Choosing a home loan

When looking for a good deal on a home loan (mortgage), the interest rate matters. A home loan is a long-term debt, so even a small difference in interest adds up over time.

Home loans come with different options and features. These can offer flexibility or let you pay off your loan faster. Some options could cost you more, so make sure they’re worth it.

Principal and interest will pay off the loan

Principal and interest loans

Most people get this type of home loan. You make regular repayments on the amount borrowed (the principal), plus you pay interest on that amount. You pay off the loan over an agreed period of time (loan term), for example, 25 or 30 years.

Interest-only loans

For an initial period (for example, five years), your repayments only cover interest on the amount borrowed. You aren’t paying off the principal you borrowed, so your debt isn’t reduced. Repayments may be lower during the interest-only period, but they will go up after that. Make sure you can afford them. 

Get the shortest loan term you can afford

Your loan term is how long you have to pay off the loan. It impacts the size of your mortgage repayments and how much interest you’ll pay.

A shorter loan term (for example, 20 years) means higher repayments, but you’ll pay less in interest.

A longer loan term (for example, 30 years) means lower repayments, but you’ll pay more in interest.

Aim for the lowest interest rate

An interest rate even 0.5% lower could save you thousands of dollars over time.

Check the average interest rate

Choose your loan and repayment types to see the average interest rate for new home loans in February 2024 (Reserve Bank of Australia). Interest rates are rising, so the average rate may now be higher.

Weigh up the pros and cons of fixed and variable interest rates to decide which suits you.

Fixed interest rate

A fixed interest rate stays the same for a set period (for example, five years). The rate then goes to a variable interest rate, or you can negotiate another fixed rate.

Pros:

• Makes budgeting easier as you know what your repayments will be.

• Fewer loan features could cost you less.

Cons:

• You won’t get the benefit if interest rates go down.

• It may cost more to switch loans later, if you’re charged a break free. 

Variable interest rate

A variable interest rate can go up or down as the lending market changes (for example when official cash rates change).

Pros:

• More loan features may offer you greater flexibility.

• It’s usually easier to switch loans later, if you find a better deal.

Cons:

• Makes budgeting harder as your repayments could go up or down.

• More loan features could cost you more.

Partially-fixed rate

If you’re not sure whether a fixed or variable interest rate is right for you, consider a bit of both. With a partially-fixed rate (split loan), a portion of your loan has a fixed rate and the rest has a variable rate. You can decide how to split the loan (for example, 50/50 or 20/80).

Mortgage features come at a cost

Home loans with more options or features can come at a higher cost. These could include an offset account, redraw or line of credit facilities. Most are ways of putting extra money into your loan to reduce the amount of interest you pay.

Weigh up if features are worth it

For example, suppose you are considering a $500,000 loan with an offset account. If you’re able to keep $20,000 of savings in the offset, you’ll pay interest on $480,000. But if your offset balance will always be low (for example under $10,000), it may not be worth paying for this feature.

Avoid paying more for ‘nice-to-have’ options

When comparing loans, consider your lifestyle and what options you really need. What features are ‘must-haves’? What are ‘nice-to-haves’? Is it worth paying extra for features you may never use? You may be better off choosing a basic loan with limited features.

Work out what you can afford to borrow

Be realistic about what you can afford. Mortgage interest rates can fluctuate, so give yourself some breathing room.

Compare home loans

With the amount you can afford to borrow, compare loans from at least two different lenders. Check the loan interest rates, fees and features to get the best loan for you.

Comparison websites can be useful, but they are businesses and may make money through promoted links. They may not cover all your options. See what to keep in mind when using comparison websites.

Compare these features:

Interest rate (per year)	interest rate advertised by a lender
Comparison rate (per year)	a single figure of the cost of the loan — includes the interest rate and most fees
Monthly repayment	how much you’ll have to pay each month on a loan
Application fee	one-off payment when starting a loan, also called establishment, up-front or set-up fee
Ongoing fees	fees charged every month or year for administering a loan, also called service or administration fees
Loan term	length of time a loan lasts
Loan features	such as offset account, redraw or line of credit and their fees (for example to redraw money)

Using a mortgage broker

With many lenders to choose from, you may decide to get a mortgage broker to find loan options for you. Speak to us for more help.

Case Study

Mai and Michael get the best deal on a home loan

Mai and Michael are looking to buy a $600,000 apartment. They’ve saved a 20% deposit and want to borrow $480,000 over 25 years.

They check a comparison website to compare:

• interest rates — variable versus fixed

• fees — application fee, ongoing fees

• features — basic versus extra (redraw facility, additional repayments)

Ticking different boxes on the website, they look at loan options to see how the cost varies. They decide they want to be able to make additional repayments. Using this as a filter, they review loan options.

They repeat the process with another comparison website.

Then, using the mortgage calculator, they compare the impact of different interest rates over 25 years.

Based on their research, they shortlist loans from two lenders. They approach each lender to get a written quote personalised for their situation, then choose the best loan.

Source:
Reproduced with the permission of ASIC’s MoneySmart Team. This article was originally published at https://moneysmart.gov.au/home-loans/choosing-a-home-loan

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