Home Loans

Home loan: what is it and how does it work?

A home loan, also referred to as a mortgage, is a loan agreement between the borrower and a lender where an amount of money is borrowed from a financial institution for the purpose of purchasing a home or property.

Repayments are made up of the amount borrowed, as well as interest charged by the lender. The amount of interest you pay is determined by the interest rate set by the lender. The interest rate affects your repayment amount and is therefore the most important part of the loan.

Any property purchased is used as security for the loan, meaning the lender has the right to sell it should the borrower fail to make their loan repayments. This enables the lender to settle the debt.

In Australia, home loans are typically paid back over an average of 25 to 30 years. It takes less time to pay off a mortgage if the borrower contributes more to their monthly repayments than agreed upon with the bank or lending institution.

Australians typically borrow between 80% and 95% of a property’s value. This is referred to as the loan principal or loan amount.  

The remainder of the money used to purchase a property is referred to as a deposit. A deposit is generally required to be saved and paid before securing the loan.

Borrowers are also encouraged to compare home loans from over 100 home loan providers available in Australia.

Who provides Australia’s home loans?

There is no shortage of home loan providers in Australia, all providing a mix of variable, fixed, line of credit/home equity, low doc and reverse mortgages.

To give you an idea of how many products are available, InfoChoice offers over 963 variable home loan products and over 559 fixed rate products to calculate, compare and potentially save from.

Put simply, there are many lenders in the Australian mortgage market, each offering a different range of products and benefits.

Even though there is an abundance to choose from, it’s important to know that they are all regulated by the Australian Prudential Regulation Authority (APRA) and other regulatory bodies.

The one thing you can do to see if you want to deal with any of these lenders, is to look up customer reviews and see what their customer service is like.

Lenders can be broken down into the types of providers they are:

The Big Four

The big four banks in Australian banking are Westpac, Commonwealth, NAB and ANZ. These banks are always competitive and offer banking apps, large customer service teams, vast ATM coverage and branches in most suburbs making it easy to always find them. They also have a larger range of mortgage products to choose from.

Alternative banks

The big four aren’t the only banks in Australia. There are numerous smaller local banks with their own range of home loans and products. These banks include:

• AMP
• Bank of Melbourne
• Bank of Queensland
• Bankwest
• Bendigo Bank
• Beyond Bank
• Citibank
• HSBC
• ING
• Macquarie Bank
• St George
• Ubank

Credit unions and non-bank lenders

There are a multitude of Australian institutions such as credit unions and building societies that are member owned, meaning they work for their members not for shareholders. Many times, these institutions are regional and are not present in every territory.

Some examples are:

• Australian Unity
• Bank First
• ME Bank

Digital banks and online lenders

These banks don’t have a store front and do things entirely online and with phone support. These banks offer competitive rates.

Examples of online lenders are tic:Toc and UBank

A how to guide to comparing home loans

When comparing home loans, it’s important to know what features you are looking for in a loan and then find the best priced loan to suit your home loan needs.

The best way to assess home loans is to compare the key fact sheets from different lenders.

Fact sheets should provide borrowers with an immense amount of information, including the total amount to be paid back over the life of the loan, repayment calculations, fees and charges.

Fact sheets will also provide a personalised comparison rate that can help borrowers compare one particular loan to another.

Credit providers must provide you with a key fact sheet for a home loan if you request one – unless you are choosing an interest-only or a line of credit loan.

Types of home loans

Variable rate home loan

Variable home loans are defined by the potential for interest rate fluctuations.

The variable interest rate may be changed regularly by a lender and is usually dictated by the Reserve Bank of Australia’s (RBA) official cash rate and changes in market interest rates. Due to interest rate fluctuations, your monthly repayments could vary from month to month.

With lower exit fees, more flexible repayment options and useful features like offset accounts and redraw facilities, variable home loans have been found to be the preferred choice for many Australians.

How do variable home loans work?

A home loan with a variable interest rate can increase or decrease whenever the lender decides to modify it. The choice by lenders to raise or lower their rates is reliant on various factors, such as their funding costs, a wish to be competitive or modifications to the official cash rate.

