Before you pull the trigger on a home loan, you need to ensure that you’ve properly compared the options on offer to find the best deal. That’s the easy part. The hard part is knowing exactly what you should be looking for.
Of course, before you start comparing home loans you need to have a good idea of your own financial situation and how much you can afford to borrow. Free online tools can help make that easier, as can seeking qualified help from professionals such as mortgage brokers.
Also, you should be aware of any extra help you may be eligible for, such as government schemes to help first homeowners like the First Home Owners Grant and the 2020 First Home Loan Deposit Scheme.
Once you know you’re on top of your finances and you’re ready to look at home loans, there are four main factors you should be comparing.
What type of loan is it?
Home loans can either be ‘principal and interest loans’ or ‘interest-only loans’. According to MoneySmart, the former is by far the most common.
For a principal and interest loan, you need to make regular repayments on the borrowed amount, as well as a certain amount of interest on that principal amount. This is done over an agreed time period.
An interest-only loan means your repayments only have to cover the interest on an agreed-upon initial period of time. This does mean that your initial repayments are lower, but you’re also not making any dents in the principal amount you borrowed. So once that interest-only period is over your repayments will go up again.
How long is the loan term?
The loan term is the amount of time you have to repay the home loan. A shorter loan term means you will have to pay more each time, but it has the bonus of less interest. On the other hand, a longer loan term will mean you pay more interest, but each repayment is smaller.
“The most common loan term is 30 years,” explains Mortgage Choice CEO Susan Mitchell. “That being said, you can reduce your loan term by increasing the frequency and amount of repayments”.
“While not common, you may also be able to secure a 40-year loan term however I would caution against such an extended loan term if you can avoid it. If you maximise your loan term, it can mean your monthly home loan repayments will be smaller but you may pay more interest over the life of the loan.”
You’ll need to review the loan term on each Home Loan and decide what time frame makes the most sense to your financial situation.
What is the interest rate?
There may not be a huge difference between the interest rates on the home loans you’re researching, but even a 0.5% difference could mean thousands of dollars added or saved by the time you finish your repayments.
You also need to check whether the interest rate is variable or fixed, as there are pros and cons to both.
A variable interest rate can change depending on changes in the lending market. A fixed interest rate stays the same for a set period before it reverts to a variable interest rate or you negotiate another fixed rate.
“Home loans with a variable interest rate will typically offer more flexibility than a fixed rate home loan,” says Mitchell. “This is because the interest rate you are charged on a variable rate home loan is determined by your lender and in part by the official cash rate which is set by the Reserve Bank of Australia (RBA)”.
“So, if the RBA decides to cut the official cash rate…you could be charged less interest on your home loan. Furthermore, if you receive a pay rise or bonus, you can make extra repayments if you have a variable rate home loan and have the ability to pay off your loan sooner.”
One of the downsides to a variable rate home loan is that if the RBA does raise the cash rate, your lender may charge you more in interest repayments so it’s important that you are disciplined with your budget.
The benefit of a fixed rate home loan is that you agree to lock into a fixed interest rate over a period of time, generally 1-5 years. This means your home loan repayments will not change during the fixed-rate period, regardless of what the RBA does with the cash rate.
A downside to a fixed rate home loan is that some lenders won’t allow you to make extra repayments during the fixed-rate period. And, if you decide that you want to refinance to another home loan product, the lender can charge you significant break costs.
The good news is you don’t have to make a decision one way or another. You can choose to split your home loan so that a portion is fixed, and a portion is variable. You can decide how you split it – 50/50, 30/70, etc. That way, you get the best of both worlds.
What are the mortgage features?
Special features on a mortgage always come at a cost, and you need to weigh up whether that’s a benefit for your situation or not.
According to the Australian Securities & Investments Commission (ASIC), features can include options like an offset account which helps reduce your interest payable, a redraw facility which allows you to access any extra money you’ve paid towards your mortgage, and a line of credit loan which allows you to use the same account for your mortgage repayments and everyday spending.
“If you want to access home loan features such as a redraw facility or an offset account, you may be limited to a variable rate home loan as these features are not typically associated with a fixed rate home loan,” Mitchell warns.
Considering these four factors when you’re deciding on a home loan will help you wade through all the options out there and ensure you pick the best one for your own circumstances.