Interested in purchasing a new home but don’t know how to get a mortgage? Finding the right house requires a good understanding of the home loan process.
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If you’re purchasing a house for the first time, a home loan application can be overwhelming. This article provides detailed information about home loans to get started.
To help you understand how home loans work, this guide breaks down the complex terms you will encounter when applying for one. It also covers the types of home loans available in Australia, some essential things to consider when comparing these home loan options, and how to choose one.
What Is a Home Loan?
A home loan is an amount of money lent from a bank or other financial institutions to renovate, build, purchase, or refinance a residential property. Since a home loan has longer terms than personal loans, it offers lower interest rates and lower loan repayment amounts.
Home loans in Australia typically have a 25-year or 30-year loan term. Loan repayments are made through accrued interest or regular settlements.
Interest is written as a percentage of the home loan amount. It is what your lender charges to let you borrow money.
Types of Home Loans
Numerous types of home loans are available in Australia. To know what loan type best suits you, consider your personal preferences, present circumstances, and the reason why you’re taking out a home loan.
A single loan can combine two or three loan types based on loan purpose, repayment type, or interest rate.
- Variable-Rate Home Loans
A variable home loan interest rate depends on the lender’s wishes even though economic factors influence banks.
The interest rate can fluctuate over time, altering your mortgage repayments. These loans allow for greater flexibility and offer more features than fixed-rate loans. However, their interest rates can be higher at times.
- Fixed-Rate Home Loans
A fixed-rate home loan enables a borrower to lock in an interest rate for a certain period -– typically from one to five years. With this loan option, the interest rate you pay remains the same for a specific amount of time.
The rate is fixed regardless of the lender’s variable rates or the Reserve Bank of Australia (RBA) cash rate.
- Split Rate Home Loans
A split loan is when a customer follows a fixed rate to pay a portion of their home loan and uses variable rate terms to settle the rest of it.
- Principal and Interest Home Loans
If your loan has principal & interest repayments, you need to pay back the loan amount, together with interest, for the duration of the loan’s life.
- Interest-Only Home Loans
An interest-only home loan is an alternative to the principal and interest option. You will only pay back the interest on the loan for the first few years before it goes back to principal and interest repayments.
This type of loan can lead to lower repayments in the short term; however, interest-only loans are usually more expensive in the long run.
- Owner-Occupier Home Loans
An owner-occupied home loan is a viable option. Meaning that you intend to live in the property rather than lease it to earn money. Compared to investor loans, interest rates on owner-occupier home mortgages may be slightly cheaper.
Other questions to consider before getting this loan type include: Are you a first home buyer? Do you want to buy another home? Do you want to build a house on vacant land? Do you want to refinance an existing home loan?
- Investor Home Loans
Investor home loans are for property investors who plan to rent or sell the property they’re purchasing for a profit, rather than living in it.
Both investor and owner-occupier home loans can be variable, split, or fixed. They may offer interest-only repayments or principal and interest, depending on the specific loan and lender.
- Low Deposit Home Loan
A low deposit home loan enables you to borrow with as little as 5% to 10% deposit rather than the usual 20%. This home loan is recommended for first home buyers because it allows them to climb the property ladder without saving up a large deposit.
- Investment Loans
Your financing options will be different if your goal is to borrow money for an investment property. Investment loans have specific interest rates, LVR requirements (loan to value ratio requirements), fees, and repayment options tailored to investors.
Your LVR is the loan amount divided by the appraised value or the property’s purchase price. If you’re purchasing a house worth $600,000 and you have a $450,000 loan, your LVR would be 75%.
Make sure you have a low LVR, so you don’t have to pay for lenders mortgage insurance (LMI).
If your LVR is above 80%, you must pay for LMI to protect your lender in the event where you can’t make the loan repayments. The average LMI fee is $6,200.
- Offset Home Loans
An offset account is a transaction account tied to your mortgage. A home loan with an offset account allows you to reduce the amount of interest you pay over the life of the loan.
With an offset account, you’ll only be charged interest on how much you borrowed minus the balance of your home loan offset. This loan type ensures that you won’t be charged interest on your full mortgage amount.
