Choosing the best home loan for your circumstances means more than just finding the lowest interest rate. Different lenders will have their own policies relating to minimum deposit amounts, mandatory insurances, hidden fees and extra products attached to home loans and it is worth researching them all before becoming locked into anything. An experienced mortgage broker will know all the ins and outs of each bank, so it is always important to consider their advice when choosing a home loan.
If you do opt to do the research yourself, you should consider the following when deciding on your home loan.
The type of loan
The types of home loans that may be available to you are interest-only and principal and interest. An interest-only loan means that for the initial period of your loan you will only pay the interest accrued on it. While the payments are lower on this type of loan, that is because you are only paying interest and the amount of your overall debt will not be reduced.
A principal and interest loan will come with higher repayments, but you will be paying off your base debt from the time you make your first payment.
It is important that you consider whether the small savings on your payments in the initial period of an interest-only loan will be beneficial to you in the long term and also that you factor in whether you can afford the increase in payments once the initial period is over.
Various fees and insurances
Interest and monthly repayments may already seem like a lot of money but be careful not to overlook any other fees that may be associated with the home loan you are interested in. These fees can include:
- Application or establishment fees;
- Property valuation fees;
- Annual fees and account-keeping fees if you have an offset account;
- Late payment fees;
- Early exit, discharge or break fees; and
- Lender’s Mortgage Insurance (LMI).
While most of the fees will only come into effect at the establishment or discharge of the loan, some ongoing costs may come as a surprise, such as Lender’s Mortgage Insurance. If you have a deposit of less than 20% of the purchase price you are almost guaranteed to have to take our LMI, which is designed to protect the lender in case you default on the loan.
The more of a deposit you have saved, the less likely it is that you will need to pay LMI.
The length of the loan
It is usually recommended that you choose to pay off your home loan in the shortest amount of time you can afford. Of course, a shorter loan term means higher payments, but that also means paying the loan down quicker, paying less in interest overall and having more equity in the property at a faster rate.
While it is beneficial to pay your loan off quicker, it is also vital that you consider factors like interest rates rising and instalments increasing and ensuring you do not overextend yourself in an attempt to pay the loan off quicker.
On the other hand, a longer loan term means paying more in interest over the life of the loan and on such a large amount of money, this can be the difference of tens or even hundreds of thousands of dollars compared to a loan with five or ten years less on its term.
The interest rate
While it’s not the only thing to think about, it is a big factor to consider. Over the life of your loan, even a 0.5% difference in interest rates could save (or cost) you thousands of dollars.
You will need to weigh up whether or not a fixed or variable interest rate is most suited to your situation, too.
A fixed interest rate stays the same for a certain period. After this period expires it will either become a variable interest rate unless you can negotiate another fixed interest rate period. The benefit of having a fixed interest loan is that you always know what your repayments will be. The negative, however, is that if there is a rate cut you will not benefit from it, meaning that interest rates could drop below yours and you will still be required to pay the higher rate.
A variable interest rate is the opposite and is subject to change depending on the market. Generally, with a variable interest rate loan, you are able to switch loans down the track with greater ease and you will benefit from any rate cuts that take place. It is, however, harder to budget for monthly payments as they may vary each time.
You may also be able to take advantage of a partial-fixed rate where a portion of your loan is subject to a fixed interest rate and the other portion is variable. You can choose the way the portion is split (for example 50/50 or 30/70) and this way you can hedge your bets and take advantage of the pros of each type of interest rate.
Taking out a home loan is not something that should be done without some research, careful planning and a little bit of negotiation. By considering your current and future earning potential, your ability to save and how an interest rate increase may affect you and your age and other personal circumstances you should be able to settle on a loan that suits your financial circumstances comfortably.
If you are considering getting a home loan or refinancing, speak to a mortgage broker at Preston Finance and Insurance in Cairns.