For most people, buying a home is the most significant financial investment they will make. A sizeable loan is usually required, and repayments are generally spread out over many years. Therefore, it’s important to also invest a little time into understanding your options and getting a deal that suits you. Let’s begin by learning the basics of how a home loan works.
Before discussing the different types of home loans it will help to understand what all home loans have in common.
The application process: You will need to show your bank manager or lending institution that you are borrowing within your means and can afford to make the repayments.
Your loan is secured by your home: In other words, if for any reason you fall behind on loan repayments, your bank or lender has the legal right to sell your home to cover their investment.
The deposit: A percentage of your new home’s value is usually paid up-front in order to secure the loan.
It’s easy to get excited when inspecting properties, and it’s not uncommon for people to dream beyond their means. You will need to work out how much you can afford to borrow before shopping around for your home. This will give you a realistic picture and help you avoid disappointment later on. Now it’s time to ask yourself the hard questions:
How much deposit do you need?
- By making a larger initial deposit you can borrow less and therefore have lower repayments.
Is it your first home?
- If so, you could be eligible for a one-off payment from the First Home Owner Grant scheme. It’s also worth investigating a First Home Saver Account which assists with a combination of government contributions and tax concessions.
How much can you afford to repay?
- Try an online loan calculator or speak to your bank manager. This will give you a good indication of repayments on the amount you hope to borrow. A longer loan term will result in smaller fortnightly or monthly repayments.
Have you factored in all the costs?
- There will be up-front costs such as stamp duty and legal fees, plus ongoing costs for rates, insurance and possibly repairs.
Once the above basics are understood it’s time to find out exactly what type of loan is best for you. There are various lending options to suit your individual circumstances, and your lender, bank or credit provider can also approve a loan in principle, giving you the opportunity to start looking at homes in your price range. Make sure the in principle loan estimate includes any additional fees and charges. There are various ways to repay your home loan:
- Variable rate: The amount you repay will go up or down according to independent decisions made by the Reserve Bank of Australia. Your bank will alter rates according to fluctuations in Australian monetary policy. An advantage of a variable rate is that most lenders allow you to make additional repayments at any time, thereby decreasing the duration of your loan.
- Fixed rate: This will allow you to lock in your interest rate, meaning your repayments remain the same even if the Reserve Bank raises the cash rate. On the other hand, you may be restricted from making additional repayments, and you don’t get the benefit when interest rates fall. There could also be an early termination fee if you decide to get out of the fixed rate.
- Introductory rate: These are often called honeymoon rates, where a credit provider offers low interest for an introductory period. On the downside, there could be high early termination fees which lock you into your present loan even when better deals are available elsewhere. The interest rate could also rise sharply after the honeymoon period is over.
- Partially-fixed rate: This is a split loan where some portion of your loan is paid at the fixed rate and other portions at the variable rate.
By far the most common type of home loan is a standard home loan that involves paying off the principal (amount borrowed) and interest. For example, if you borrow $100,000 at 5% interest (annually), the first $5,000 repaid will only cover the interest without reducing the loan amount. Any repayments over and above $5,000 will reduce the principal amount.
Smart borrowing tips
- Work out what you can afford to borrow. Do your research.
- Get the best possible deal. Shop around and you will be surprised how flexible credit providers are when they want your business. Even small interest rate variations will make a big difference over time.
- Find out about your lender. Anyone who engages in credit activities must be licensed with ASIC, or be the lenders authorised representative.
- Don’t be pressured into making a hasty decision. Don’t sign anything until all your questions are answered to your satisfaction and any concerns are dealt with. Take time out to consider your options, or speak with a financial expert if you feel it will help.
- Keep up with your repayments. If possible, have repayments directly deposited from your pay to avoid overspending or incurring any penalty fees.
- Sometimes the best of plans can go wrong. If you are having difficulty making repayments, contact your loan provider without delay to investigate solutions. Ignoring the problem will only escalate it into a bigger problem.
When all is said and done, getting a home loan isn’t rocket science. However, your hard earned money should be protected by a thorough understanding of the home loan process. Your home loan shouldn’t be the cause of stress, and on the contrary should help you achieve peace of mind and become a sound investment that could pay big dividends in the future.