- Refinancing Your Home Loan
When you refinance a home loan, you take out a new home loan to replace your current one. Your new loan will pay out your existing mortgage, but you’ll need to make repayments towards the new loan.
People usually refinance their home loans because the new mortgage suits their circumstances better. You may refinance your home mortgage with your present lender or a new lender, depending on what works for you.
Steps to Refinancing Your Home Loan
If your situation has changed since you considered getting a home loan, a review of your mortgage may be in order. Check if it’s still aligned with your needs.
Here are the five steps to refinancing your home loan:
- Review Your Current Home Loan
You should first check the remaining time before you can fully repay your mortgage. Think about the type of loan you have and the last time you spoke with your lender.
Is your loan fixed, variable, or a combination of both? If you’ve applied for a fixed rate home loan, you may need to pay break costs. Therefore, you should consider the amount to exit your loan, the annual fees you’re paying, your current interest, and your short- and long-term plans.
Do you have an offset account? If you’ve made additional payments, can you access redraw? How essential are online services to you? These are some things you need to consider.
- Compare Home Loans
Now that you have a clear perspective of how you want your home loan, start researching your options.
You may speak with a home loan specialist through a mortgage broker or a specific lender. You can also research this online.
When interest rates are low, many people take advantage by paying off their mortgages faster. As a result, some consider making additional repayments, while others switch to fortnightly payment (paying half the monthly amount every two weeks).
Low advertised interest rates can be tempting, but there’s more to home loans than low rates. Consider these factors when comparing home loans:
- Fees – There are home loans that offer low interest rates but have ongoing fees or high annual charges. Other lenders have upfront costs when processing new loans. Therefore, make sure you’re getting a good deal after keeping financial accounts.
- Features – Before taking out a new home loan, you should also consider the features of your current mortgage, especially those that are important to you.
- Flexibility – Think about how much flexibility you need. Are you interested in making extra repayments? Do monthly repayments work for you?
Consider the amount and the frequency of your home loan repayments when making comparisons.
Look for home loan products that offer better deals, so you’ll know whether to refinance or not.
- Eligibility – A lender determines what type of borrower you are and the amount of deposit you have.
Owner-occupied borrowers looking for a principal and interest loan can access the lowest rates. Meanwhile, borrowers who want an interest-only home loan, or investor home loan, may have to pay higher rates.
Many lenders also offer lower rates to borrowers with lower LVR. Let’s say you’re looking to refinance your current home loan. If you have 30% equity in your property, you have an LVR of 70%, giving you access to cheaper rates.
Equity is the variation between your property value and the outstanding loan balance used to fund it.
For example, you buy a house for $400,000 and pay a $100,000 loan, your equity in the property is $100,000.
There’s a chance your equity can be negative if the value of your property falls below the balance of your home loan.
If you’re an (Australian business number) ABN holder, you’ll need to have an ABN for at least two years to prove that you’ve been in the business long enough to be considered financially stable.
- Negotiate With Your Current Lender
Speak to your current lender about your priorities. Tell them what’s not working for you and how other home loan options could better meet your needs.
Ask your current lender about all of your options. You’ll have more bargaining power if you have at least 20% equity in your home and an excellent credit score.
Your credit score depends on your financial and personal information. It’s calculated based on what’s in your credit report, which you are entitled to get for free every three months.
You get access to your report online within a day or two. However, it usually takes up to 10 days to get it by mail.
If you can strike a better deal with your current lender, you can avoid the extra paperwork and money that comes with switching to a new lender.
- Apply for a New Home Loan
If your current lender can’t offer you the option you need, then it may be time to refinance. You can apply for refinancing at a branch or online. Just provide your personal details and financial information, such as income, debt, living expenses, and property information.
Prepare all your documents beforehand to ensure smooth processing. Your new lender will then evaluate your application and check your credit record to determine your property value.
- Sign Your New Home Loan Contract
Read the documents carefully before signing them. If you’re unsure about some files, don’t hesitate to consult your lawyer.
After you sign all the documents, your new lender will contact your current lender to arrange a settlement. This period is when your old home loan ends and your new loan starts. You may have to pay some fees as part of the refinancing settlement.
