With hundreds of home loan products on the market, trying to make sense of what’s on offer can sometimes be a little overwhelming. Your Mortgage shows you how to avoid the mortgage minefields and find the right loan.
Which is the best home loan? Unfortunately, what seems like a simple question doesn’t have a simple answer. With the vast array of home loans now available, borrowers face a difficult task when trying to decide what is a good deal.
A thorough analysis of what is on offer can take some time. However, having a plan of attack can make the process flow more smoothly.
If you know what you want and the right questions to ask, you can save yourself time and effort.
There are many different ways of choosing a home loan that is right for you. The strategy outlined here breaks the process into three stages:
- determining your requirements
- measuring the costs of different loans
- evaluating loan features
STAGE 1: Determining your requirements
It is important for borrowers trying to wade through the choices to realise that a product that is appropriate for one person may be unsuitable for another. A large number of factors, including a person’s or couple’s individuals goals and circumstances, need to be considered.
One crucial thing to determine before you get too involved in choosing a loan is to be clear about what you are trying to achieve. This may have the following simple answer: borrowing money to buy a home as cheaply as possible. This is as good a goal as any and it’s important to keep in mind, especially when you start getting offered products with all sorts of bells and whistles which you don’t really need.
An increasing number of borrowers have a different goal: to find a product which allows them to take advantage of the equity they have built up in their home to fund other purchases or investments.
A line of credit allows you to access the equity you have in your home when you need it. Lines of credit are discussed later in the article.
What do I want?
1. Investment or owner-occupied
One question that should be easily answered is whether the loan is for an owner-occupied property or a residential property investment.
This should be fairly straightforward. If you are borrowing to buy a property you are going to live in, you need a home loan. If you are borrowing to purchase a residential property as an investment you need a residential investment loan.
The differences between the two types of loans have reduced over time, and in many cases the products on offer are practically identical. But there are some loans which are only available to borrowers who are to occupy the property and some loans only offered to investors. For example, some institutions offer interest-only repayments to investors but not to owner-occupiers.
2. The optimal loan term
If you can afford to repay your loan faster you can save substantial amounts in terms of the total amount of interest you pay.
Consider the following table which shows the total amount of interest paid on a loan of $100,000 with an interest rate of 6.5% and the monthly loan repayment (interest paid does not include the principal amount of $100,000):
Monthly repayment ($)
Total interest repaid ($)
It can be seen that the faster you repay the loan, the less interest you’ll pay. The difference in the repayments between a loan of five years and a loan of 30 years is just over three times more on the shorter loan, but the interest paid is more than seven times less.
Everyone would like to be able to repay their loan in next to no time but this is usually not possible. If you choose too short a loan term you may run into trouble, particularly if your financial situation has changed as a result of job loss. One way around this can be to get a loan that allows additional repayments with no additional repayments fee. This allows the borrower to select a loan with a longer term but pay as if they had a shorter term. This will reduce the total amount of interest paid.
3. Which loan is right for me?
Home loans come in a variety of shapes and sizes. There are:
- introductory loans
- standard variable loans or fully featured loans
- basic or no-frills loans
- all-in-one accounts
- revolving lines of credit
- home loans with a salary account
- 100% offset accounts and partial offset accounts (this can also be a feature of a standard variable loan or a professional package)
- a variety of fixed rate loans covering different lengths of time
Confused yet? If every home loan had identical features, you could safely compare loans adopting the ‘cheapest is best’ policy. However, the features and flexibility offered with home loans today make such a simple comparison unrealistic.
Cheap home loans typically offer lower interest rates than their feature-packed colleagues. Will this result in lower minimum monthly repayments for the borrower? In most cases, yes. However, will the borrower be able to make additional repayments, redraw these additional payments at a later date or credit their salary directly into their loan account? Probably not, although some no-frills products are now available in the market offering the ability to make extra repayments and take it out as needed.
