The interest rate being offered will have a huge effect on how much you pay over the life of your home loan and there are three main types of interest rates to consider;
- Variable rate – this is a rate of interest that fluctuates according to the market. Variable rate loans are usually cheaper than fixed rate loans because you are basically taking a punt on whether the rate will rise or fall in the future. This rate moves in response to the Reserve Bank’s cash interest rate and most lenders adjust their rates according to its movements. The gamble you take is that if the interest rate goes down you will be paying less, but if it goes up, you will be paying more for your loan.
- Fixed rate – this is a predetermined rate of interest that applies to a home loan for a set period of time (usually one to five years). That means you will be charged the same rate of interest for that entire period, allowing you to budget ahead with confidence, knowing you will be able to meet your repayments. The downside of this is that a fixed rate mortgage typically costs more than a variable rate one. So you would need to decide whether a sense of security is worth more to you than the possible savings a falling variable interest rate might afford.
- Split rate – this is a partially-fixed rate, where you can choose to pay a fixed rate on part of your mortgage (usually the majority) and a variable rate on the remainder. This can give you the best of both worlds; the security of knowing what your payments will be on the fixed portion plus the possible benefit of lower interest on the variable portion.
Because they are typically more affordable, many of the home loans taken out in Australia are variable rate mortgages. A variable interest rate of 4% or less is considered to be a good rate, although the lowest interest rate does not always mean the best value, because other factors such as fees can add thousands to a home loan. That’s why a more important rate to compare is the comparison rate.
The comparison rate is the rate that gives you a more accurate picture of the cost of a loan. It not only includes the interest rate but also most of the fees and charges relating to the loan and presents them in a single percentage figure which you can compare with other rates at a glance.
Credit providers are required to include a comparison rate when they advertise an interest rate or weekly payment rate for a home loan. And this can quickly sort the sheep from the goats when what appears to be a good offer based on the interest rate alone has a raft of fees and charges added to it, which significantly increases the comparison rate.
Typical fees attached to a mortgage can include application fees, valuation fees, settlement fees, discharge fees and ongoing monthly and annual fees, all of which can add thousands of dollars to the cost of your home loan.
But it’s important to keep in mind that the comparison rate alone may not take every cost into consideration, as some mortgages have special costs that aren’t required to be included or valuable extra features that aren’t accounted for, so the comparison rate can only ever be an approximation, albeit a valuable one.
Home loan features
Along with the comparison rate, another consideration when comparing home loans is the features offered by each. Many mortgages come with a range of useful and money-saving features including;
- Offset account - a savings or transaction account linked to your home loan which is included when calculating your interest to help limit the size of your mortgage repayments.
- Redraw facility - allows you to withdraw surplus funds from your loan which can be used to manage unexpected expenses.
- Extra repayments - allows you to make extra payments if you wish, helping you to reduce the interest more quickly and begin paying off more of the principle.
Whether a home loan includes these features will depend on the lender and you should make sure they are useful in your situation before allowing them to influence your decision on whether a particular mortgage is right for you.
Other factors to consider
As well as a home loan’s interest rate, fees and features, other factors which can influence how much you will pay and whether it is the right loan for you can include;
- Your Loan to Value Ratio (LVR) – this is determined by dividing the amount of the loan you are applying for by the value of the property you intend to buy. The higher your LVR, the greater your risk to the lender and hence the higher your interest rate will be. If your LVR is higher than 80%, you will also be required to pay lender’s mortgage insurance (covers the lender if you default on your home loan).
- Your likelihood of suffering mortgage stress – this is experienced when 30% or more of your income is going towards your mortgage repayments. Mortgage stress is most often the result of people taking out variable rate mortgages without being able to afford potential rate rises.
- The length of loan term you select - most mortgages are over a period of 25 or 30 years, so while opting for a shorter period than this would involve higher repayments, they would be over a shorter time and you would pay less interest as a result.
- The type of borrower you are – if you are an owner occupier, you will typically be offered a lower interest rate than an investor, as you are considered less of a risk to the lender than an investor and less likely to default on your loan because you would risk losing your home. Additional government regulations also apply to investment home loans, making them more expensive.
- The type of repayments you opt for – whether you choose principal and interest (P&I) or interest only repayments will affect how much interest you pay over the life of the loan. But while interest only repayments are cheaper, the principal is not being reduced as fast, so most people opt for the slow and steady principle and interest payment method.
Need help with your home loan comparisons?
A home loan is the biggest financial commitment most of us ever make, so it’s important to get it right first time. Enlisting the services of a mortgage broker won’t cost you a cent and it could well save you thousands of dollars in invaluable advice.
To calculate how much you can afford to borrow, benefit from free professional advice and compare home loans from over 30 different lenders, see us first at Loan Market.