Ways to Choose the Best Home Loan Deal
The interest rate matters when looking for suitable mortgage deals. A home loan is a long-term debt with different options and features that offer flexibility, so you can pay off your loan faster. Some loans, however, may cost you more, so make sure to choose one that best fits your needs.
- Consider Principal and Interest to Pay Off the Loan
Most people get principal and interest loans and make regular payments on the principal (the amount borrowed), and pay interest on that amount. The terms include paying off the loan over a particular period, like 25 years.
For interest-only loans, your repayments only cover the interest on the principal for an initial period. Since you aren’t paying off the amount you borrowed, your debt isn’t reduced. During the interest-only period, repayments may be lower, but they will rise after that.
- Apply for the Shortest Loan Term You Can Afford
Your loan term (how long you have to pay off the loan) impacts the size of your mortgage repayments and the interest you need to pay.
A shorter loan term means higher repayments, but you’ll pay less in interest. Meanwhile, a longer loan term means lower repayments, but you’ll pay more in interest.
- Go for the Lowest Interest Rate
Even a 0.5% lower interest rate may save you thousands of dollars over time. Check the average interest rate and weigh the pros and cons of variable and fixed interest rates to decide which one best suits your needs.
|Variable interest rate||Fixed interest rate|
More loan features could offer you greater flexibility Allows you to switch loans more easily if you find a better deal
Makes budgeting easier since you know what your repayments will beFewer loan features may cost you less
Makes budgeting more difficult as your repayments may changeMore loan features may cost you more
Doesn’t entitle you to the benefits when interest rates go downCould be more costly when you switch loans, especially if you’re charged a break free
If you’re unsure whether a variable or fixed interest rate suits you best, consider a partially fixed rate. These rates mean a part of your loan has a fixed rate and the remaining amounts have a variable rate. You decide how you want to split the loan.
- Mortgage Features Can Come at a Higher Cost
Home loans with more features can be more costly. These benefits may include a line of credit facilities, an offset account, or a redraw.
For instance, you’re considering a $500,000 loan with an offset account. As long as you’re able to keep $20,000 of savings in the offset, you’ll pay interest on $480,000. It’s not worth paying for this feature if your offset balance is always low.
Do the maths to make sure the cashback offer still gets you ahead over the long term. Consider the deal against other aspects, such as interest rates and fees.
Always take into account your lifestyle and your needs when checking different comparison rates. If it isn’t worth paying extra for features you may never use, it’s better to settle for a basic loan with limited features.
Also, watch out for comparison rate warnings. A comparison rate is calculated on a $150,000 secured loan over a 25-year term. Note that a comparison rate is only accurate for the examples given and may not include all fees.
ASIC (the Australian Securities and Investments Commission) generated a MoneySmart website with a home loan calculator feature to help Australian consumers and investors improve their finances.
Check this mortgage calculator to help you manage your repayments and compare rates.
- Be Realistic About What You Can Afford
It’s crucial to work out first what you can afford to borrow. If interest rates go up, your loan repayments could also go up.
- Weigh Loans From at Least Two Different Lenders
Similar to when you consider refinancing, it’s also advisable to compare loans from at least two different lenders. This measure helps you choose the best loan option.
Comparison websites are helpful, but keep in mind that they’re still businesses and may profit from promoted links. They may not cover all your options.
A mortgage broker can help advise the right loan option for you. Before meeting with one, check first if they have an Australian Credit Licence (ACL) to give you professional loan advice.
You should also search these three lists on the ASIC Connect’s Professional Registers:
- Credit Registered Person
- Credit Representative
- Credit Licensee
A broker is operating illegally if they are not on the list.
Upon deciding on a broker to transact with, make sure to ask them questions. Have them explain everything about loan options, the costs, and their recommendations.
If you’re not satisfied, ask the broker to give alternatives. Some of the questions to ask your mortgage broker are:
- What is the threshold for a lender’s mortgage insurance (LMI)?
- Why do you recommend this loan to me?
- What fees will I have to pay?
- What information do I need for the loan application?
Some Fees That Apply to Home Loans
When choosing a home loan, you should prepare for some fees, including:
- Application fee – this is an upfront fee that you settle when you first apply for a home loan.
