How To Choose The Right Home Loan For Your Needs
When searching for the best deal on a home loan, the interest rate is a key factor to consider. Since a home loan is a long-term commitment, even a slight difference in interest rates can accumulate significantly over time.
Home loans in Australia come with various options and features designed to suit different needs. Some loans offer greater flexibility, while others might help you pay off your mortgage more quickly. However, it’s important to assess whether these additional features will truly benefit you, as some may come with higher costs. Always compare your options to ensure you're choosing the best home loan for your financial situation.
Principal and interest will pay off the loan
Principal and interest loans
The most common type of home loan is a principal and interest loan. With this type of loan, you make regular repayments that cover both the amount borrowed (the principal) and the interest charged on that amount. The loan is repaid over an agreed period, such as 25 or 30 years, allowing you to gradually pay off the loan balance while managing interest payments along the way.
Interest-only Loans
Interest-only loans allow you to make repayments that cover only the interest on the loan for an initial period (e.g., five years). During this time, you're not reducing the principal you borrowed, meaning your overall debt remains unchanged. While your repayments may be lower during the interest-only period, they will increase significantly once the principal starts being paid off. It’s important to ensure that you can afford the higher repayments once the interest-only period ends.
Getting The Shortest Loan Term You Can Afford
Your loan term determines how long you have to repay your mortgage, and it directly affects both the size of your monthly repayments and the total amount of interest you’ll pay.
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A shorter loan term (e.g., 20 years) means higher repayments, but you'll pay less in interest overall.
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A longer loan term (e.g., 30 years) results in lower repayments, but you’ll end up paying more in interest over the life of the loan.
Aim for the lowest interest rate
An interest rate that's even 0.5% lower can save you ten of thousands of dollars over the life of your loan. When choosing between fixed and variable interest rates, it’s essential to weigh the pros and cons of each to determine which option best suits your financial goals and circumstances.
Fixed Interest Rate
A fixed interest rate remains the same for a set period (e.g., five years), after which it may switch to a variable interest rate, or you can negotiate another fixed rate.
Pros:
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Easier budgeting, as your repayments are predictable.
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Fewer loan features, which could reduce your overall costs.
Cons:
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No benefit if interest rates decrease.
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Break fees could make it more expensive to switch loans later.
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You may not be able to make extra repayments without incurring additional costs.
Variable Interest Rate
A variable interest rate can fluctuate up or down based on changes in the lending market, such as shifts in official cash rates.
Pros:
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More loan features offering greater flexibility.
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Easier to switch loans if you find a better deal.
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You may have the ability to make extra repayments.
Cons:
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Harder to budget, as repayments may change.
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More loan features could increase your costs.
Split Loan
If you're unsure whether a fixed or variable interest rate is the best option for you, consider a split loan. With a partially-fixed rate, a portion of your loan has a fixed rate, while the remaining part has a variable rate. You can choose how to split the loan (for example, 50/50 or 20/80), giving you the flexibility to balance the benefits of both options.
Mortgage features come at a cost
Mortgage features often come with additional costs. Home loans that offer more options or features, such as an offset account, redraw facility, or line of credit, may have higher fees or interest rates. These features can be beneficial as they allow you to deposit extra money into your loan, which helps reduce the amount of interest you pay over time. However, it’s important to weigh the added cost of these features against the potential savings they offer.
Weigh up if features are worth it
For example, let's say you're considering a $500,000 loan with an offset account. If you're able to maintain $20,000 in the offset, you'll only pay interest on $480,000, potentially saving you money in the long run. However, if your offset balance tends to stay low (for instance, under $10,000), the cost of this feature may outweigh the benefits. In such cases, it might not be worth paying extra for the offset account if it doesn't significantly reduce your interest payments.
Avoid paying more for 'nice-to-have' options
When comparing home loans, it's essential to consider your lifestyle and determine which features are truly necessary. Ask yourself, what are the 'must-haves' and what are the 'nice-to-haves'? If you’re not likely to use certain features, it may not be worth paying extra for them. In many cases, opting for a basic loan with fewer features could save you money in the long run, especially if you don’t need the extra flexibility or options offered by more complex loans.
Work out what you can afford to borrow
Be realistic about what you can afford when taking out a home loan. To ensure you have some financial flexibility, calculate what your repayments would be if interest rates increased by 2%. This will give you a clearer picture of your potential future costs and help you avoid financial strain if rates rise. Always plan for the worst-case scenario to ensure your loan remains manageable even if the market conditions change.
Using a Mortgage Broker
With so many lenders and loan options available, enlisting the help of a mortgage broker can make the process easier. A mortgage broker can help you navigate through different home loan products, compare interest rates, and find a loan that best suits your needs.
Before working with a broker, it's important to know what to ask. Consider asking about their experience, the types of lenders they work with, any fees they charge, and how they can help you find the most suitable loan.
If you're looking for expert guidance, Avenstone can help you navigate the home loan process and find a loan that meets your needs. Our brokers are here to assist you every step of the way.
Case Study - Sophie and James
Sophie and James are looking to buy a $650,000 apartment. With a 20% deposit saved, they need to borrow $520,000 over a 25-year period.
To find the best loan deal, they start by checking comparison websites. They compare:
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Interest rates — variable vs fixed
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Fees — application fees, ongoing fees
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Features — basic vs extra features (like redraw facility and making additional repayments)
By ticking different boxes on the website, they filter loan options and narrow them down based on their priority of being able to make extra repayments.
Next, they repeat the process using another comparison website to ensure they're getting the best options.
After comparing the impact of different interest rates on the total loan cost over 25 years using a mortgage calculator, they shortlist loans from two lenders. Sophie and James then approach each lender to get a personalised written quote for their situation and ultimately choose the best loan option.
By carefully researching and comparing loan options, they make sure they're getting the best deal for their new home.
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Years Experience
20+
in Residential & Commercial Banking