Cheap loans with minimum features may be useful for people who know that they will never need additional flexibility with their loan, do not have the means to pay more than their minimum repayments, and have accepted the fact that they are in for a 25- or even 30-year haul before they can call their home their own. A generation ago, this description probably suited many home loan borrowers but the story has changed today. Lack of flexibility is a definite turn-off for many people contemplating cheap loans with minimum features.
Also known as ‘honeymoon rates’, these loans usually offer the lowest interest rates available in the market. Interest rates are discounted for a certain period of time, usually between 12 months and three years. After this ‘honeymoon’ period, the interest rate reverts to the higher variable rate. This means the minimum monthly repayment you had been enjoying very quickly turns into a standard variable rate – or, in some cases, an even higher rate. Unless your income has risen over the honeymoon period, you could be required to do some serious belt tightening. But if you decide a particular honeymoon loan is competitive, we recommend you skip the ‘honeymoon’ and make full repayments from day one of your loan.
Fixed rate loans
A fixed interest rate will not change during the fixed period. In Australia, most institutions offer fixed periods of between one and five years.
This is different from some other countries. In the US, the majority of borrowers take out a 30-year loan with a fixed interest rate.
Variable rate loans
Historically, a variable home loan interest rate should move up and down with market interest rates. The main determinant of variable interest rates is the cash rate set by the Reserve Bank of Australia (RBA).
Traditionally, when the RBA changes the official cash rate, most variable home loan interest rates changes by a similar, if not identical, amount. However, the credit crisis has prompted lenders to pass on just a portion of rate cuts as they try to claw back some of the increased funding costs.
Borrowers with a variable interest rate will be relatively better off than borrowers with a fixed interest rate when interest rates fall, because their variable rate are likely to move lower while the fixed rate will remain unchanged.
Conversely, when interest rates rise the borrower with the fixed interest rate will be relatively better off. This is due to their home loan interest rate remaining the same while the borrower with the variable rate will pay a higher interest rate.
Lines of credit
A line of credit allows the borrower to draw down money to a prearranged credit limit as required. Lines of credit often do not have a set term; they are ongoing with no set termination date. In some cases, the borrower is required to make a regular repayment of the interest owing for the period. In others, no repayment is required as long as the borrower has not exceeded their credit limit.
The credit limit is usually set as a percentage of the property’s value, generally around 80%. So if your property is valued at $200,000 the credit limit will be around $160,000. Note that there are significant differences between the products on offer. Some work like this for an initial period, say 10 years, then turn into an amortising principal and interest loan.
STAGE2: Measuring the Cost
If you fall behind in your loan payments you may be penalised. The penalty can be in the form of a higher interest rate on the outstanding amount or a flat fee after the payment is overdue for a set period
Once you have determined which sort of loan you want, you need to be able to compare the costs associated with different products for this type of loan.
The main cost in most loans is the interest rate. In addition, most loans charge a number of fees. Two important fees to consider are entry fees and any ongoing fees.
One way of doing this is to use a comparison interest rate which incorporates the loan fees into the interest to provide an indicator of the total cost.
Fees you will have to pay and fees you may need to pay
It’s important to distinguish between fees you will definitely have to pay and fees you might have to pay.
You will have to pay any establishment/ application fees associated with the loan. Also, if the loan has ongoing fees, you’ll have to pay this. There are a large number of other fees which are contingent on the borrower’s actions. It is important to consider these in relation to the likelihood that you will have to pay them.
Other home loan fees
There is a long list of other fees you could be asked to pay. Here are some to look out for:
Additional repayments fees
Some loans have a fee if you make a lump sum payment. When charged, it is usually a set fee. On fixed interest rate loans, additional repayments are generally considered a privilege and the fee can be significant, for example, $75 per payment.
Break costs are usually charged when a borrower exits a fixed interest rate loan before the end of the fixed period. Different lenders calculate break costs in different ways.
The calculation is usually based on the balance of the loan, as well as the movement in interest rates between the time the fixed loan was entered into and when it was exited. If interest rates have fallen the amount payable can be large.
