“The public has been pretty well educated and knows that every couple of years you should review your finances and have a look at what’s available, because the market does change”
“Even if you’re looking at 100% borrowing, you still in fact need to have some funds available to complete the purchase”
“Mortgage brokers offer property buyers a one-stop-shop for a comprehensive range of mortgage products from the group of lenders they are accredited by”
Owning your own home is the great Australian dream. The process of buying a property can seem daunting, but for anyone who has felt the futility of renting, or the mild embarrassment of living at home until well into your thirties (and beyond), there can be no doubting the appeal of owning your own home.
Once you’ve done some research regarding the location of your property and have some idea of the price you are able to pay – perhaps after visiting a financial planner to put your affairs in order or set you on track – the next hurdle is to establish just how much you can borrow. This in turn will largely be determined by how much deposit you have saved. There are online calculators to help you determine how much you will be able to borrow.
While some lenders will allow you to borrow up to 95% of the value of the property – and others up to 100% – you will need to consider lenders mortgage insurance (LMI) and mortgage protection insurance if you borrow more than 80% of the value of the property. For a loan of $300,000, with LMI calculated at 1.5%, expect to pay $4500. Mortgage protection insurance covers you for missed payments due to sickness or unemployment and will cost around 1% of the loan value ($3000 on a $300,000 loan).
The term ‘100% loan’ is somewhat misleading, as you will still need some funds to complete the transaction. “Even if you’re looking at 100% borrowing, you still in fact need to have some funds available to complete the purchase,” says Alison Whittle, managing director, The Mortgage Detective. “You need to include the mortgage insurance premium, the lender’s application fee, stamp duty, and so on. Many first homebuyers may find that the first homebuyers grant is sufficient to cover that.”
The generally accepted view is that repayments should not exceed 30% of your net monthly income. However, bear in mind that while borrowing the maximum amount possible will allow you to purchase a more expensive property, it also means your repayments will be higher. The additional costs, fees and charges associated with home buying also need to be considered. These can include conveyancing fees ($700–$2000), property valuation fees ($400–$500), building and pest inspection fees ($275–$500), stamp duty (a sliding scale based on property purchase price), bank application fees and insurance costs ($250–$1000 annually for building insurance).
Once you have a clear idea of where you stand financially, you should consider what sort of borrower you are and the loan options available to you. There are four broad categories of borrower. Prior to making any choices about the type of home loan you need, you will need to decide which segment you fall into. Each segment is largely self-explanatory and may share certain characteristics. They are first homebuyers, upgraders, refinancers and investors.
Driven by high employment levels and stable mortgage finance rates, first homebuyers remain a significant driving force in the home buying market. The latest figures from the Australian Bureau of Statistics show that first homebuyers account for 18.3% of all housing loans.
As a first homebuyer, you will have special considerations such as saving for a deposit and taking advantage of the government’s first homebuyer’s grant. Many first homebuyers, particularly in the larger metropolitan city areas, will no doubt be on a tight budget. A fixed rate loan may be more appealing than a standard variable rate – simply because you may not have much ‘fat’ to play with in terms of extra money for higher repayments should rates rise. With a fixed rate you know how much your repayments will be and outside factors such as Reserve Bank of Australia (RBA) rate fluctuations will not have an impact.
Taking onboard all these considerations, lenders have devised loan products and features to assist first homebuyers break into the market. The proliferation of 100% (‘no-deposit’) loans, introductory rate loans with attractive ‘honeymoon’ rates and loans with greater flexibility such as redraw facilities has made home ownership a reality for more people than ever before.
However it’s easy to be caught out, especially when lured by tempting introductory interest rates and products such as 100% loans, which boost up the loan to value ratio (LVR) to risky levels. With the increased risk of default, you’ll need to think beyond the short term to ensure a reasonable interest rate is charged for the life of the loan. Loans packed with special features may sound attractive, but ultimately you will need to decide whether such features are really cost-effective for you.
