What should I look for in a home loan?
When hunting for a house, you'll generally have a list of factors and features you want and need in a property – perhaps a certain number of bedrooms or an island bench. But savvy homebuyers and refinancers will also take the time to think about what they need in a mortgage.
Here’s a list of questions to ask yourself when choosing a home loan, broken down into five key themes:
- Loan needs: How large is my deposit and what is the value of the property I want to buy?
- Type of loan: What’s the best loan for my financial situation and lifestyle?
- Ongoing cost of the loan: How much am I willing to pay in interest and fees in the years to come?
- Upfront costs of the loan: How much should I set aside to get my mortgage up and running?
- Conditional costs: Do I need to pay for Lenders Mortgage Insurance (LMI)? Will I roll stamp duty into the loan or pay it out of pocket?
1. Loan needs: How large is my deposit and what is the value of the property I want to buy?
Working out how much you want to spend on a property compared to how much of a deposit (or equity) you can contribute is a good place to start when considering your home loan needs. These two figures will determine your loan-to-value ratio (LVR), which can influence the home loans you’re eligible for. There are two things you need to calculate your LVR:
- Property price: You should have a rough idea of what property you want to buy and how much you’re willing to spend to buy it. It’s not essential to have an exact figure – a ballpark number should suffice.
- Your deposit or equity: How much you’ve saved for a deposit or how much equity you’ve built in a property will influence risk a lender takes on in offering you a loan.
LVR represents the percentage of the property’s value that you're borrowing, which depends directly on the size of your deposit. The larger your deposit, the lower your LVR will be.
If you have a deposit of $120,000 and want to buy a property worth $600,000, you’ll probably need to take out a $480,000 home loan. That means your LVR will be 80%, as per this calculation:
($600,000 – $120,000) ÷ ($600,000) x 100 = 80%
Many lenders charge higher interest rates to borrowers with higher LVRs and, if your LVR is above 80%, and you may be required to pay for Lenders Mortgage Insurance (LMI).
It’s important to note that lenders will weigh up the following criteria before approving or rejecting a home loan for the amount you want:
- Your financial situation (your outstanding debt, expenses, and income)
- Your credit history
- The type of property you want to buy
It’s also worth considering getting home loan pre-approval, which can give you a more accurate assessment of your borrowing power, helping you work out which properties you can afford to buy.
2. Type of loan: What’s the best loan for my situation?
There are several different types of home loans available, and the right one for you will depend on whether you plan to live in or rent out your property, how stable you’d like your interest rate to be, and how soon you want to start repaying the debt.
When shopping around for a home loan, it’s important to differentiate between whether you’re looking for property:
- To rent out, in which case you’ll need an investment home loan or
- To live in, which will require an owner-occupier home loan.
You can also choose whether to pay down the debt straight away or wait for a period:
- Principal-and-interest (P&I) loan: your repayments go towards paying off the amount you borrowed (the principal) and any interest charges.
- Interest only (IO) loan: your repayments only go towards paying the interest accruing for a certain period of time, before your loan reverts to P&I repayments.
Then, consider how stable you want the interest rate you’re charged to be. There are three options here:
- Fixed rate home loan: The interest rate won’t change for a set period, and repayments will remain the same for that time.
- Variable rate home loan: The interest rate can fluctuate alongside market conditions. Variable rate home loans often have more features than fixed rate home loans and can offer more flexibility
- Split rate home loan: A combination of both of the above, whereby part of the debt has a fixed rate of interest and the rest has a variable rate, potentially allowing a borrower to access certain features and enjoy a greater level of flexibility while also realising stability.
Different loans can yield different outcomes depending on your situation. For example, fixed rate home loans provide repayment certainty while variable rate home loans often have more features. These might include:
- A redraw facility, which lets you access extra repayments you’ve made
- An offset account, which works like a savings account, but any balance reduces the amount of mortgage debt that interest accrues on
- The ability to make extra repayments
- The ability to pay off the loan early.
3. Ongoing cost of the loan: How much am I willing to pay in interest and fees in the years to come?
Your home loan’s interest rate can help determine how much you’ll end up paying in the long run. However, the lowest rate home loan available to you may not have the features you want, which is why it’s important to compare your home loan options.
Additionally, you should also consider a home loan’s comparison rate, which factors in both interest and fees to reflect the total cost of a loan.
4. Upfront costs: How much should I set aside to get my mortgage up and running?
When it comes to fees borrowers are usually charged to take out a loan, you can expect the following:
- Loan application or establishment fees
- Mortgage registration fee
- Lenders Mortgage Insurance (if applicable)
- Loan-specific charges, such as annual or monthly fees, settlement, and valuation fees.
5. Conditional costs: Do I need Lenders Mortgage Insurance (LMI)?
Depending on your LVR, a lender may require you to pay for LMI, which protects the lender from loss if the borrower defaults on their home loan.
LMI is often required for borrowers with LVRs above 80%, as they’re typically considered a greater risk for lenders than borrowers with a larger deposit.
Several factors can affect the cost of LMI, such as:
- The size of your home loan
- Your deposit amount
- Whether you’re buying the property for investment purposes or to live in
- Your financial situation
- The insurer used by the financial institution
Some government schemes, such as the Australian Government 5% Deposit Scheme and the Help to Buy scheme, can allow buyers with smaller deposits to enter the market without paying for LMI. Several banks also offer LMI waivers to those in specific professions, and some lenders, such as Ubank, won’t charge LMI to borrowers with deposits of 10% or more.
What other factors should I consider when looking for a home loan?
Taking on a home loan is a major financial decision and if you feel unsure about making the decision yourself, or you'd like some extra information to help you choose, you might consider the following courses of action:
- Get advice from a professional like a mortgage broker or clarify any questions you have with your potential lender
- Check your credit score (you can check your credit score for free with Canstar or via the Canstar App)
- Make sure you could still meet your repayments if interest rates change before you commit to a home loan