- Service fee – this might be charged annually or monthly to cover the cost of maintaining your loan.
- Legal, valuation, and settlement fee – these are other fees you must pay upfront. These charges cover the legal paperwork and the valuation of your property
- Discharge fee – an amount you have to pay when you settle your loan in full.
- Feature fee – fees for certain features, such as extra repayments, an offset account, or a redraw facility. Not all home loans charge fees for these features. Therefore, you should ensure you’re not paying fees when you don’t have to.
How Much Money Can You Borrow?
You should consider how much money you can realistically borrow.
The amount of money a bank will grant you depends on several factors. Therefore, the final costs might significantly vary from what you initially expect.
How Much Should You Save for a Deposit?
You first need to work out how much you can afford to borrow before saving up for your deposit. Ensure to include the other costs of purchasing a house like conveyancing fees and stamp duty.
This is the formula to determine how much you need for your deposit:
(Amount you need to purchase the property) + (Fees) – (Amount you can afford to borrow) = Deposit you need to save
Why a Larger Deposit Will Save You Money
Some lenders only require a 5% deposit for purchasing a house. A smaller deposit, however, means a bigger loan, and you’ll also have to settle the lenders mortgage insurance.
Bigger deposits show your lender that you’re a good saver and can manage your finances. Such amounts may increase your chances of getting home loan approval.
Credit cards can affect your home loan application. Therefore, make sure to close any credit card accounts you no longer use.
In terms of credit limits, make sure to reduce them to the lowest amount that you can comfortably work with. Lower credit limits help you reduce your credit card expenses. These payables are factored into the assessment of your home loan application.
Ensure that you pay your cards on time and limit additional personal loans, as these factors will affect your overall debt.
Home Loans FAQs
- What is a home loan pre-approval?
A home loan pre-approval is simply an indication of your borrowing capacity. You may choose to seek approval anytime to determine your borrowing power. However, a pre-approval doesn’t guarantee a mortgage offer.
- How much stamp duty must I pay, and what is negative gearing?
Stamp duty is a tax imposed upon the sale of a property to cover the amount of the legal documents in the transaction. State governments levy such taxes and may vary depending on what state you reside in.
Some eligible investment owners in Australia take out a home loan and buy a real estate property to save money on tax. This practice is called negative gearing.
As the Australian Taxation Office (ATO) explains, negative gearing refers to a financial situation where the rent or other income an owner receives from an investment property is less than what they spend. It is different from positive gearing, where the owner makes a profit on their property.
If your property investment is negatively geared, you may be able to deduct your expenses from your overall taxable income in a financial year. This could mean paying a deducted amount.
- What is a home loan guarantor?
A home loan guarantor is usually a related third party who provides added security to help a relative or family member buy their first home or next home. Although the original debtor is responsible for the debt, guarantors become liable in the event of a default.
- What exactly is a First Home Owners Grant (FHOG)?
FHOG is a national scheme that subsidises the construction or purchase of newly built homes. It also helps fund homes that are substantially renovated.
FHOG is only available to Australians who have not owned residential properties before. Your state or territory determines the amount on offer, whether you’re building a new home or purchasing a new one.
- What does the First Home Loan Deposit Scheme (FHLDS) mean?
The First Home Loan Deposit Scheme is an initiative of the Australian Government to assist eligible first home buyers in purchasing or building their first home sooner.
The National Housing Finance and Investment Corporation administers the scheme. With less than a 20% deposit, first home buyers should pay lenders mortgage insurance.
Under this arrangement, eligible individuals can build or purchase a new home with a deposit of as little as 5%. Moreover, NHFIC guarantees up to 15% of the property value to a participating lender.
Buying a property shouldn’t be stressful, so make sure to find the best bank for home loans. The most appropriate bank doesn’t just offer great rates, it also provides features that lessen the hassles of buying your first home.
Check Your Borrowing Power with MMS Mortgage Calculator
Knowing your borrowing power is just the first step. A mortgage is a big investment of both time and money, which is why It’s often best to receive guidance from a financial expert like a mortgage broker.
Many people may be unaware of this…but just like you, 41% of Aussies intend to get financial advice rather than going it alone, according to an Australian Securities and Investments Commission (ASIC) report.
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