The top 5 questions to ask when choosing a home loan

The top 5 questions to ask when choosing a home loan

The process of getting a home loan can feel daunting, especially for first home buyers. This is why it’s so important that you come prepared when you start the home loan process. 

Whether you’re working with a mortgage broker, or doing it alone, there are some essential questions you need to ask when choosing a home loan.

1.    How much can I borrow?

One of the most important questions to ask when looking for financing for a property is how much you can borrow. After all, without a guide you could find yourself looking at properties well outside of your price range. If you’re not working with a broker, there are borrowing power calculators online that can help give you a good indication of this.

  •  A home loan lender will determine your borrowing power by looking at a few things:
  • Your income and any other applicants’ income;
  • Number of dependents;
  • Your living expenses; and
  • Your current debt - including credit cards, car loans and even your HECS/HELP debt.

It’s important to keep in mind that a lender calculates your borrowing power by looking at any regular spending you make, particularly in the few months leading up to your home loan application. So, if you’re ordering food delivery every week, or addicted to Afterpay, your lender may assume that this expense will continue for the life of a loan and deduct it from your borrowing power. 

2.    What fees and costs are involved?

There are a range of fees that a home loan lender may charge you that, as mentioned above, can significantly increase the costs of a home loan than first expected. But it’s not just lender fees to look for, with the real estate agent and Government charging their own costs. 

The potential fees and costs of a home loan include:

 Type of costs About 
Upfront costs  One-off application fees, valuation fees, conveyancing charges, legal costs, government costs, Lenders Mortgage Insurance (LMI) and stamp duty.
 Ongoing costs Annual fees, monthly service fees, extra repayment costs, redraw fees, late payment costs, switching fees, portability fee and discharge fees.

3.    What features does the loan offer?

It’s not just how much the loan will cost you that you want to consider, but how the loan can benefit you too. Home loans can also come with a range of features and perks that can help you to pay down your debt faster and meet savings goals, such as:

  • Extra repayments. Some lenders will charge you a fee if you make extra repayments, so keep an eye out for loans that allow this feature at no cost.
  • Redraw facility. Allows borrowers to ‘draw down’ on any extra repayments made on their home loan.
  • Offset account. A linked transaction or savings account connected to your home loan. Any amount you put into this account will ‘offset’ the balance of your home loan. Meaning, if you have a $400,000 home loan and a $50,000 offset account balance, your repayments and interest will be as if you have a $350,000 balance.
  • Split rates. Some loans allow you to split the interest rate type between variable and fixed, so you can have the stability of some fixed rate repayments and the flexibility of variable rate repayments. This can come in handy for borrowers who cannot decide between the two interest rate types.

4.    What repayment options do I have?

You have more control over your repayments than you think. There are a few repayment ypes and frequencies you may want to choose from, including:

  • Interest rate types – lenders offer two main types of loan rates: fixed or variable. The former means you fix, or lock in, an interest rate for a set period of time, typically around 2-3 years. The latter means your interest rate is subject to fluctuation in the market and by the lender. If the Reserve Bank of Australia were to cut the cash rate, or if the lender were to hike rates, your home loan rate would likely move too. As mentioned above, you can also opt to split your rate between the two types instead.
  • Repayment types – you may also have the option of choosing between paying principal and interest or interest only on your mortgage. Interest only repayments aren’t as common as they once were, as there is inherit risk in not chipping away at your home loan debt. If you find an interest-only loan, it will generally revert to the lender’s standard variable rate after a fixed period of time.
  • Repayment frequency – You may also choose between weekly, fortnightly or monthly repayments. Making more frequent payments can understandably help reduce your principal faster, and therefore potentially cut down on the amount of interest you’ll be charged over the life of the loan. If your budget were to get tighter down the track though, switching to monthly repayments would likely offer much needed breathing room. 

5.    How big of a deposit do I need?

While saving for a smaller deposit of 10 per cent can be a lot easier and more achievable for many Australians, especially those living in capital cities, often lenders reward borrowers with even bigger deposits.