It may seem that this could be a negative choice for some. If interest rates are increased, so too are your monthly repayments, but the benefit that outweighs all negatives is the fact that if the interest rates drop, so too will your monthly repayments.

What to look for in a variable rate?

When comparing variable interest rate mortgages, you should look at three major components:

1. Look at the interest rate. A lower rate means lower monthly repayments.
2. Features can be useful. Search for loans with the features you need such as an offset account.
3. There are a range of fees associated with a variable home loan. Do the maths and make sure the fees that you will pay are worth your while. As long as the interest rate is low, the fees may be acceptable.

Fixed rate home loan

With a fixed rate home loan, the interest rate is locked in for a certain period of time – usually between one and five years.

During this time your repayments don’t change.

At the end of the fixed rate period, borrowers have the option to refix their loan at a new market rate or switch to a variable rate. The benefit of a fixed loan is borrowers don’t have to pay more on their loan if interest rates rise. However, the disadvantage is that borrowers won’t be able to reduce their payments if interest rates drop.

There are a few different aspects of a fixed rate loan you may need to look into before deciding if it is right for you:

• The cost of having a fixed rate may be higher as the rate is usually higher than a variable rate. This does depend on the loan and lender.
• There is less flexibility with a fixed rate loan. Extra repayments might not be possible and there may be higher costs if you choose to leave this mortgage.
• Finally, it’s rare to find a fixed rate loans with offset accounts.

What happens when the fixed period on my interest rate ends?

Once your fixed period is over, your rate will switch to the current variable rate. When you reach that period, look up the revert rate so you know how your repayments will be affected.

It is hard to say if your repayments will be higher or lower once the fixed period ends. The rate at the time depends on the lender, the product and what the current market rates. If the revert rate is high, it would be a good time to refinance or speak to your lender and see if they can offer you a discount

What do I look for when comparing fixed rates?

Finding a good fixed rate product is not too difficult if you know what to look for. You should look for the following:

• A low interest rate: A lower interest rate will mean your monthly repayments will in turn be lower. Locking in a good rate is protection in case interest rates sky rocket.
• Low fees:Research all monthly and annual fees and see which one has the lowest fees for the same features.
• Length:When selecting a fixed rate, you will be offered a choice between 1 to 5 years to lock it in. There are different rates for each length of time. Shorter fixed terms are usually lower so you will find a fixed rate for 1 year is more competitive than that of a 5 year contract.

Should I fix my home loan?

Even though most Australians go with variable home loans, there are some great reasons to fix yours, especially in times when interest rates are incredible low.

The benefits of fixing your home loan

The biggest and most obvious advantage in having a fixed rate is that your monthly repayments will remain the same, month after month. It makes it easier to budget and you won’t have any nasty shocks throughout the fixed period.

And, if variable interest rates rise, you will not be affected during that time.

The disadvantages of fixing

There are numerous reasons why fixed interest rates are not the loan of choice for most Australians.

Fixed rate loans have less features and flexibility compared to variable rate mortgages.

You may need to pay a break cost if you decide to leave a fixed rate loan before the end of the specified term. This can be quite costly, ending up being anywhere from a few hundred dollars to thousands.

If the RBA slashes the cash rate you will end up with a much higher interest rate than is necessary.

Are fixed rates cheaper?

The purpose of  fixed rate loan is to give you peace of mind knowing exactly what your repayments will be, month after month. If you are happy with your rate and don’t think you will need to exit the loan for the required amount of time, then a fixed rate could be for you. You just need to always keep in mind that if interest rates drop, your repayments will stay as they are.

There are other mortgage types.

1. Split rate home loan

A split home loan is when you divide your loan into two parts.

This means a portion of the loan could come under a fixed interest rate with the remainder being variable.

This is a popular choice by many borrowers, as it gives them the flexibility to make extra repayments on the variable portion, whilst mitigating the uncertainty of fluctuating rates through the fixed part of the loan.

2. Low deposit home loan

A low deposit home loan (also known as High Loan to Value Ratio Loan) is one that allows a borrower to buy a home with a small deposit: as little as 5 to 10% of the home value. A low deposit home loan, means the loan amount will be much higher, however it’s a great option if you want to break into the property market but don’t have a sizeable deposit.

