5 questions to ask when choosing a home loan

From choosing your ideal suburb to furnishing your new digs, there’s plenty to get excited about when buying a home. For most people, the first thing on the to-do list should be finding a perfect home loan fit.

There’s heaps of choice in this area. Even with a single lender, there could be a dozen home loan options to investigate. Plus, during times of economic uncertainty (aka the COVID-19 world) the details of these offerings can change regularly.

If you’ve skimmed the options and are feeling overwhelmed, here are some of the questions you should be asking. It’s kind of like a personality quiz, but for home loans.

1. Am I an owner occupier or an investor?

This is essentially asking what you intended to do with the property. Do you plan to live there yourself, or will you attempt to profit off the purchase by renting it out or renovating and selling? Your answer could impact a few home loan elements, including:

Interest rates: An owner occupier will generally be able to access a better rate than an investor, who is often seen as a great risk. Investors will need to prove they have the funds to service this loan and existing housing costs. Potential rental or sale profits may also be considered to assess how this could help investors pay down the loan. 

Grants and exemptions: You may not be eligible for some government support grants and offers if you don’t plan to live at the property for a set time (often 6-12 months). A lot of these apply to first-time homeowners, like the First Home Owners Grant, First Home Super Saver Scheme and stamp duty exemptions. Read up on the details of each if you’re reaching for that first rung on the property ladder.

2. Should I start paying back principal and interest or interest only? 

To chip away at the amount of money you owe the bank, you’ll need to make repayments covering interest and the principal loan amount. This means you’ll steadily be paying less in interest as the loan reduces.

Interest-only loans will have smaller repayments since you’re not cutting into your debt, but normally have a cut-off time before you have to start paying back the mortgage. This might be a good short-term option if you want to get into the property market sooner without accruing more debt, but you will end up paying more in interest in the long-run. 

Generally, an interest-only home loan will come with a higher interest rate and stricter lending criteria. This is because borrowers who require lower repayments initially might be seen as a greater risk of defaulting on their loan. 

You may also find the required loan to value ratio (LVR) is set lower with an interest-only option. A high LVR means you have a smaller deposit to put towards the property purchase (say 10% of the property value instead of the suggested 20%). 

Since you’re borrowing a larger amount, this is riskier for the lender. They may only offer loans with a higher LVR to borrowers who can start paying off the principal and interest immediately, or set a higher interest rate.

3. Should I choose a fixed or variable home loan?

This is all tied to the market, how consistent you’d like mortgage repayments to be, and the kind of home loan features you want. Fixed rate home loans allow you to lock in an interest rate for a set period without it being affected by market fluctuation. Alternatively, the interest on variable rate home loans can increase or decrease at the lender's discretion.

There are benefits and disadvantages with each option, so assess them below and see how they might align with your circumstances.

Fixed rate pros

• currently lower interest rates on average than variable options
• favourable rates can be locked in, regardless of market changes
• repayments stay the same within the fixed period, making budgeting easier

Fixed rate cons

• no benefit from rate cuts
• typically not as fully-featured or flexible as variable loan
  

Variable rate pros 

• generally more access to cost-saving features
• often more flexible
• can benefit from rate cuts
  

Variable rate cons 

• interest rates can increase
• can be harder to budget with fluctuating repayments
  

4. What’s better: a lower interest rate or flexible features?

You may have to compromise on interest rates and fees to access beneficial home loan features, and vice versa. The trick is knowing which options suit your personal and financial situation best.

For example, you might be looking for a home loan that offers an offset account. This is a standard bank account linked to your loan which reduces the loan amount you pay interest on by whatever is in the account. So if you have a $400,000 mortgage but have $20,000 in savings sitting in an offset, you’ll only pay interest on $380,000 of the loan.

This sounds great, but you’ll need to do some calculations to see if it’s worth your while. If you don’t have a solid savings bundle and this feature comes with a fee or perhaps the loan has higher interest, it may not be to your advantage.

It’s a similar scenario for other potentially beneficial home loan features. You should consider your employment and salary security when seeking flexible repayment periods, free extra repayments, redraws or mortgage holidays. 

5. How does my deposit size impact home loan choices?

As mentioned, your deposit size can impact the interest rate and the kind of repayments available to you. However, if you do have a smaller deposit but want to take advantage of current market conditions or just get on the property ladder sooner, there are other factors to consider.

Lenders mortgage insurance (LMI) is an additional home loan cost generally charged if your deposit is under 20% of the property’s value. It functions as a kind of insurance for the lender in case you were to default on your home loan. 

Some banks have recently decreased this limit for borrowers in certain professions or have waived the fee in recent months for some borrower types. 

Another way to avoid this extra cost is by applying for the First Home Loan Deposit Scheme, through which the government guarantees the remainder of the deposit for first-time buyers. You can also get someone else to act as guarantor, putting up a portion of their own property as security on the loan.

Besides LMI, you’ll want to be on the lookout for ‘low-cost’ or ‘no-frills’ home loans if you can’t make the most out of other cost-saving features. Once you build up more equity in your home, you can also consider refinancing for a better deal.

How to save money on your home loan

Hopefully you’ve got a better grasp on all the important factors to consider when choosing a home loan. No matter the loan you land on, here are a few pearls of home loan wisdom to live by:

• Always shop around for a top interest rate.
• Don’t be afraid to negotiate when buying your home or settling on a mortgage.
• Find a home loan that suits your circumstances, with features you’ll get the most out of
• Take advantage of any government grants and subsidies.
• Save up as much of a deposit as possible, or look for ways to avoid low-deposit costs.
• Look to pay down the home loan sooner by setting manageable repayments within your budget, thereby paying less in interest. 
  

If you’ve got more home-buying questions, head to Mozo’s first home buyers hub.