Combination loan fee
Most lenders now allow borrowers to take out a combination loan. For example, you might borrow $100,000 and have $50,000 variable and $50,000 fixed. The combination loan fee is the additional amount you will pay to take out a combination loan. Many lenders do not charge to have a combination loan, but others charge up to $600.
Deferred establishment fee
More and more lenders are charging what is often referred to as a deferred establishment fee. This is a fixed amount charged if the borrower exits a loan within a certain period of loan establishment, usually around three to five years.
Direct debit fee
If your loan is not with the same institution you do your banking with and you have your loan payment automatically transferred to your lender, you are likely to be charged a direct debit fee. These fees can be significant, for example, $3.50 each, which would add over $14 a month to the cost of your home loan if you made weekly payments.
See Break cost, Mortgage discharge fee and Deferred establishment fee.
Not exactly a fee but still relevant. A number of loans allow the borrower to use their home loan as a transaction account or to have an offset account. These often have a number of free transactions, usually a number per month, which can reduce the borrower’s overall cost of banking.
A growing number of institutions allow their customers to conduct transactions at Australia Post outlets using the giroPost system. The giroPost fee is the fee to make a withdrawal using this system.
Internet transaction fee
The fee for making a transfer using the lender’s internet banking system.
Late payment fee
If you fall behind in your loan payments you may be penalised. The penalty can be in the form of a higher interest rate on the outstanding amount or a flat fee after the payment is overdue for a set period.
Mortgage discharge fee
This is the lender’s charge to transfer ownership of a property to the borrower when the loan has been repaid. It covers the lender’s legal and administrative costs. Generally, the government transfer fees must be paid in addition to the quoted amount. These vary from state to state.
Basically, a fee for having a home loan. It is usually charged at regular intervals, often monthly.
Over the counter fee
The fee for making a withdrawal in a branch over the counter. Over the counter transactions are usually more expensive than using other electronic means such as ATMs, phone banking, the internet or EFTPOS.
The fee to transfer your loan to a new property. Some loans aren’t portable. When a fee is charged, it’s usually $150–300. This is often significantly less than the cost of closing the old loan and establishing a new one. However, there can be a number of restrictions on the timing of changing the properties over.
The fee for making a redraw. A number of loans have a number of free redraws per year following which a fee is charged.
The fee to have another fixed period at the end of a fixed interest rate term.
Switch to fixed fee
The fee to switch from a variable interest rate to a fixed interest rate.
STAGE 3: Evaluating Loan Features
The old adage that ‘you get what you pay for’ is very often true in the lending market. If you are content to make your minimum monthly repayments over the full term of your loan, then the cheapest loan you can find can often be the best.
However, if you want to wipe out your mortgage much faster, you may want to consider some of the following ‘mortgage exotica’ – loans with features that can help you pay off your loan faster and save you serious dollars in the long term.
Choosing a loan with the features you require can save you money, even if you have to pay a slightly higher interest rate. But paying for features you don’t use doesn’t make sense.
Some of the features available are:
- additional repayments
- all in one/100% offset
- ability to switch to a fixed rate
- ability to refix when the current fixed term expires
Portability means you can keep the loan when you sell your home or investment property and purchase another one. Doing this is sometimes referred to as security substitution. A portable loan with a low portability fee could be valuable to someone who expects to move home frequently.
There are usually a number of restrictions on portability concerning the values of the new and old property and the settlement dates on the two properties. You need to ask your lender or broker what these may be.
To keep your loan when you sell your old property and purchase a new one, you generally have to pay a portability or security substitution fee. This can be anything up to $500, occasionally more. However, some lenders may waive these fees, so it is worth checking before you settle on a mortgage.
The ability to make additional repayments can lead to substantial savings in the total amount of interest you pay over the term of the loan.
For example, if you pay even just an extra $50 per month on your $300,000 loan taken over 30 years, you will slash two years off your loan term and save $23,291 in interest.
An all-in-one loan effectively combines of all your savings and cheque accounts into one loan account.