3. Owner occupier loan

Owner occupier loans are for those who want to live in the property and not rent it out.

These loans are highlighted by lower interest rates and fees as compared to investment loans, as the banks see these loans as less risky than an investment property loan.

4. Investment loan

Investment loans may have slightly higher interest rates and fees to those of owner occupier loans. They offer a different selection of benefits and features, that are more relevant to investors such as longer interest-free periods.

5. Offset home loans

An offset account is a transaction account linked to your home loan. It is used just like a regular account where you can make withdrawals and deposits, except the interest payment due on the loan is calculated on the net balance of the loan minus what’s in your savings account. This reduces the amount of interest charged on your home loan.

6. Reverse Mortgage

A reverse mortgage is for people over 60 years old. It allows them to use the equity on their home as a source of income, allowing them to redraw on that money at any time to use as they please.

How much money can I borrow?

Before you start looking for your dream home, it’s advisable to know where you stand financially as this will indicate how much you will be permitted to borrow.

Lenders will look at all aspects of your finances from your income to your spending habits. So before you approach a lending institution, make sure you have a comprehensive list of all your income and expenditure so you will know exactly where you stand.

InfoChoice has a range of calculators to help you calculate your expenses and borrowing power.

The amount the lender will allow you to borrow depends on a number of things:

• your income and expenses
• your debts and liabilities
• how much deposit you have
• the value of your property
• your credit history
• your employment history

Always check your credit rating in advance so you now where you stand.

It’s also advisable to modify your spending habits in the months leading up to applying for a loan. Reducing any outstanding credit card debt or personal loans will be of enormous benefit to your chances of a successful application.

How much of a deposit do you need to buy a home?

Saving for a deposit is the first obstacle on the journey to buying a home.

If you aim to save 20% deposit of the property’s value, then you will have a better chance at securing a home loan with a more competitive interest rate.

Having an 80% LVR (loan-to value ratio) will put you in a decent position to get a home loan with all the features you may need.

In some cases, you can enter the property market with a deposit of as little as 5 to 10%, but keep in mind these types of loans may have restricted benefits and may also incur Lenders Mortgage Insurance (LMI) fees on top of your loan. These fees can add thousands of dollars to your final loan amount.

What type of home loan fees are there?

There are a variety of fees you will need to budget for.

1. Application fee

The upfront fee you pay when first applying for your home loan.

2. Service fee

This covers the cost of maintaining your loan. It may change monthly or annually. As a general rule, the more benefits you have with your home loan, the more chances you will incur a service fee.

3. Legal fees

These fees are paid upfront and cover the cost of all your legal documents.

4. Valuation fees

These fees cover the cost for someone to value your property.

5. Settlement fees

The fee charged to have someone present at the settlement of your loan.

6. Discharge fee

Once your home loan is paid off in full, you may be charged a discharge fee to cover the completion of the mortgage process and documents.

7. Feature fees

Certain features, such as extra repayments, a redraw facility or an offset account  may attract a fee. Not all home loans exact these fees.

What types of features are available for home loans?

Having the right features available to you on your home loan may help you pay off the loan in a shorter amount of time. They might even mean you could redraw the money you have already paid into it, to use for other purchases.

Here are is a list of features you should consider when comparing home loans.

1. Extra repayments

If your loan allows it, you can make extra repayments whenever you have the extra money. The extra payment comes draws down on the principal, meaning you can pay off you loan in a shorter amount of time. You may also end up paying less in interest, as the interest charged is calculated on your current principal. Not all home loans allow extra repayments. If you are on a fixed interest rate, you may not be eligible for this feature.

2. Redraw facility

Certain loans allow you to redraw on the extra repayments you have made into your home loan. The benefit of a redraw facility is you can put any extra money you have into your loan at times when you don’t need to use it. This will decrease the principal and, in turn, reduce the amount you are paying in interest. You can then take that money out and use it at any point in time. Fees and redraw limits may apply.