If you’re hoping to get the most competitive interest rates in the market, when shopping for a home loan ask what the LVR (loan-to-value-ratio) requirements are for the lowest rates on offer. If your ideal home loan lender is offering its lowest rates to borrowers with LVRs of 80 per cent or even 70 per cent, this mean you’ll need a home loan deposit of 20 – 30 per cent to qualify for these rates. 

While this may not be within reach for many first home buyers, it is worth keeping in mind for when you’re looking to refinance in a few years. If you’ve managed to build up some equity and get your LVR below 80, you may now qualify for some of the most competitive rates around.  

Low rate home loans

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What is an ongoing fee?

Ongoing fees are any regular payments charged by your lender in addition to the interest they apply including annual fees, monthly account keeping fees and offset fees. The average annual fee is close to $200 however there are almost 2,000 home loan products that don’t charge an annual fee at all. There’s plenty of extra costs when you’re buying a home, such as conveyancing, stamp duty, moving costs, so the more fees you can avoid on your home loan, the better. While $200 might not seem like much in the grand scheme of things, it adds up to $6,000 over the life of a 30 year loan – money which would 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.

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.

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.

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 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.

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.

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.

What are the responsibilities of a mortgage broker?

Mortgage brokers act as the go-between for borrowers looking for a home loan and the lenders offering the loan. They offer personalised advice to help borrowers choose the right home loan for their needs.

In Australia, mortgage brokers are required by law to carry an Australian Credit License (ACL) if they offer credit assistance services. Which is the legal term for guidance regarding the different kinds of credit offered by lenders, including home loan mortgages. They may not need this license if they are working for an aggregator, for instance, as a franchisee. In both these situations, they need to comply with the regulations laid down by the Australian Securities and Investments Commission (ASIC).

These regulations, which are stipulated by Australian legislation, require mortgage brokers to comply with what are called “responsible lending” and “best interest” obligations. Responsible lending obligations mean brokers have to suggest “suitable” home loans. This means loans that you can easily qualify for,  actually meet your needs, and don’t prove unnecessarily challenging for you.

Starting 1 January 2021, mortgage brokers must comply with best interest obligations in addition to responsible lending obligations. These require mortgage brokers to act in the best interest of their customers and also requires them to prioritise their customers’ interests over their own. For instance, a mortgage broker may not recommend a lender who gives them a commission if that lender’s home loan offer does not benefit that particular customer.

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.

How much money can I borrow for a home loan?

Tip: You can use RateCity how much can I borrow calculator to get a quick answer.

How much money you can borrow for a home loan will depend on a number of factors including your employment status, your income (and your partner’s income if you are taking out a joint loan), the size of your deposit, your living expenses and any other debt you might hold, including credit cards. 

A good place to start is to work out how much you can afford to make in monthly repayments, factoring in a buffer of at least 2 – 3 per cent to allow for interest rate rises along the way. You’ll also need to factor in additional costs that come with purchasing a property such as stamp duty, legal fees, building inspections, strata or council fees.

If you are planning on renting the property, you can factor in the expected rental income to help offset the mortgage, but again it’s prudent to add a significant buffer to allow for rental management fees, maintenance costs and short periods of no rental income when tenants move out. It’s also wise to factor in changes in personal circumstances – the typical home loan lasts for around 30 years and a lot can happen between now and then.

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).

Do mortgage brokers need a consumer credit license?

In Australia, mortgage brokers are defined by law as being credit service or assistance providers, meaning that they help borrowers connect with lenders. Mortgage brokers may not always need a consumer credit license however if they’re operating solo they will need an Australian Credit License (ACL). Further, they may also need to comply with requirements asking them to mention their license number in full.

Some mortgage brokers can be “credit representatives”, or franchisees of a mortgage aggregator. In this case, if the aggregator has a license, the mortgage broker need not have one. The reasoning for this is that the franchise agreement usually requires mortgage brokers to comply with the laws applicable to the aggregator. If you’re speaking to a mortgage broker, you can ask them if they receive commissions from lenders, which is a good indicator that they need to be licensed. Consider requesting their license details if they don’t give you the details beforehand. 

You should remember that such a license protects you if you’re given incorrect or misleading advice that results in a home loan application rejection or any financial loss. Brokers are regulated by the Australian Securities & Investment Commission (ASIC), as per the National Consumer Credit Protection (NCCP) Act.