First homebuyers: Choosing a home loan

By Nila Sweeney

Unless you’re extremely lucky and hit the lotto jackpot, or have the good fortune of being wealthy, chances are you’re going to need a mortgage to buy that home you’ve been dreaming about.

Taking out a mortgage is a lifetime commitment and probably the biggest debt you’ll ever undertake in your life. Understandably, you want to ensure that you get the best deal possible. The consequences of a wrong choice could result in tens of thousands of dollars lost over the life of the loan.

Generally, the maximum term for a mortgage is 30 years, although some lenders such as GE Money have started introducing 40-year loans and some banks are even considering 50-year loans.

The duration of the loan can be negotiated if you wish to shorten the term of your mortgage. The advantage of having a shorter term is you’ll pay less interest over the life of the loan. However, the monthly repayments are higher in order for you to repay the debt sooner. This means that you have to make drastic lifestyle changes to meet your loan obligations.

On the other hand, longer term loans allow you to pay your mortgage and still maintain your lifestyle. The downside is that you’ll be paying the loan over a longer period of time, which is more costly over the life of the loan.

Which one?

Mortgages have come a long way in Australia. Today, there are almost 3,000 home loans offered by about 160 financial institutions. You need to take time to compare different deals because even an incremental difference in rate can make a huge difference to your repayments. So how do you ensure you pick the right loan?

The first step is to understand the different products on offer and weigh up your options.

Go to page 82 for the YMM product overview – a guide to all the different types of home loans on offer. Then come back to finish reading First Homebuyer 101!

No-deposit loans: are they for you?

One of the biggest hurdles any new homebuyer has to face is raising enough deposit for a property. Banks generally require a deposit of 20% of the property price while non-bank lenders such as credit unions or building societies may accept 5%.

Having a deposit is a safer and more effective strategy for any homebuyer because it will open more doors for you as a borrower and give access to standard loans that are generally cheaper and more flexible.

However, it’s not always easy to get a deposit together, especially if you’re starting out on your own. A survey conducted by the Mortgage Industry Association of Australia (MIAA) found that saving a large enough deposit is in fact holding back about 69% of prospective homebuyers.

“The problem facing the current generation of first homebuyers is the difficulty of raising the 5% or 10% deposit while paying rent. Properties are so expensive these days that it takes a lot longer to save for a deposit,” says Ian Grant, CEO of First Permanent.

“The other risk in raising a deposit and delaying the purchase of a property is that the market may simply move ahead so far that it becomes out of reach.”

Luckily, an increasing number of lenders are now offering 100% loans where you don’t need to scrimp and save for a deposit before you can get a mortgage. This means you can borrow the full amount of the purchase price of the property and only have to save for the costs associated with the mortgage. Some lenders even allow you to borrow up to 106% of the purchase price to cover all those other expenses.

Pros and Cons

Elaine Wood, national sales and training manager for Greater Freedom Home Loans, thinks 100% loans are particularly helpful for new homeowners trying to break into the market.

“They can get into the market today. They don’t have to wait the traditional six months where things can go wrong” she says.

However, there’s no such thing as a free lunch. These types of loans attract stiffer rates that include a ‘risk premium’ to cover the expected losses from higher mortgage repayment delinquencies. Lenders protect themselves further by subjecting applicants to a more rigorous screening process to judge if they’re able to meet their loan obligations.

“We assess them through employment and ability to repay the loan,” explains Sandy Awad, credit manager with Mortgage Merchants.

“Generally they need to be employed by the same employer for at least 12 months. Even if they’ve just been employed there for three months, and we can confirm they’re full-time, that they are off their probation period and they’ve held a job in the same industry, we’ll allow for that.

“Obviously we have to go back and check their credit files to ensure that they haven’t been bankrupt or had defaults. We generally accept small defaults like under $1,000 but we check their credit history thoroughly and their ability to repay the loan including the interest.”

Another downside of 100% loans is you could have higher costs, including monthly fees, account-keeping fees, annual fees and other account-related charges.

