Article by Mozo
Mr and Mrs Smith have been happily renting an inner-city two bedroom unit for the last four years. All along, they’ve also been well disciplined in saving for a deposit for their own home.
With children on the horizon they know they’ll need to move out of the unit in the foreseeable future and into a family home. So the Smiths have decided they’re now in the best financial situation to ditch the rental market and take the plunge into the world of mortgages!
Unsure of how much they can borrow, uncertain of where to look for the best loan deal and with advice coming from all directions, the Smiths are a little overwhelmed! So they agree to visit one reliable and expert source – a mortgage broker. Also known as a home loan negotiator, a mortgage broker is the middleman between the borrower and the lender. They’ll aim to find you the best home loan deal for your situation and will be there every step of the way from applying for the home loan to settlement of the property.
The Smiths are elated, they have saved $100,000 for the deposit of their first home. The higher the deposit the less the Smiths will pay in interest over the life of the loan. Before heading off to see the mortgage broker, the Smiths would like to get a realistic idea of their borrowing capacity. Based on the deposit amount and their combined incomes Mr Smith plugs some figures into ahome loan borrowing calculator. It reveals, they can borrow $400,000 which gives them a total amount of $500,000 for the purchase of a home.
The Smiths visit the broker to move forward with the loan process and disclose their finances and deposit amount. They’re immediately informed of good news, they won’t be hit with lenders mortgage insurance (LMI)! This insures the bank against you not being able to make your mortgage repayments and can cost tens of thousands of dollars depending on how much deposit you have. If you have a deposit of 20% or more you will avoid LMI, which is the case for the Smiths, if they’re to purchase a $500,000 home with a $100,000 deposit.
The mortgage broker then goes through the different home loan and interest types the Smiths can choose from. Keeping in mind, there is no right or wrong, it comes down to the choice of the borrower. A variable rate home loan means the interest rate will change according to the market, so you could be subject to a rate rise. The other option is taking out a fixed rate home loan where the interest rate is locked in for the introductory period (1-5 years) of the loan. At the end of the period it reverts to a variable rate. If the Smiths would like a mix of both rate options they do have the option of a split rate loan, which as the name suggests splits one portion as fixed and the other as variable.
The Smiths think long and hard, as choosing the interest type is one of the biggest decisions they’ll make in getting a home loan. After looking at the pros and cons of each, they decide that a fixed rate home loan suits their situation at this point in time. On a strict budget, the Smiths want to know exactly how much they will be making in repayments each month for the next three years. They can’t afford to suddenly be paying more one month if interest rates rise. They have also chosen a short 3 year fixed term as the longer the fixed rate term the higher the interest rate. At the end of the 3 years the Smiths believe they will be more comfortable switching to a variable home loan which will have a lower interest rate.
While the Smiths have chosen to go with a fixed rate home loan, it does have its disadvantages. There are less flexible features with this type of loan compared to a variable rate home loan. The broker explains to the Smiths that they won’t have a loan which has a mortgage offset feature. An offset account is linked to your home loan and the amount that is in this account is offset against the balance owing on your home loan. The more money in your offset, the larger amount in interest you save. The Smiths aren’t too concerned at this stage about not having this feature as they don’t have any additional savings, it’s all been going towards the deposit!
Hard at work finding the most suitable home loan for the Smiths, the broker has found a great deal which offers free extra repayments. The Smiths are very happy to have this feature as every Christmas Mrs Smith gets a substantial bonus from her employer. Putting the bonus towards the loan will save the Smiths money in the long run and it will help reduce the time it takes to pay off the loan. Once the Smiths make an extra repayment with the home loan deal they are considering, they are entitled to a repayment holiday. This feature may come in handy when Mrs Smith goes on maternity leave, as it means they can have a ‘break’ from making repayments on the loan but only for a short time of up to six months.
Decisions, decisions, decisions! The Smiths need to select a loan term of 25 or 30 years in which they will repay the loan off in full. The longer the loan term, the more it will cost them in interest. The shorter the loan term, the more the monthly repayments will be. For example it looks like the mortgage broker has found a hot deal for the Smiths with a 5% fixed interest rate on a $400,000 home loan. With a loan term of 30 years, monthly repayments would be $2,147 and interest paid over the period would be $373,023. But after doing the maths with aloan repayments calculator the Smiths realise they can save $71,515 in interest if they take out a loan for 25 years. Monthly payments will be $2,338 ($191 more) but in the long run the Smiths are all about paying off the loan quickly and paying less in interest.
With all the big decisions made, from loan type, features and loan term, the mortgage broker is ready to get the Smith’s paperwork sorted for a loan pre-approval. They pile together, pay slips, notice of assessments, a full copy of their last two tax returns and account statements of their savings and credit card accounts. A home loan pre approval means the Smiths can make a “conditional” offer on a property, which is subject to finance. They’re well on their way to purchasing their first home!