rate increase is something you could afford with your current household income.

2. Low rates but high fees

A common trap that borrowers can fall into is not looking at the fees associated with their home loan. Low advertised rates on a home loan can often mean you will be charged higher than average fees for other services. This is why it’s valuable to look at a home loan’s comparison rate, not just its advertised rate.

Comparison rates were introduced in response to lenders advertising low rate loans to attract customers. The loan would end up costing more due to high upfront and ongoing fees, so these comparison rates provide an ‘accurate’ view of what a loan may really cost you.

You might be able to skip some fees altogether, if you do your research. According to RateCity data, the average application fee is $570 and the average ongoing fee is $257. However, 47 per cent of home loans in the RateCity database don’t charge application fees and 53 per cent don’t charge any ongoing fees.

  • It’s also valuable to get a Key Facts and Figures Sheet from your lender, to be sure you are aware of all fees associated with the loan.

3. ‘Honeymoon’ rates with a sting in their tail

Introductory, or ‘honeymoon’ rates are the name of special low interest rates applied to new loans for an initial period of time, usually 6 – 12 months. After this introductory term, the rate then reverts to the (generally higher) standard variable rate.

These types of rates are designed to attract new borrowers to banks. You may feel a bit of breathing room in the first year, but you run the risk of paying higher repayment amounts than you can afford once the introductory term ends.

First home buyers should do their homework before choosing any home loan. Keep an eye out for the comparison rates with introductory loans. If it’s significantly higher than the advertised rate, there may be a costly catch.

4. Sticking with your childhood bank

You wouldn’t buy a house without doing the research first, such as looking into the neighbourhood or comparing prices of other houses sold on the street. So why don’t we do the same for home loan providers?

Getting a home loan with the bank you’ve been with since you were a kid is often the option that takes the least effort, but it may not be the best option for you.

In fact, you could miss out on some serious savings by not shopping around.

Get a low rate home loan that works for you

According to RateCity research, owner-occupier principal and interest home loan rate is 3.75 per cent and the average variable investor principal and interest home loan rate is 4.13 per cent.

If you’re considering a home loan with a much higher rate than the rates above, you might want to consider checking out smaller lenders with more competitive rates.

Here is a list of the current lowest rate loans on the RateCity marketplace:

Low rate owner-occupier loans

Lender Home loan Advertised rate Comparison rate
Reduce Home Loans Low Rider Home Loan

2.69

2.71

Homestar Finance Star Essentials Home Loan

2.74

2.77

Freedom Lend Freedom Variable Home Loan

2.79

2.79

G&C Mutual Bank First Home Premium Package

2.79

2.79

Pacific Mortgage Group Standard Variable Home Loan

2.79

2.79

Note: Data accurate as at 5 December 2019. Figures based on 30-year home loan under $1 million, paying principal and interest.

Low rate investor loans

Lender Home loan Advertised rate Comparison rate
Reduce Home Loans Rate Slasher Variable Investment Loan

2.99

3.01

Freedom Lend Freedom Variable Investment Loan

3.09

3.09

Pacific Mortgage Group Standard Variable Investment Loan

3.09

3.09

Well Home Loans Well Balanced Investment Loan

3.12

3.16

Homestar Finance Variable Rate Investment Loan

3.14

3.17

Note: Data accurate as at 5 December 2019. Figures based on 30-year home loan under $1 million, paying principal and interest.

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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 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 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.

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 is a comparison rate?

The comparison rate is a more inclusive way of comparing home loans that factors in not only on the interest rate but also the majority of upfront and ongoing charges that add to the total cost of a home loan.

The rate is calculated using an industry-wide formula based on a $150,000 loan over a 25-year period and includes things like revert rates after an introductory or fixed rate period, application fees and monthly account keeping fees.

In Australia, all lenders are required by law to publish the comparison rate alongside their advertised rate so people can compare products easily.

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 standard variable rate (SVR)?

The standard variable rate (SVR) is the interest rate a lender applies to their standard home loan. It is a variable interest rate which is normally used as a benchmark from which they price their other variable rate home loan products.

A standard variable rate home loan typically includes most, if not all the features the lender has on offer, such as an offset account, but it often comes with a higher interest rate attached than their most ‘basic’ product on offer (usually referred to as their basic variable rate mortgage).

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.

What's wrong with traditional ratings systems?

They’re impersonal 

Most comparison sites give you information about rates, fees and features, but expect you’ll pay more with a low advertised rate and $400 ongoing fee or a slightly higher rate and no ongoing fee. The answer is different for each borrower and depends on a number of variables, in particular how big your loan is. Comparisons are either done based on just today or projected over a full 25 or 30 year loan. That’s not how people borrow these days. While you may take a 30 year loan, most borrowers will either upgrade their house or switch their home loan within the first five years. 

You’re also expected to know exactly which features you want. This is fine for the experienced borrower, but most people know some flexibility is a good thing, but don’t know exactly which features offer more flexibility than others. 

What is the flexibility score?

Today’s home loans often try to lure borrowers with a range of flexible features, including offset accounts, redraw facilities, repayment frequency options, repayment holidays, split loan options and portability. Real Time Ratings™ weights each of these features based on popularity and gives loans a ‘flexibility score’ based on how much they cater to borrowers’ needs over time. The aim is to give a higher score to loans which give borrowers more features and options.

They’re not always timely

In today’s competitive home loan market, lenders are releasing new offers almost daily. These offers are often some of the most attractive deals in the market, but won’t get rated by traditional ratings systems for up to a year. 

The assumptions are out of date 

The comparison rate is based on a loan size of $150,000 and a loan term of 25 years. However, the typical loan size is much higher than that. Million dollar loans are becoming increasingly common, especially if you live in metropolitan parts of Australia, like Sydney and Melbourne. It’s also uncommon for borrowers to hold a loan for 25 years. The typical shelf life for a home loan is a few years. 

The other problem is because it’s a percentage, the difference between 3.9 or 3.7 per cent on a $500,000 doesn’t sound like much, but equals around $683 a year. Real Time Ratings™ not only looks at the difference in the monthly repayments, but it will work out the actual cost difference once fees are taken into consideration. 

What is a debt service ratio?

A method of gauging a borrower’s home loan serviceability (ability to afford home loan repayments), the debt service ratio (DSR) is the fraction of an applicant’s income that will need to go towards paying back a loan. The DSR is typically expressed as a percentage, and lenders may decline loans to borrowers with too high a DSR (often over 30 per cent).

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.

Can I change jobs while I am applying for a home loan?

Whether you’re a new borrower or you’re refinancing your home loan, many lenders require you to be in a permanent job with the same employer for at least 6 months before applying for a home loan. Different lenders have different requirements. 

If your work situation changes for any reason while you’re applying for a mortgage, this could reduce your chances of successfully completing the process. Contacting the lender as soon as you know your employment situation is changing may allow you to work something out. 

What is a guarantor?

A guarantor is someone who provides a legally binding promise that they will pay off a mortgage if the principal borrower fails to do so.

Often, guarantors are parents in a solid financial position, while the principal borrower is a child in a weaker financial position who is struggling to enter the property market.

Lenders usually regard borrowers as less risky when they have a guarantor – and therefore may charge lower interest rates or even approve mortgages they would have otherwise rejected.

However, if the borrower falls behind on their repayments, the lender might chase the guarantor for payment. In some circumstances, the lender might even seize and sell the guarantor’s property to recoup their money.

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.