All-in-one loans allow you to have all your earnings placed directly into your loan account. Amounts above the minimum repayment can then be accessed from the loan account just like a day-to-day transaction account.
This means that the money which would normally be sitting in your daily transaction account earning little (if any) interest can be saving you money on your home loan instead.
It’s a very simple system. Because interest is calculated daily but only charged monthly, every dollar left in your loan account reduces the amount on which interest is calculated. The more money left in your account for a longer period of time, the faster you will pay off your home loan. This is similar to, but not quite the same as, loans with an offset account.
100% offset loans
A 100% offset account is similar to an all-in-one account. Rather than having all your money consolidated into one home loan account, a 100% offset account is a separate account run in conjunction with your home loan account. It operates like a savings or transaction account with an interest rate equal to that charged on your loan account.
So, for example, if your loan balance is $120,000, in a regular home loan account interest would be calculated on a daily basis and charged to the account each month on that full amount. If you have a 100% offset account, where you place all your earnings, and the balance of your savings is, for example, $10,000, this amount acts to reduce the balance on your home loan. Rather than earn interest on the $10,000 at the current term deposit rate (which is always lower than the interest charged on your home loan), the money in the 100% offset account effectively reduces the balance of your loan, so you only pay interest on $110,000 at, say, 5%.
Partial offset loans
The poorer cousin to the 100% offset account is the partial offset account. When you put cash into a partial offset account, you only offset at the interest rate applicable on that account, which by definition is less than the interest rate on your loan.
Using the same example as above, if you have a home loan balance of $120,000 and have $10,000 deposited in a partial offset account, that money still acts to reduce the balance on your home loan.
However, the deposit account may only be earning interest of, say, 2%. In other words, you will be paying 5% interest on $110,000 and 3% on the $10,000. Why only 3%? This is the loan rate of 5% less the offset rate of 2%.
All-in-one home loans allow borrowers to deposit all their income into their home loan account with the knowledge they can access it when required.
All-in-one accounts are also popular because of the additional features they offer over traditional home loans. Most of these features relate to access to funds, and are an important consideration when choosing the type of loan for your circumstances. The following three key questions should be asked:
- how do I access my funds?
- how many free transactions do I get per month?
- how much will additional transactions cost me?
Access to funds is becoming less and less of an issue as many lenders offer products that allow access via branches, telephone banking, the internet and EFTPOS terminals.
However, the ability to easily access funds should still be confirmed. A smaller lender may offer a slightly better interest rate, but if funds are only available over the counter (or with a minimum of 24 hours’ notice) you may prefer a slightly higher rate for the added convenience. Making large cash withdrawals simply because gaining access to funds is ‘inconvenient’ works against one of the key benefits of this type of loan.
To best benefit from having an all-in-one or offset account, it needs to be the main financial product that you use. Having separate cheque and savings accounts reduces the effectiveness of the product so if you require facilities such as a cheque book ensure that these are available with the loan product that you choose.
To encourage borrowers to use their loan account as their main financial product, most all-in-one loans allow a number of free transactions each month. Beyond these free transactions, fees are usually charged and may vary depending on the method used to access the funds. Ideally, if you combine this type of loan with a credit card, you should only need one transaction per month but, realistically, not all payments can be made with a credit card (see below).
You can check the access details, number of free transactions and transaction costs of various lender’s products in the Home Loan Tables at the back of this magazine.
While the benefits of using all-in-one loans and offset accounts seem sizeable, they usually come at a cost. The most immediate cost is usually a higher interest rate, possibly up to 1% higher than the basic variable rate.
Generally, the more features a product contains the higher the interest rate that is charged. Some lenders also charge an ongoing fee on these types of loans, so it is best to check these details before settling on a particular product.
