With so many lenders and home loan products on the market, searching for the right loan can feel overwhelming.
It’s important to research which products are available in the market and how they work. It’s also worthwhile speaking with a lender or broker to understand which home loan will best suit your needs.
How do interest rates work on a home loan?
The interest rate on a home loan is the amount of interest payable as a percentage of the principal, which is the total amount borrowed. The interest rate is usually quoted as an annual percentage. Interest on a home loan is usually calculated on daily balances and added to the amount owing at the end of each month. Different borrowers may pay different interest rates.
Lenders typically display two home loan interest rates on their products:
- A nominal (advertised) rate, and;
- A comparison rate
For example:
1.88% p.a. 2 Year Fixed, P&I, Owner Occupied
2.86% p.a. Comparison rate
A nominal rate does not include the cost of any additional lender fees and charges, whereas the comparison rate includes the nominal rate plus the cost of any additional lender fees and charges.
Examples of additional fees that may be included in the comparison rate are:
- Application fees
- Annual account-keeping fees, and;
- Charges for optional additional features such as an offset account or a redraw facility
As the comparison rate reflects the true total cost of the loan over a standardised loan term, borrowers can use the comparison rate to compare different home loans on a like for like basis.
What’s the difference between a principal and interest and interest-only loan?
Principal and interest (P&I)is the most common home loan type. P&I loans require borrowers to make regular repayments on the amount borrowed (principal), plus interest on that amount. Borrowers pay off the P&I loan over an agreed period of time, usually 25 or 30 years.
On the other hand, interest-onlyhome loans require the borrower to only make interest and fee repayments for a defined period of time, usually for the first initial five years of the loan. There is no reduction of principal during this time. At the end of the interest-only period, the loan typically reverts to a standard principal and interest repayment arrangement until the outstanding balance is repaid in full.
Which loan is best: fixed rate or variable rate?
The more common types of home loan finance options in Australia are fixed rate and variable rate.
Fixed rate
The interest rate on a fixed-rate home loan stays the same for a defined period of time, usually one to five years. At the end of the fixed term, the borrower may have the option to choose another fixed term or the loan may automatically convert to their lender’s current variable rate.
Here are the main benefits and potential disadvantages of getting a fixed rate home loan:
Benefits
- If interest rates increase, borrowers with fixed rates are charged less interest than those with variable rates for the same loan amount.
- Makes budgeting easier as borrowers know what their repayments will be.
- Fewer loan features could result in less fees.
Disadvantages
- Borrowers won’t benefit if interest rates go down.
- Fixed rate products usually have higher fees than variable rate products.
- If a borrower wants to switch their loan before their fixed period ends, the borrower may have to pay a break fee.
- Most fixed rate products limit a borrower’s ability to make additional repayments to their home loan.
- Most fixed rate products don’t have access to additional features such as offset accounts and redraw facilities.
Variable rate
The interest rate on variable rate home loans can increase or decrease, usually based on changes to the Reserve Bank of Australia’s (RBA) cash rate or market conditions.
Here are the main benefits and potential disadvantages of getting a variable rate home loan:
Benefits
- If a lender reduces their interest rates, the borrower will see their minimum repayment amount reduced. Borrowers may decide to maintain their current repayments, meaning they will pay additional repayments and pay off their loan balance sooner, also saving on the amount of interest paid over the life of the loan.
- Access to more loan features, such as an offset account or redraw facility, can offer borrowers greater flexibility and save on the amount of interest paid over the life of the loan.
- Variable rate products usually have lower fees than fixed rate products.
- It may be easier and more cost effective to switch home loans as there are no break fees.
Disadvantages
- If a lender increases their interest rates, then the borrower’s repayment amounts will increase.
- Borrowers may find it more challenging to budget as it can be hard to predict what their repayments will be in variable market conditions.
- More loan features may come with more fees.
Borrowers can also split their home loan. A split loan can be a good option for borrowers who would like the benefits of both a fixed and variable interest rate having, a portion of the loan on a fixed rate and the other portion on a variable rate. Borrowers can decide how to split the loan, for example, 50/50 or 20/80.
Ultimately, the most suitable arrangement for a first time borrower will depend on both their individual circumstances and general market conditions.
If you’re unsure of which home loan option is right for you, it’s worthwhile speaking to a mortgage broker or lender. They can help assess your financial situation and goals to help select the find option for you.
What is an offset account?
An offset account is a transaction account linked to your mortgage. The balance in the account is offset against the balance of the home loan meaning no interest is charged on that portion of the home loan balance, reducing the total amount of interest paid.
There are two main types of offset accounts: balance and interest.
A balance offset account is most common. In this instance, interest is only charged on the home loan balance minus the balance in the offset account.
