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Last Updated on 18 October 2018

New to Home Loans? Everything You Need to Know


There’s a lot to understand when it comes to home loans. If you’re buying your first home, you might get confused with a bunch of rates and terminology you don’t understand.

We’ve compiled a comprehensive guide to understanding home loans to help you out. This piece should give you a better understanding of some of the terms and features you need to grasp to make an informed decision on the best home loan for you.

 

Key Points
  • You’ll need to decide whether a fixed or variable-rate loan is the best option for your circumstance. You can also hedge your bet by splitting your loan between the two.
  • You will be able to make interest-only or principal and interest repayments on your loan.
  • There are several helpful terms you should know so you are better equipped to understand what these lenders are offering.

Fixed Vs. Variable-Rate

One of the biggest considerations you want to make is whether you want a fixed-rate or variable-rate home loan.

The difference between the two is in the name. A variable-rate mortgage is subject to change. Interest rates might rise and fall over the course of the loan.

A fixed-rate mortgage locks your rate in place for a period of one to five years. There are benefits and disadvantages to choosing either kind of mortgage.

Which Option is Better?

As you can see, there are some attractive reasons to choose both fixed and variable-rate loans. Lenders incentivise variable-rate loans since they can charge higher interest rates if the market shifts.

If the borrower chooses a fixed-rate loan, the lender can’t adjust their price until their fixed period ends in the next five years.

Choosing between the two will come down to your circumstances. Variable-rate loans are best for people who plan on making extra payments during the early portion of their mortgage.

You will probably end up saving some money if you choose a variable-rate loan and make additional repayments the whole way through.

A fixed-rate loan is better for someone who wants security for the first few years of their loan. This model is better for a person or family who doesn’t plan on making additional repayments for the first three to five years.

A fixed-rate loan transitions into a standard variable-rate loan once the fixed-rate period is over. At this time, you’ll have access to all of the benefits a variable-rate loan offers.

Check with multiple lenders to make sure you’re getting the best rates and the most benefits out of your loan. The loan features vary significantly from lender to lender, so accurate comparison could save you thousands in the long-run.

Splitting Your Loan

Many lenders offer you an option to split your loan between variable and fixed. This means that a portion of your loan will change with the market while the other part will remain steady.

People choose to split their loan when they want to hedge their bets against interest rate changes.

Repayment Options

You’ll probably come across loans that offer principal and interest or interest-only repayments. Interest-only repayments can be attractive, but most investors agree that principal and interest repayments are a safer bet.

Interest-only repayments mean you’re only covering the interest for the first few years of the loan. These payments will be smaller than principal and interest repayments, but once the interest-only period ends you’ll end up paying more money.

You also won’t gain equity in your home as fast as you would with principal and interest repayments.

Interest-only repayments work for some circumstances – mostly investment properties – but not all. You might want to consider this structure if you have an investment opportunity that you’re confident will outweigh the value of your loan.

This structure might allow you to afford renovations and build equity that way, but you’re still at the mercy of the market to a degree. Your payments will eventually rise, and you need to make sure you have enough income to keep up.

Terms to Know

You’ll probably come across a few unfamiliar terms when you’re on the hunt for a home loan. It can be difficult to understand all of the information if you don’t have prior experience with home loans.

Below, we’ve listed some of the common home loan terminologies you’ll come across. You can use this guide for reference, so you know what these lenders are talking about.

Equity

Many lenders offer you an option to split your loan between variable and fixed. This means that a portion of your loan will change with the market while the other part will remain steady.

As an example: if you own a $300,000 house but owe the bank $100,000, you have $200,000 worth of equity in your home.

You can raise the amount of equity you have in a home by making improvements, increasing your monthly payments, and keeping up with regular maintenance.

If you let the quality of the property fall, the price will fall as well. You’ll still owe the bank the same amount of money, though, which means your equity will shrink. It’s possible to have negative equity in your home in a worst-case scenario. See our example on Sarah below.

The other factor that contributes to equity is the neighbourhood’s value, but this is largely out of your control. Prices rise and fall—which will affect your equity—but there isn’t much you can do about these market shifts.

LTV

LTV stands for loan-to-value, and it represents the difference between the house price and the loan amount. For example, a 60% LTV means you’re taking out a loan for 60% of the home’s market value. Having a loan with a 60% LTV means you need to put down a 40% down payment.

