Sourcing the best mortgage involves more than simply looking for a cheap rate. There are other important factors you need to consider, including the ongoing fees and charges payable, the loan’s flexibility, and the level of service the lender provides.
Compulsory comparison rates were introduced to help borrowers understand the true cost of a loan once all the miscellaneous expenses and fees are accounted for, but other features are not as easy to ascertain.
"Sometimes you will be attracted by a low interest rate, but it’s important to make sure that the loan has the features you need," explains Lisa Montgomery, head of marketing and consumer advocacy at Resi Home Loans. "Because first homebuyers might not have the luxury of experience, they often don’t understand that what suits them now and what will suit them in five years time can be totally different. It's really important to understand all the characteristics of the loan so you can determine how it will work for you in the future."
Types of loans
Standard variable: A mortgage product that generally carries flexible features such as a redraw facility, an offset account and the ability to make additional repayments.
Basic variable: A type of variable rate loan that is stripped of most – or all – of the features of a standard variable loan. It usually comes with a lower interest rate compared to a standard variable product.
Fixed: This product carries a fixed interest rate for a certain period, usually one year, two years or five years. After the fixed term, the rate reverts to the lender’s standard variable rate.
Introductory: Also known as a 'honeymoon' loan, this product offers a discounted (usually variable) interest rate during an initial period, typically 12 months. After this period ends, the rate goes up, often reverting to the lender's standard variable rate.
Equity/Line of credit: This type of loan allows the borrower to draw money out up to a specified limit, using their equity in the property. interest rates are generally higher compared to standard variable loans. This product is more suitable for existing property owners as it requires equity in it.
Interest-only: Not technically a loan type, but a method of repaying your loan whereby you only have to repay the interest component of the loan, not the principal. These loans are generally offered for up to 10 years before they revert to a standard variable product.
Now that you know what each loan offers, how do you decide which one is right for you?
These are probably the most popular mortgages on the market, Montgomery says. "It's like the cheeseburger of the loan world," she explains. "Effectively, it's the most popular loan that all homebuyers look to take up, because it's easy to compare in terms of rates – and it comes with all the bells and whistles you can imagine."
Those 'bells and whistles' can include offset accounts – whereby you put your savings in an account that’s linked to your loan and only pay interest on the balance of the loan minus your savings. If used properly, this facility can help you reduce the interest you pay and shorten the loan term. You would need to keep a substantial amount in the offset account to make it beneficial.
At the very least, standard variable loans offer a redraw facility and allow you to make extra repayments.
Standard variable loans generally track the rate movement of the Reserve Bank of Australia (RBA). This means that when the RBA cuts rates, lenders tend to cut theirs by the same amount. However, since the start of the global credit crisis, lenders have been raising and cutting rates independently of the RBA.
Standard variable mortgages are ideal for all borrowers, and first homebuyers can benefit greatly from their flexible features. However, they can be more expensive than basic variable loans.
Basic variable loans carry cheap rates and work the same way as standard loans, but without the extras. "You often find they have a lower interest rate, but that comes with a reduction in flexibility," Montgomery says.
While the rates and fees are some of the lowest in the market, most basic variable loans do not provide consumers with the same flexibility as their fully featured standard counterparts.
With a basic variable mortgage, you may not be allowed to make extra repayments and then have access to those funds later. Some lenders may also impose a penalty and place other restrictions on paying extra.
"It's because it has these characteristics and is missing these extra features that it has the lower rate," Montgomery says.
"You need to get a good feel for that, because your loan as a package needs to address the interest rate, fees, flexibility and service. You need to know which features are important to you in order to operate the loan and manage it."
If you're looking for a cheap loan and don’t need all the extras, a basic variable can be an economical way to pay for your property purchase.
In an uncertain rate environment, fixed rate loans offer some security and comfort. This can be appealing to new homeowners, who are taking on the largest debt of their lifetime.
Fixed rate has a number of advantages for a first homebuyer. These include an interest saving if rates increase during the fixed term of the loan and the knowledge that your monthly repayments will remain the same.
With this certainty, it’s easier to budget for the medium to long term. If you fix your loan at the bottom of the market – where we could be heading very shortly – you can reap the benefit of a secure, low rate while the rest of the market bears the risks of higher interest rates. On the other hand, if interest rates fall, you are stuck with the higher fixed rate.
