Home loans are no longer just about signing up for 25 years and making regular loan payments – nor even just about trying to pay off the mortgage as quickly as possible. Flexibility and peace of mind are just as important, and there are a range of loan options that offer such benefits. However, these extras can cost money, and the key feature is still the interest rate.
Types of home loans
There are three main types:
- Basic loans: no frills loans with few features and a low interest rate. May offer redraw but there can be restrictions and fees so a basic loan may not suit if you want to make extra repayments and access them later.
- Standard loans: offer more flexibility than basic loans. You can redraw any extra money you've paid in, for example, and have the option to switch to a fixed rate, or split the loan into a fixed and variable portion. They also often offer a 100% offset account. But they come at the cost of a higher interest rate.
- Home loan package: standard loan with an interest rate discount of up to 1.2% depending on your loan amount, cheaper than many basic loans. The package normally includes a free transaction account and no annual fee credit card. However, high package fees apply of up to $400 per year.
Fixed or variable
At a time of historical low interest rates, low fixed rates sound tempting. But they can come with the downside of reduced flexibility. High break costs apply if you want to repay the loan early or relocate, and you're often not allowed to make extra repayments.
Don't try to beat the bank - it's very hard to predict if you'll save with a fixed rate over the next three or five years.
Instead, ask yourself if you can afford higher rates. If not, fixing at least part of the loan could be a good option for you. A split loan offers the best of both worlds allowing you to make extra repayments in the variable portion of the loan and still giving you the security of a fixed rate.
Watch the fees
Interest rates are just one of the costs to consider. You should also check the regular fees and charges. Fees and establishment costs can make a big difference to the amount you pay for your mortgage.
Don't be shy to ask your bank for a better deal. Interest rate discounts and fees waived are two things often on offer, especially if you're wanting to borrow a large amount.
Pay attention to the comparison rate, which takes into account the fees, making it easier to compare loans.
Some common fees include:
- Application fees: lenders may charge an upfront establishment fee and application fee. Ask the lender to waive these fees, or at least try to negotiate a discount.
- Valuation fees and lender's legal fees: lenders may also charge for a valuation of the property. If you're concerned you may not meet a lender's income requirements for the loan, ask them to check first before going ahead with the valuation, as you may have to pay for the valuation even if your loan doesn't get approved.
- Lender's mortgage insurance (LMI) can apply if you don't have an 20% deposit and it can cost you thousands of dollars. It doesn't insure you, but rather the lender (in case you default on the loan). It doesn't even absolve you from the debt – the insurer can chase you for it. Try to have as high a deposit as possible; even a small difference in the deposit can make a difference in the LMI cost.
- Monthly or annual fees: high ongoing fees can have an impact on how quickly you can pay back the loan.
- Break costs: fixed-interest loans can have high exit fees, especially if the variable interest rate is lower than the fixed rate you're paying. If you want to get out of the mortgage, you may have to make up all the 'lost' interest the bank would have made if you'd paid the higher rate through to the end of the fixed term. This is called the 'break cost'.
Features to look for
- Extra repayments: Some loans – particularly those with a fixed interest rate – may limit the amount you can pay without getting charged a break fee.
- Redraw facility: With many loans, if you make extra payments you can get the money back later. This can have considerable tax advantages and provide useful security as you can store your savings in your mortgage. Some redraw facilities are much easier to access than others – check whether you'll be required to apply in writing, how long it might take for approval to come through, and the costs involved.
- Repayment holidays: Some mortgages allow you to take a 'repayment holiday' for a short period such as six months, for example if you've just had a baby. Check the conditions, as sometimes you can only make use of this feature if you've made extra repayments, or you may have to make higher repayments after the repayment holiday to make up for it.
- Interest only: Paying interest only can be a useful feature for investors. It's usually available for five years but some loans offer it for up to ten years. It's risky though, as generally you'd want to pay back the loan as quickly as possible to minimise interest charges and avoid owing more than the property is worth in case of a market downturn. Here's some more info on negative gearing.
- Mortgage offset accounts: You deposit money in an account and receive interest in the form of a reduction in the interest due on your loan. Because offset accounts don't actually pay you any money, they don't add to your taxable income – so, like redraw facilities, they offer tax advantages.
For some features offered to first home buyers such as no-deposit home loans, family guarantees and 40-year home loans, check our report risky home loans.
Still confused? A good mortgage broker may be able to help.
Check out some more mortgage tips.