Most lenders allow you to borrow around 85-90% of the property value, meaning you’ll need to save at least 10-15% as a down payment. If you want to borrow more money for the house, you’ll be entering the low deposit loan territory.

These loans often cost more and come with greater stipulations. Some major financial institutions don’t offer low deposit loans since they are a risk for the lender.

Offset Accounts

Many variable-rate loans from major banks come with a feature known as an offset account. This feature allows you to open an account with your bank, and use the savings within that account to offset what you owe on your loan. You’ll only be charged interest on the difference between the two.

Put simply, the bank charges you less interest, which means more money in your pocket. Why? Because you’re not paying interest on the full, remaining balance of your loan. The deduction you receive depends on the type of offset account you have.

Offset accounts allow you to reduce your payments and earn equity in your property at a quicker rate. Most banks restrict offset accounts during the fixed-rate period of a loan.

Partial Offset

A partial offset account allows you to offset the principal or interest rate on your home loan. If you have $100,000 in your offset account with a bank that allows a 50% offset, then $50,000 of your balance will count towards bringing down the principal.

Another kind of partial offset account affects the interest rate. The interest rate on your offset account helps to lower the interest you pay on your home loan.

Partial Offset

A partial offset account allows you to offset the principal or interest rate on your home loan. If you have $100,000 in your offset account with a bank that allows a 50% offset, then $50,000 of your balance will count towards bringing down the principal.

Another kind of partial offset account affects the interest rate. The interest rate on your offset account helps to lower the interest you pay on your home loan.

100% Offset

The other type of offset account is a 100% offset account. As the name suggests, lenders take the entirety of your offset balance into account when calculating your principal. If you have an offset account with $100,000 in it with a $600,000 loan, you’ll only have to pay for the interest on $500,000.

Additional Repayments

Additional repayments are straightforward—they are any repayments you make on top of your required monthly payment on your loan.

Making additional repayments means you’re shortening the duration of your loan and saving money on interest. Most lenders cap or completely restrict your extra repayments on fixed-rate mortgages. So, keep this in mind if you’re looking for that extra flexibility.

After you reach the cap, any additional repayments will usually come with an early repayment fee. You can withdraw these additional repayments if needed with a redraw facility (see below).

Redraw Facilities

Redraw facilities refer to the ability to withdraw funds you make through your additional repayments. A redraw facility is useful if you suffer unexpected financial hardship and need immediate money.

When lenders allow additional repayments on fixed-rate loans, they often don’t offer a redraw facility feature. If a redraw facility sounds good to you, make sure you shop around for a loan that offers it.

Line of Credit

A line of credit loan works a bit like a credit card—you, as a borrower, can draw funds from your home’s equity when and if you need them. For example, you may want to invest in another property, take a holiday or renovate your home. Note that you will have a credit limit, and will only able to use funds until you reach your cap.

Most of the time, a bank uses your home equity as collateral for your loan. Therefore, these loan types can be somewhat risky for the borrower. As a result, most people use them to fund home improvements or for emergency spending.

The upside of a line of credit is the flexibility it provides. No one can predict their financial future, so the back-up funds can provide peace of mind to a degree. The other advantage: you only have to pay interest on the money you take out—for example, say you have $200,000 available to withdraw, but only spend $50,000, you’ll only pay interest on $50,000. The remaining $150,000 will continue to be available if you need it, but you won’t accrue interest until you actually touch it.

A line of credit is probably not the best idea for someone who lacks discipline. It’s tempting to use the money, especially as it is so accessible.

Collateral: An asset that the lender uses to secure the loan. In this case, the equity in your home will be the collateral. The lender evaluates how much your home is worth, and how much of that home you own. If you default on your loan, the lender will then own the piece of your house that was once yours.

Comparing is Your Greatest Ally

When you’re new to home loans, they can seem complicated and overwhelming with so many variables that come into play. Lenders offer different terms, features, and rates. Finding the right home loan for your situation is essential, so you don’t spend too much money in the long-run. Or worse, spend money or things you don’t need to.

We encourage you to use our free comparison tool if you’re looking at potential home loan rates and features. It can give you a better idea of what you can expect from some of the most popular lenders in Australia. What’s more? You can speak to one of our loan advisors, free of charge, to understand more about the options available to you.


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