At the moment, fixed rate loans are around 0.5–1% lower than their standard variable rate counterparts, so as well as locking in certainty, first-time borrowers opting for a fixed rate can lock in a lower interest rate.
The key disadvantage of fixed rate loans is that once you’re locked into one, it can be quite expensive to get out. If you picked the wrong time to fix, you can end up paying a lot more interest than you would otherwise have on a standard variable rate. Fixed rates are also largely devoid of the features that enable you to pay off your mortgage faster.
"The thing to remember with a fixed rate is that you are quite restricted and often can't make extra repayments," Montgomery says. "You're really in a position where you've made a choice, and you're going to be stuck with it."
Fixed rate mortgages appeal to any borrowers who seek the peace of mind that their monthly outgoings won’t change, regardless of what the economy is doing. Montgomery warns you to think long and hard before you opt to fix your loan, as hefty exit fees are usually enforced if you want to break the loan contract down the track.
Introductory rate – or honeymoon rate – loans offer a reduced interest rate for a set period of time, usually 12–36 months.
Interest rates on introductory loans are typically around 1% lower than the lender's standard variable rate. Don't forget, though: when the 'honeymoon' is over, your 'revert rate' – the rate to which the loan returns after the introductory period – could be unexpectedly high.
So while you might be very happy having secured a 5.8% interest rate for 12 months, your loan could snap back to a standard variable rate of 7.2% after a year, while other standard variable customers are accessing 6.9%.
"You need to be aware of what the intro rate is going to roll up to, because you need to make sure that rate is competitive," Montgomery says.
"You should also ask whether you can make extra repayments throughout that introductory period, because you want the opportunity to pay as much off that loan as you can from day one. That will really get you ahead in those first few years."
Introductory rate loans would benefit those first homebuyers who need breathing space while getting used to having a mortgage, because loan repayments are cheaper during the introductory period. The money you save during this time can be used to furnish your new home or fund any renovations that may be needed.
When considering an introductory loan, make sure that the revert rate is not so high that it wipes out all the savings you made during the initial period. You need to make detailed calculations, possibly with the assistance of a mortgage broker, in order to work out the true cost of a variety of loans over the long term and compare them.
The duration of the introductory period is also important – obviously the longer, the better. Exit fees can be massive if you want to pay off the loan within four years, so beware of these costs when making your decision.
Equity/line of credit
More popularly known as a line of credit, equity loans enable you to access any home equity you’ve built up in your property. These loans are mostly used by people who already own a property.
Equity loans "are really for those more seasoned borrowers", Montgomery says. These products do not have a specific loan term. In fact, they are often referred to as ‘evergreen’ loans because you don’t have to pay them back within a pre-arranged period.
"You really have to have an intimate understanding of how the mortgage works, and the discipline that is required to make it work," Montgomery advises.
"You need to be putting all your income into the loan and all your expenses on your credit card – which is 'swept' at the end of the month to reduce the balance to zero. If you’re not disciplined, you could easily find yourself spending more than you should."
As a first homebuyer, Montgomery says you would be better off avoiding this loan structure, and instead "edge in with a standard loan and a monthly repayment system – at least until you've explored all your options".
Interest-only loans mean just that – you repay only the interest charged on the principal. Borrowers are permitted to make additional repayments off the principal of the loan if they wish, but it is not mandatory. Generally, these types of loans appeal to investors more than owner-occupiers.
"Interest-only loans are often chosen by first homebuyers because they are one of the lower-cost options," Montgomery notes. "If, for financial reasons, you wish to take out an interest-only – because a principal & interest loan will push your budget – then I don't think you should really be getting the loan at all."
This is because you’re not paying anything off the principal of the loan, so you’re not creating any equity in the property. If you get an interest-only loan for $300,000, three years later, your loan balance will still be $300,000, unless you’ve been making some voluntary additional repayments.
"Aside from the fact that purchasing your own home is the great Australian dream, the main reason people venture into this form of asset is that you’re going to start creating equity, which is going to create options for you down the track," Montgomery says.
"That's really what you want, because then it sets you up to go and purchase another asset. Wealth creation is the primary focus, and interest-only loans go against that philosophy."
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