3. Offset Account

An offset account is a transaction bank account connected to your home loan. The money from this account is used to offset your mortgage, which means you’re only charged interest on the difference between the total loan balance and the amount offset. For example, if you owe $200,000 on your mortgage but you have $20,000 in your offset account, the bank would only calculate interest on $180,000.

Who do I speak to in regards to getting a home loans?

Once you have conducted all of your research and made your comparisons, it’s time to approach a bank or lending institution. You can go into a branch or even chat on line. Some lending institutions have mobile lending services where they can send someone to your home or place of work to discuss your home loan needs.

If choosing a home loan provider and relevant home loan product is too overwhelming, you can request the help of a mortgage broker.

Mortgage brokers are experts in home loans who can assess your finances and suggest the best home loans for you. They can also negotiate with lenders on your behalf often resulting in a better deal for you.

Mortgage brokers are paid commissions by banks when they sign up new home loan customers, therefore using their services shouldn’t cost you a cent.

7 steps to take to buy a property

Before approaching a bank or broker, you should put your financial and administrative affairs in order. This means you should:

1. Collect all of your financial documents. Include all payslips, bank statements and bills. Also list all your expenditure from food to entertainment.
2. Fill out a lenders mortgage application form.
3. Get pre-approval, (also known as conditional approval). This means that a lender has agreed to lend you money, but hasn’t proceeded to final approval.
4. Make an offer on the property you are interested in.
5. The lender will do a credit check on you and make a valuation on the property to make sure it is within a price range that you can comfortably repay.
6. Upon application approval, sign the formal offer and contract.
7. Prepare for the legal transfer of all documents and property title. This is known as the settlement. Usually a solicitor or conveyancer attends the settlement on your behalf.

10 steps to take to move into your property

There are many more things to consider when buying a home, than just taking out a mortgage. Some of these we have touched on already, but the following points offer a comprehensive guide of what should be considered when applying for a home loan.

1. Research property prices and understand your borrowing power?

Your entire buying experience will be dictated by this first step. You need to establish what your income and expenses are, which you can do by using the InfoChoice Borrowing Power Calculator. This will determine how much you can afford in repayments. This is also the time to start researching property prices in the area you would like to purchase, so you have a realistic idea about budget.

2. Save a deposit

Have a minimum deposit of 5% saved up to avoid having to pay the extra fee for mortgage insurance. Having a 20% deposit is better.

3. Compare home loans

Do your research and find a loan that suits your needs in terms of features as well as a comparative interest rate. You can compare home loan interest rates here.

4. Find a property

Finding the perfect home for you is a very personal experience. Search online for properties that have the facilities you need, then go to as many inspections as possible to make sure it looks and feels the same way in real life as it does from the images online. If you find a property that you are serious about, don’t forget to get a building inspection done.

5. Get pre-approval

Getting pre-approval gives you peace of mind when it comes to putting in an offer on a property. If you have pre-approval, you know the lender will almost certainly give you the loan, as they have already assessed your financial situation and deemed you a good candidate for a home loan.

6. Contract of sale

A contract of sale is a document that is signed once you have put it an offer on a property and it has been accepted. Make sure to have a licensed conveyancer look over the contract and assist you with settlement. There is a cooling off period of three business days where you can change your mind. This is a good time to bring in the building inspector and make sure the property doesn’t have any underlying issues that you weren’t aware of.

7. Mortgage application

Once you have put in your deposit and signed the contract of sale, it’s time to get full approval for your mortgage.

8. Approval

After your lender approves your application, you need to wait until date of settlement.

In the meantime, get a few things in order such as building and contents insurance.

9. Settlement

This is the day that the property becomes yours and you receive the title and the keys.

All legal checks are performed by the conveyancers to complete the property titles transfer.

10. Move in

Time to move in and make this house your home. This is the date that your mortgage repayments will begin.

How do I refinance a home loan?

There are many reasons why people choose to refinance home loans. Refinancing may put you on a lower interest rate or give you a mortgage with cheaper fees.

Refinancing your home loan may also be undertaken if you need to borrow more money for renovations, or consolidate debts.

You will still require a deposit if you are refinancing, but that deposit doesn’t have to be in the form a cash payment. You could use the equity in your current property.