Congrats, you've started your journey to purchasing your first home - an exciting time indeed! So what's next?
We understand that purchasing your first home and getting a mortgage can be a daunting prospect, that's why we've created this quick cheat sheet to run you through everything you need to know about getting your first home loan.
What home lending jargon do I need to know?
There's a lot of financial jargon that gets thrown around in the property buying sphere and as a first time borrower it can be a bit daunting. Read on and we'll get you up-to-speed on Australian lending acronyms and the terms you'll need to understand to get a great home loan deal.
Deposits and genuine savings
The recommended deposit for a property is a 20% down payment, though there are some options for first home buyers to have less (more on this later in the article). Most mortgage lenders now have a mandatory genuine savings policy which means that as an applicant you need to demonstrate that you can save consistently. Genuine savings is classified as having a growing balance (at least 3 months worth) in a savings account, term deposit or managed fund, and not relying on things like a tax refund, government first home owner grant or gift from family for your deposit.
LVR – Loan to value ratio
LVR stands for loan to value ratio and the easiest way to explain it is by giving an example. Say you're a first time buyer looking to buy a property for $300,000. If you have saved $30,000 you have a 10% deposit. This means your LVR would be 90% as you are borrowing 90% of the money needed to purchase the property.
The LVR is a way lenders determine whether or not you as a borrower will need to take out lender's mortgage insurance. Any loan with an LVR of 80% or more will require this insurance.
Banks have a range of home loan products and each loan will have different LVR requirements. Generally, loans with an LVR of 80% and under have the lowest interest rates. In the past it was possible for first home buyers to borrow up to 100% of the loan amount but after the GFC lending criteria was tightened and the maximum major banks will now lend is up to 95%.
Lenders mortgage insurance
As mentioned above if your first home loan deposit is less than 20% of the property value, you will have an LVR of over 80% and be required to pay lenders mortgage insurance (LMI), which is added to the cost of your home loan.
Don't confuse LMI with mortgage protection insurance because lenders mortgage insurance doesn't protect you the home loan borrower, instead it protects the home loan lender if you default on your loan. If you want to get protection in case you are unable to make repayments at some point in the future, you should consider mortgage protection or income protection insurance.
Another key aspect of lender's mortgage insurance you should be aware of as a first time buyer is that LMI is not transferable between loans. This means that if in a couple of years, you want to switch to another lender because your current deal isn't as competitive, unless you have got to the situation where you've built up 20% equity in your home, you will need to pay the insurance again. This is a major drawback as it can mean that the cost of paying the insurance a second time is likely to negate any savings you'd make by switching loans.
You've probably noticed that all advertised home loans display a comparison rate. The comparison rate is a government requirement and it is designed to show you the true cost of a loan. It is not, as many people think, a comparison between say Bank A's interest rate and other home loans. The comparison rate includes the interest rate (the amount you will be charged in interest) as well as any fees that you may have to pay upfront such as application, valuation or ongoing fees for a home loan.
You should use this rate, rather than the headline interest rate, to compare home loans as this will give you a truer indication of how much your loan will cost.
It is important to note however, that the advertised comparison rate displayed is an example only, based on monthly and principal interest repayments on a $150,000 loan over 25 years. If you are borrowing more or less than this, your comparison rate will be different and all lenders will be required to tell you what this will be based on your situation when you enquire about a home loan.
Choosing a home loan, what should I look for?
Now that you're in the know when it comes to bank lending jargon, it is time to run through the key features to look for in a home loan.
Competitive Interest rate
A great interest rate should be high on your priority list, as the lower your ongoing interest rate, the lower your monthly repayments will be. As a first home buyer you'll have the choice between choosing a variable and a fixed interest rate.
- A variable rate home loan means that your interest rate will change in line with the market, so over the loan term your repayments could go up or down. Generally, variable rate home loans have lower interest rates than fixed and also have extra features that help you save money like extra repayments and offset accounts. Watch out for ‘introductory’ rates that are low for the first couple of years then skyrocket to a much higher interest rate.
- While fixed rate loans are great for managing your repayments as they can’t change during the fixed term (usually 1 - 5 years), before signing on the dotted line you should check what the loan’s variable revert rate will be at the end of the fixed term and make sure it’s not excessively high compared with other loans in the market now. The reason is, if you don’t have an LVR of 80% or less at the end of the fixed loan term you will be stuck on this rate as refinancing to another loan would be costly as you’d need to pay LMI again.
- Split rate loans. This is an option on many home loans and it allows you to split your loan between a fixed and a variable rate. Generally, you can nominate the percentage split, eg. 60% fixed, 40% variable, but there are some lenders that will have a maximum split percentage.