Tips and tricks
Using a credit card with interest free days is one of the most effective ways to take advantage of all-in-one and offset accounts. With a large number of lenders offering credit cards with up to 55 days interest free, you effectively gain 25 interest-free days from the date on your credit card statement. Regardless of when in the statement cycle you make a purchase, you are still able to take advantage of the interest-free days. Purchase on the day before you receive your statement and you will get approximately 26 days interest free, and purchase the day after the statement is sent and you will receive the maximum number of interest-free days.
The strategy is to make as many purchases on your credit card as possible and pay off the total balance before the end of the interest-free period. This leaves as much money as possible in your home loan account for as long as possible.
The balance of the loan account is kept lower until the payment is made and the resulting interest charged on the loan is reduced. In effect, you are keeping the size of the loan down by transferring your expenses to your credit card and then using the features of the card to delay payment for as long as possible.
A redraw facility operates in a similar fashion to an all-in-one and 100% offset accounts but is less flexible. With an offset account, there is a separate account where you make your deposits, but with a redraw facility you make your deposits directly into the loan account. However, unlike an all-in-one account, redraw facilities are often much less flexible in terms of accessing your funds.
Essentially, a redraw feature allows you to access any additional repayments that you have paid into the loan account.
If you have a fixed term loan, you may not be able to redraw. Also, a number of basic variable home loans don’t have a redraw facility.
In a similar fashion to an all-in-one loan, home loans that have a redraw facility allow borrowers to withdraw additional repayments which have been made, subject to certain terms and conditions. These terms and conditions vary significantly between lenders.
A redraw facility can be a valuable feature, because it allows you to make additional repayments (reducing the total interest you pay on the loan) with the knowledge that you can access the money at a later date should you need to.
Redraw facilities come at a cost. Factors that need to be considered include:
- cost of activating the redraw facility
- number of free redraws per year
- fee per redraw
- maximum number of redraws per year
- minimum redraw amount
- maximum redraw amount
Before you even access a redraw facility, some lenders charge you for simply activating the facility. Fortunately, you only need to pay this fee once, and that’s only if and when you decide to use the facility. You may want to use this as an ‘emergency fund’ where you put any spare money you have. There may be a fee involved to access these funds, but this money is better occupied reducing the size of your outstanding balance than sitting in a transaction account or in your back pocket.
The number of free redraws per year is the number of times each year you can withdraw additional home loan repayments you have made at no charge.
Once a borrower has used the quota of free redraws, they are charged a set fee for each additional redraw made. For example, if you are permitted four free redraws per year and the fee per redraw is $50, you will be charged $50 when you make your fifth redraw and $50 for each additional redraw during the year.
Redraw fees usually vary from $15 to $50, with a number of lenders not charging for redraws at all.
The maximum number of redraws per year can range from only two to an unlimited number.
The minimum redraw amount is the smallest amount a borrower can withdraw at a single time. This feature is important in determining the true flexibility of a loan. Many lenders offer no minimum redraw, while others offer minimums as high as $4,000. This type of reduced flexibility is the distinguishing point between all-in-one accounts and loans with a redraw facility.
The maximum redraw amount is typically the total amount of additional repayments which have been made, although some lenders reduce this amount by an amount equal to one month’s payment.
Tips and tricks
The correct strategy to adopt when using a redraw facility is dependent upon the features and fees associated with the facility.
If a redraw facility contains many of the features of an all-in-one loan and does not charge any fees for its use, it’s possible to adopt a similar approach as an all-in-one loan.
However, it’s more likely that use of the redraw facility will be restricted by one of the following factors:
- redraw activation fee
- fee charged per redraw
- number of redraws per year
- minimum redraw amount
Surprisingly, it’s the minimum redraw amount that restricts the use of a redraw facility the most. Unless you are confident that your monthly credit card payments will always exceed the minimum redraw amount, you may be forced to withdraw more money from the home loan account than you really need. This could undo the financial benefits of using the redraw facility in conjunction with a credit card.
Ultimately, redraw facilities are not designed for frequent use and the restrictions mentioned above illustrate the complications involved in trying to use a redraw facility in this way.
Redraw facilities are designed to allow you to make additional payments when possible, knowing that occasional access to these additional funds is available should it be required.