Basic loans – without the bells and whistles – clearly have their advantages. “The basic loans generally have a cheaper rate than feature-packed loans,” says Mark Hanson of Simple Finance Australia. “And besides, now that some of them have free redraw facilities they can operate like the feature-packed loans anyway.”
As an upgrader you are looking to either move into a bigger or better home, or to improve your existing home without necessarily taking on the onus of refinancing. Generally, this is a slightly older group than first homebuyers, and you’ve already gone through the first homebuyer’s period. Upgraders may have moved several times and be old hands at maximising the benefits of moving by renovating before selling, ensuring higher returns come sale time. If you’re an upgrader, you may also want to consolidate other debts (like credit cards, car loans and personal loans) at a lower interest rate.
Upgraders may also be looking to make the most of the equity in their existing home by renovating or making other investments. Flexible loan features like portability, redraw facilities and offset accounts are often attractive to upgraders, as are construction loans for larger renovations.
The desire to refinance may come about due to changes in personal circumstances such as a growing family or a desire to upgrade the family home. If you are considering refinancing you may also want to take advantage of a more flexible loan with better features or a more competitive rate.
Like upgraders, refinancers may also be driven by the desire to consolidate other debts. “The public has been pretty well educated and knows that every couple of years you should review your finances and have a look at what’s available, because the market does change,” Whittle says. “If you’re just coasting along with your lender there may be products out there that could be beneficial to you, particularly people looking at investment opportunities other than property. They may benefit from a line of credit to provide finance for managed funds, share portfolios and so on.”
In a cooling market, this segment suffers the most. Instead of investing in other properties, many people are looking to stay in their existing homes and add value via renovations, or are taking other investment options. Nevertheless, a recent Mortgage Choice survey of 651 Australians aged 40–55 years found that 36% plan to buy an investment property in the next 12 months and 46% of these will do so for the first time.
Forty-six per cent will fund this investment purchase through equity, while 21% will use line of credit, 20% will use the more traditional launching pad of a saved deposit and 13% will fund it through other means.
It comes as no surprise that lenders have created a range of products that are well tailored to the needs of investors. Interest-only loans are a popular option for investors. For these loans you don’t pay off the principal, only the interest. An obvious tax advantage is that interest payments for investment properties are tax deductible, while payments off the principal are not. Asset-rich, cash-poor retirees are also taking advantage of the reverse mortgage boom as they unlock the value of their biggest asset – the family home.
Fixed rate investment loans have also recently been increasing in popularity. “There’s been some concern from investors about the possibility of a rise in interest rates,” Whittle says. “They’ve remained pretty stable but people are aware that there may be changes during the year, so they’re trying to pre-empt that by securing a fixed rate. If you’re buying an investment property a fixed rate is good because you know what you have to pay, and you know what your rent coming in will be.”
Choosing your lender
The deregulation of the finance industry in the early 1990s opened the floodgates for new mortgage operators. There are now countless institutions offering mortgages; some cater to all markets, others target highly specialised market sectors. Before making a choice, you will need to consider the competitiveness of their rates, the fees and penalties they charge, their product range, lending criteria, customer service and reputation. “There’s really not that much difference between the product groups,” Hanson notes. “And it will change every couple of months – the market’s very competitive at the moment.”Although lending criteria varies between banks and non-banks, you will generally be designated a ‘conformer’ or a ‘non-conformer’ when applying for a loan. Conforming loans are traditional loans given to borrowers with a solid credit history, who can fully document their income, have a good savings record and low debts. The benefit of a conforming loan is that you will have access to a wide range of lending products, most of which will have flexible extra features. You will also be able to shop around for the best interest rate.On the other hand, non-conforming loans are suitable for a wide range of borrowers who may not be able to obtain a conventional loan. There can be many reasons for this – being self employed, recently arriving into the country, having no deposit saved, having infrequent or seasonal income, having past credit problems, bankruptcy or default, and older borrowers for whom a 25-year repayment term may not be appropriate.