While your LVR can determine which home loan option you will be eligible for, the other factor that can determine which interest rate you are charged will be the amount of money you are borrowing. Banks usually have lower rates for higher value home loans. It is important to realise however that just because it's your first home loan, this doesn't mean that you should accept the advertised rate from a bank or lender. The home loan market is very competitive and lenders are vying for your business so don't be shy in negotiating for a reduction in rates or fees.
Mozo has a free service that can help first home buyers get a better deal on their home loan. Our in-house experts can explain your home loan options, negotiate with banks on your behalf and secure you a top deal. See here for more info.
If you can limit the fees you pay, you can reduce the cost of your home loan. All home loans will have some fees attached so it is about finding a loan that has the least amount of fees for the features you require or the financial situation you're in.
Fees fall into two categories, upfront fees and ongoing fees. Buying a home isn't cheap so if you can limit the amount of upfront fees you can put more money towards things like furniture and appliances for your new home.
Common upfront fees include:
application fee. This is a fee payable to the lender to process your home loan application.
valuation fee. This is a fee for the bank to value your property. It is important to understand that the bank’s valuation may be different to the price you paid for the property. Some lenders will waive this fee if you proceed through to settlement.
settlement fee. This is a fee some banks will charge for their representative to attend settlement.
- package fee. If you opted for a home loan package which includes things like an offset account, credit card or discounted insurance you will pay a package fee. This will be an annual fee charged every year for the life of the loan.
- service fee. This is generally an administrative fee charged by your lender. Some lenders will charge this fee monthly or you may pay this fee annually.
There are a number of other fees that you may have to pay depending on your loan. A loan termination or loan discharge fee is a fee payable at the end of the loan to transfer the title into your name.
With fixed rate home loans, if you decide to pay out the loan early you would be up for break cost fees which can be expensive. These fees will be determined by the lender, see our page on fixed rate home loans for more information on break costs.
This is going to be your first home loan and it is likely that in the years to come your financial situation (as well as your personal one, a.k.a kids) will change, which is why you'll want a loan with flexible features that can help you reduce your interest repayments and time it takes to repay your loan and offer some repayment flexibility. However, not all of these features will come 'free' with the loan so if you are not going to use them, then you could be better off opting for a basic home loan with a low rate and less features. Here's the top ones you should look for:
- Offset account. An offset account is a transaction account that is linked to your home loan. The amount that is in this account is offset against the balance owing on your home loan. Here is an example. You have a $350,000 home loan and an offset account with $10,000 in it. Instead of paying interest on the full home loan amount, you only pay interest on $340,000. The more money in your offset the more interest you save so the best way to do this is get your salary or wage deposited into the offset as well as any savings.
- Extra repayments. While interest rates are low it is a good idea to make more than the minimum monthly repayment so that you can get ahead on your repayments. Not only will this save you money in the long run (as it will reduce the amount of interest you’ll pay) over time it will also reduce the time it takes to pay off your home loan.
- Repayment holiday. Some home loans have a repayment holiday feature which allows you to take a ‘break’ from making repayments on your loan. This can come in handy at times when maybe one partner isn’t working but it will only be for a limited time. Some loans will also require you to be ahead on repayments to access this feature.
The standard term for a home loan is 25 years but most lenders have a maximum loan term of 30 years. As a first home buyer it can be tempting to opt for a 30 year loan term as this will reduce your ongoing monthly home loan repayments but the catch is over the life of the home loan you'll pay more in interest. If you do take out a home loan over 30 years, be sure to get some of the flexible features like free extra repayments and an offset account that will allow you to pay off the loan faster if you are able to.
First home grants and calculators, what do I need to know?
Whether you are borrowing as an individual or you are a joint applicant with a partner, friend or family member, how much you will be able to borrow will depend on your combined income, current assets and liabilities. To get a ballpark for how much you will be able to borrow from a bank or lender, try Mozo's borrowing calculator. Plug in your income and expenses, and it will tell you how much you can afford to borrow at today's average rate and how much your monthly repayments will be.
Another cost you will need to factor in to your home buying budget is stamp duty. This is a fee charged by state and territory governments in Australia. But did you know you could avoid this cost completely if you're a first time buyer eligible for your state's First Home Owner Grant, where you'll receive a one off grant and pay no stamp duty?
If you find you're not eligible for the first home owner grant, then you can use Mozo's first home loan stamp duty calculator which will give you an estimate of how much stamp duty will cost you on your first property.