So are 100% loans for you? It depends, according to Luke Sheales, national sales manager with Mortgage House. “If you have a good income and buy in a good spot, maybe you can refinance in two years so it’s not a great pain.”

Features to consider

No matter what type of loan you choose, make sure that it comes with features that will help you maximise your savings and facilitate repayments.

Redraw facility: One of the most popular and widely used mortgage features on the market, a redraw facility enables you to make additional repayments into your loans and draw them back if you need them. This encourages borrowers to make extra payments, make savings on interest costs, and provides easy access to funds when necessary.

Offset account: This is simply a transaction account linked to your home loan account. It works as a regular savings account, but any money in this account is offset against the amount owing on your home loan, so you only pay interest on the outstanding balance.

For example, if you have a mortgage of $300,000 and you have a balance of $10,000 in your offset account, you only pay interest on $290,000. Interest is calculated on a daily basis so over time you can reduce interest payments.

The catch: if the offset account doesn’t come as a part of the loan package, you are usually charged higher interest on the mortgage to be given access to this feature.

Repayment holiday: This feature enables you to take a break from your mortgage repayments. Some lenders allow you to put your repayments on hold for up to three months (90 days). This is useful especially if you are going on maternity leave or if you have a major unexpected expense such as car or house maintenance.

The downside is that you will need to pay an additional amount when you return from ‘repayment holiday’ to make up for the break, or you can pay the amount in full after the end of the repayment break period.

Portability: This enables you to keep your existing loan should you wish to sell your property to buy a new one. This saves you time going through the whole application process again; however, there may be some conditions and fees attached to this option. Some lenders waive application fees if you keep the same loan.

Pitfalls to be aware of

If you’ve done your homework well and weighed up your options, you should be fairly confident that you’re getting the best mortgage deal on offer. However, you may want to check your preferred loan against the following factors.

1) Interest rate: The interest rate is an essential component of a home loan. It significantly impacts the amount you will be paying back in the long run. It’s crucial to shop around for the best possible rate, but also bear in mind that rate isn’t everything.

Luke Sheales of Mortgage House recommends that you take extra caution when taking introductory (or ‘honeymoon’) loans and make sure that you’re comfortable with the rate it converts to after the discounted period. “You should be wary about these types of loans because what you are doing is getting in six months of cheap repayment but when you come out of it you’re going to have a fairly expensive loan,” he says.

2) Fees: Fees can make a huge difference to the amount you will pay over the life of your mortgage. As discussed earlier, there are various fees that you have to be aware of when taking out a loan. It’s important to look at the fees associated with the loans. Are there any hidden charges? If you want to increase the loan later in life or switch, you need to find out what the fees are and work around that.

“Watch out for exit fees/deferred establishment fees if you plan to refinance the loan within five years,” says Greg Stevens, general manager for servicing and marketing, AIMS Home Loans. “If you take a loan with flexible features that meets your changing lifestyle, then in most cases with a multi-purpose loan you won’t need to change loan products. If the borrower takes a loan with a higher interest rate based on current circumstances, then refinancing becomes a more probable option.”

3) Bells and whistles: It’s important to understand the features that are attached to loans. If you’re not going to use them regularly, taking a basic loan that covers your current needs might be a better option.

“There’s no point in getting a loan with heaps of features if you’re not going to use them; they cost money because they have higher rates,” says Tim Brown of Macquarie Mortgages. “Saving every cent to meet your mortgage repayments because you’re paying premium rates isn’t a sustainable strategy.”

Affordability: One of the biggest mistakes new homebuyers make is borrowing more than they can afford to repay.

“Often people have unrealistic expectations of what they can afford, or haven’t raised enough for a deposit, but still want a premium property,” says Brown.

So how do you pick the right loan? Luke Sheales of Mortgage House advises: “You should take into account what your goals are down the track. Find out if the loan is flexible, if the rate is competitive and the person you’re dealing with has an understanding of what you want.

“You need to soak in as much info as you can. Take your time, don’t rush into it and take a step back and make sure you’re comfortable, make sure the loan product you’re taking meets your circumstances at the time.”