For many Australians, purchasing a home is one of the biggest – and scariest – financial decisions they will make.
Previously I discussed considerations regarding how much to save and home loan approval criteria. In part 2 I look at how to select the best home loan that suits your personal circumstances.
Choosing a home loan
Before you rush into signing up with any home loan, you should consider the type of loan that’s right for you. The fees and features offered by each lender differ and there are a multitude of variations available to suit your personal needs.
Depending on whether you’re a first homebuyer, second homebuyer, are self-employed or thinking about renovating, refinancing or investing, your loan needs to accommodate your individual circumstances. The following factors should be considered when making a home loan decision.
Fixed Rate Vs Variable Rate Home Loans
As the name suggests, a variable rate home loan means the interest you pay can change at any time, depending on the RBA’s official cash rate and the overall state of the economy. The risk of choosing a variable rate home loan is the potential for rates to go up, however this loan traditionally has lower interest rates than a fixed rate home loan.
On the other hand, with a fixed rate home loan you will know exactly how much your repayments will be. Knowing your rate in advance can help you budget more effectively. However, fixed rate home loans usually have less features than a variable rate home loan and higher break cost fees apply if you switch home loans or pay the loan out during the fixed rate period.
It’s important that you compare interest rates between different home loan options. Interest will be the single biggest cost you face – a $300 000 home loan with a 6.5% interest rate will cost you over $300 000 in interest alone.
You will generally see two rates when you compare interest rates on home loans – the ‘headline’ or advertised rate, and the comparison rate.
The headline rate is the one that you’ll pay your debt on day one, but is not a sufficient enough indicator to understand the cost of the loan. The comparison rate looks at the fees and charges that supply to a loan. A loan with a 6% headline rate may look attractive when compared to one with a 6.5% headline rate, but if the 6% loan has a $500 p.a. fee, then it may end up being just as expensive.
In other words, the comparison rate is a reasonably accurate guide to help you compare interest rates more accurately between two loans.
The ASIC mortgage calculator can help you work out how much your mortgage repayments will be, how much you can borrow, and how you can repay your home loan sooner: https://www.moneysmart.gov.au/tools-and-resources/calculators-and-apps/mortgage-calculator
Lenders offer many home loan features. Home loan options need to align with your needs, so loading up on features won’t necessarily maximise your returns.
The difference between a good and an outstanding home loan can include options such as no or low fees, a redraw facility, an offset account, flexible repayments and a repayment holiday. There is often a trade-off between having many features and a low interest rate, so make sure you are being selective by choosing a few key features that suit your circumstances.
There are many options to carefully consider when it comes to choosing a home loan – the decisions you make now will impact your life for years to come. Taking on too much debt can make reaching financial independence more difficult, particularly if things go wrong.