Line of credit vs redraw
What is the difference between a line of credit and a redraw facility? With a redraw facility, you can withdraw any additional repayments you have made. Additional payments being anything paid above the regular required loan repayment, whether it be a lump sum payment or payments you made, or you pay a little extra with each periodical payment. With a line of credit you can draw down to the credit limit but it does not relate to additional repayments.
For example, a borrower with a redraw facility has been making loan repayments for 15 years exactly equal to the minimum repayment, such that they have reduced their loan balance from $160,000 to $60,000, on a property valued at $200,000. This borrower would not be entitled to redraw anything because they have not made any additional repayments.
If, alternatively, they had a line of credit which allowed them to draw down to a credit limit of 80% of the property’s value, they would be in a position to withdraw $100,000 from their line of credit.
By Your Mortgage’s definition, the term ‘line of credit’ does not relate to the ability to have all your income paid into the facility and use it like a transaction account, withdrawing amounts as required. However, this is usually what is meant by the term ‘revolving line of credit’ which is sometimes used to describe products.
By Your Mortgage’s definition of line of credit there is significant variability between the flexibility of the products on offer. Some loan providers may require over 48 hours’ written notice to access funds, whereas others may provide ATM, EFTPOS, cheque and over the counter access.
Similarly, the minimum withdrawal amount can vary significantly. Some lines of credit have no minimum withdrawal, which would allow the user to pay for a newspaper via EFTPOS, for example (retailer permitting). Others are designed for infrequent use with a high minimum withdrawal amount, sometimes as high as $2,000.
How much are features worth?
Putting a value on loan features is not a particularly easy task. It’s possible to try to put a value on each feature you want and deduct it from the comparison rate.
An alternative is to make a list of all the features you need and the associated costs then compare these costs and the comparison rate for the products that meet your needs to see which provides the best value for money.
How do they compare?
By now, a number of factors should be clear. Firstly, that flexibility usually comes at a price, and the more flexible a product is the more it is likely to cost you, both in terms of higher interest rates and/or additional fees. In a perfect world the trade-off between features and costs would be plain to see, but unfortunately this is not evident to the average homebuyer. A close look at the loans currently on offer reveals that the relationship between cost and features is not as clear as you might expect – there are loans offering considerably more features at little or no additional cost.
Secondly, strategies can be employed to take maximum advantage of a loan’s features and minimise costs. Once you have decided on a loan that has a particular feature, it’s in your best interests to use that feature effectively. Study the terms and conditions of the loan carefully, ensuring that you know any activation and ongoing fees, limits on use and special conditions that apply to the feature you want to use. For example, depositing your entire salary into your loan account may be useful for home loans with no redraw fees or limits but disastrous if you are charged $50 a withdrawal, or can only make four withdrawals a year.
Thirdly, without discipline and a strategy in place, a loan with ‘bells and whistles’ may not offer a significant reduction in the number of years it will take to repay the loan. Having a potentially useful feature will not benefit you unless you are prepared to use it appropriately.
A number of features currently available with loans are double-edged swords. For example, the benefit of being able to make additional repayments at any time can be quickly undone by frequent withdrawals. Have a long-term plan in place and sit down and plot your progress on a regular basis. You may determine that features you thought you would need are not really necessary after all.
The work to be done
Knowing the right questions to ask and what you are looking for is the first step in the process of choosing a loan. After deciding what you are looking for, you need to collect information about the products on offer. Then you have to analyse the information you’ve collected to reach an informed decision.
Doing this properly is not a quick or easy process. However, it’s important to keep in mind that, for many people, choosing a home loan is the most important financial decision they make. The cost difference between loans can be in the tens of thousands of dollars. Choosing a suitable, well-priced loan can lead to big savings.
It can be confusing to know whether to get a variable rate or fixed rate mortgage, and what features are important. That's why it's important to not only check the right rates, but make sure that you're getting the right features in your home loan. Get help choosing the right home loan