Banks, building societies and credit unions are known as traditional lenders. Traditional lenders will use their own funds to provide home loans. Although loans can be obtained directly through them, today many traditional lenders will also use intermediaries such as mortgage brokers to recommend their loans.
With many years of lending experience, wide networks and broad product ranges, traditional lenders remain the first choice for many borrowers, especially if the borrower conforms to the lending criteria. Loans are managed and administered by the lender for the life of the loan, creating a sense of continuity for borrowers.
Non-bank and non-conforming lenders
Non-bank lenders operate in a similar way to traditional lenders, but will use funds from investors, financiers or trusts to provide home loans to customers. Many non-bank lenders will use intermediaries such as a mortgage manager to package, distribute and manage the loans on their behalf. Examples of non-bank lenders include Aussie Home Loans, RAMS and Wizard.
Non-conforming lenders are by their very nature more flexible in terms of their lending criteria and will cater to higher risk borrowers who, for a variety of reasons, may be unable to obtain a conventional loan. When assessing a loan application, non-conforming lenders don’t rely on the computerised credit-scoring methods used by traditional lenders. Instead they look primarily at the borrowers’ debt repayment record.
However, you will likely be charged a higher rate of interest to cover the perceived risk of the loan and there may be strict repayment conditions. Examples of non-conforming lenders are Liberty Financial, Bluestone Mortgages and Pepper Homeloans.
With so many loan options on the market, borrowers are increasingly turning to mortgage managers and mortgage brokers to assist with finding the right loan. Mortgage managers are home loan specialists who act as intermediaries between non-traditional lenders and borrowers. They will provide products and manage/administer them for the life of the loan, although loan repayments are made directly to the lender.
Mortgage brokers act as intermediaries between borrowers and lenders. “Mortgage brokers offer property buyers a one-stop-shop for a comprehensive range of mortgage products from the group of lenders they are accredited by,” says a spokesperson for the Mortgage Industry Association of Australia (MIAA). The majority of brokers are paid a commission from the lenders so their services are effectively free to the borrower. Do your research to determine how your broker is paid and which lenders they are associated with.
More than anything, brokers take the hard work out of choosing a loan. Instead of researching loans and lenders by yourself, brokers know where to look and can draw on their experience of dealing with every type of borrower.
There are loan products to suit just about every personal financial situation, but no matter what lender category you slot into, you will need to pay attention to interest rates.The interest charged on a variable rate loan will fluctuate along with the official RBA rate. As the RBA rate rises, so will your loan repayments. Conversely, when it falls, you’ll benefit from lower repayments. It’s important to factor rate variations into your budget to ensure you can service your loan if rates rise. Variable rate loans are very popular and will usually include more flexible features than a fixed rate loan.
A fixed rate loan will lock the interest rate you borrow at for a set time within the overall loan term. Fixed terms tend to be 1–3 years, although it’s also possible to find lenders with 10–15 year terms. The appeal of a fixed rate is that you know how much your repayments will be each week/fortnight/month – and these will not be affected by RBA rate fluctuations. Of course, this is highly attractive when rates are rising, but on the flipside you can’t take advantage of the savings falling rates might bring.
A fixed rate loan may sit on a slightly higher rate than a variable loan because the loan provider is taking a risk on the market, based on their predictions and assumptions about future interest rate movements.
Some lenders now also provide split loans whereby the money borrowed will be split into different segments – part fixed, part variable. Check with your lender about establishment and ongoing fees to ensure you don’t pay more than one lot of both fees for the privilege of splitting. Introductory or honeymoon rates are also popular, but again you need to do your research to determine what the rate will be after the introductory period ends.
Do your homework
Your loan provider will outline the flexibility and features of your loan, but it’s important to ask the right questions. You need to determine what your immediate and future needs will be. A successful choice comes down to research.
“We find a lot of our clients are aware of what’s available – they’ve done their homework,” Whittle says. “They know what’s a fair rate in the market and have some knowledge of what products may suit them.”