For example, if a borrower owes $400,000 on their home and has $20,000 in an offset account, they would be charged interest on a debt of $380,000 (i.e. $400,000 less $20,000).
An interest offset account is the less common option. In this instance, the interest payable by the borrower is reduced by the amount of interest that they earn on their deposit funds.
For example, if the borrower earns $1.50 per day on their deposit funds and is charged $15.00 per day on their outstanding home loan balance, they will only be charged $13.50 interest per day (i.e. $15.00 less $1.50).
A borrower who makes use of an offset account for short or long-term deposit savings could save themselves a significant amount of interest over the typical 25 or 30 year loan term. However, if a borrower’s offset account balance is always low (for example under $10,000), it may not be worth paying additional fees to access this feature.
What is a home loan redraw account?
A redraw facility allows borrowers to access any extra repayments made to their mortgage. Extra repayments include any amount above their regular minimum home loan repayment amount.
In addition to being able to access additional repayments, there are several other potential benefits to having a redraw facility. These include:
- Interest savings. Making additional repayments can reduce the amount of interest you pay on your home loan, which can help you pay off your loan quicker.
- Tax savings. Any interest a borrower earns on funds they have in a savings account are taxed at a marginal rate. However, if they use those funds as extra repayments on their home loan, they will not earn any taxable interest.
However, there are also potential drawbacks to having a redraw facility. These include:
- Fees. Lenders typically charge fees for providing a redraw facility and they may also charge a higher interest rate.
- Redraw restrictions. Lenders may place restrictions on the number of redraw transactions a borrower can make within a certain period. Some lenders may also place restrictions on the amount that can be redrawn at any one time. Such restrictions may affect a borrower’s ability to quickly access the funds they need.
- Only usually available on variable home loans. Fixed rate loan or interest-only loan holders typically won’t have access to a redraw facility, as these borrowers typically can’t make additional repayments as part of the terms and conditions of the loan.
What other types of loans are available to me?
There are several different types of home loan options that can be applied to principal and interest, interest-only, fixed and variable rate products. These include:
- Construction. This type of loan finances the building of a new dwelling. Borrowers progressively draw down funds to pay their builder as milestone construction stages in their building contract are reached. Construction loans are typically interest-only during the building process and revert to a P&I loan once the home is completed.
- Debt consolidation. This type of loan enables a borrower to combine any additional high-interest debt they may have into their lower-interest home loan. A debt consolidation home loan can make it easier and more convenient for borrowers to manage their repayments.
- Guarantor. This type of home loan enables a borrower to nominate a person who agrees to become legally responsible for their debt if they default on their repayments. This may be beneficial to a first time borrower who has little or no credit history, or borrowers with high loan-to-value ratio (LVR).
Should I go with a bank or broker?
Australians have a wider range of lenders to choose from than ever. This can be good news for first time borrowers as it means the competitive market can drive lenders to offer attractive rates and inclusions to entice borrowers.
But on the other hand, the sheer volume of lenders can make it hard for potential borrowers to choose the right one for them, especially if it’s their first time doing so.
Mortgage brokers
A mortgage broker can assist with the process of taking out a home loan. They act as the go-between with banks and other lenders and must always act in your best interest when suggesting a loan for you.
A good mortgage broker will work closely with you to understand your property needs and goals, determine what you can afford to borrow, find and explain home loan terms and options that suit your needs, and help you take out the loan, from application all the way through to settlement.
Using a mortgage broker is normally free. Lenders usually pay the broker a fee or commission when the borrower settles a loan, so there’s no cost to the borrower.
If a mortgage broker is paid commission, they are obliged by law to disclose this information and the amount. Commissions generally vary minimally between lenders, meaning there is often little reason to push buyers towards certain products apart from the loans that are most suitable.
An online mortgage broker, like @realty Finance can make the home loan process quicker and easier. An @realty Finance Home Loans Specialist can help match you with suitable loans and help guide you through the entire process, from finding a loan to application, settlement and beyond.
Banks
A bank can also assist borrowers take out a new home loan.
Getting a home loan through the same bank with which you have other products, such as an everyday bank account, might also be convenient. As an incentive to keep your business, a bank may offer discounted interest rates or low or zero dollar establishment and account-keeping fees.
However, banks can only offer you their own loan products, so you may not get the best available loan, or the lowest rate possible.
At the end of the day, there’s no right or wrong choice. Choosing a broker or lender is an entirely personal decision and can be dependent on many unique factors.
Regardless of whether you choose to get a home loan with a mortgage broker or go directly to a bank, you should always thoroughly explore your options. This can be done through speaking to different lenders or mortgage brokers about their home loan options, as well as asking family and friends about their lending experiences and reading reviews of different banks and brokers.
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