There’s more to the cost of a home loan than its rate

By Will Keall

It’s no surprise that one of the main reasons borrowers choose particular home loans is because of the interest rate on offer.

Interest rates receive the greatest amount of attention in the media and with the cash rate currently at the lowest it has been for a long time (2.75 per cent), many more potential homeowners are choosing to enter the market for the first time.

I’m not saying that interest rates aren’t a useful guide when comparing loans, as even a small difference in the rate can equate to thousands of dollars in extra repayments. But there is so much more to the cost of a home loan than the interest rate.

So it’s important to have an understanding of some of the nuts and bolts of the loan, such as the type of loan and fees and charges.

Types of loans

The main options regarding the type of loan are variable, where the interest rate changes in response to changes in the lender’s funding costs; fixed, where you lock in a rate for a term that is typically one to five years; or split, where you pay a fixed rate on a specified portion of your loan and a variable rate on the remainder. A fixed-rate loan (or the fixed-rate component of a split loan) will revert to the appropriate variable interest rate at the end of the fixed term.

Ask for a fact sheet

If you are considering a particular home loan, ask for a key fact sheet. This document sets out important information, such as monthly repayment amounts, total payments over the life of the loan, and all relevant fees and charges, which can help you compare and select the best loan for you.

Ask about all fees

Understanding all the fees and charges associated with a loan is wise. Ask your lender what fees are applicable and whether there are any charges for actions such as early repayment or redraws.

Different lenders may call fees different names, so check you understand what any mean. In a nutshell, fees fall into four categories:

  • Upfront fees
  • Ongoing fees
  • Exit fees
  • Fees related to particular events, such as redraw

Upfront fees consist of costs of establishing the mortgage. These are one-off payments you are charged when you take out a loan, and vary between lenders and products. They may include things like application fees, valuation fees, legal fees and settlement fees.

One charge that often catches out new borrowers and one that can add thousands to the cost of your home loan is lender’s mortgage insurance. It doesn’t protect you, rather it protects the lender from you not being able to repay your loan. On a typical loan, this will be payable when the loan size is greater than 80% of the value of the property being purchased.

Ongoing fees (or service or maintenance fees) are the recurring amount you pay per month or annually to the lender for administering your mortgage account. These don’t apply to all loans, so it is important to check whether the product you are considering includes such fees.

Exit fees typically will include a discharge fee from the lender as well as any legal fees payable. Early termination, deferred application, early repayment or early discharge fees have been banned on new loans since 1 July 2011. If you took out a loan before then, you may be charged an exit fee, however many lenders have removed them from existing loans. Other lenders may pay the exit fee for you if you move your home loan across to them.

While fixed rate mortgages are very attractive at the moment, if you decide to switch out of one, you may be charged a break or switching fee. These are usually in the thousands of dollars and should be factored into your decision to switch.

Finally, some products may include ‘event-related’ fees, such as redrawing on your loan. While these aren’t overly common, it is a good idea to check whether they apply on the product you are considering.

Comparison rates

A good guide as to the overall cost of a loan is the comparison rate, as it takes into account all the fees and charges that you are liable for over the life of the loan. However, a factor to keep in mind is that by law, with any advertised interest rate mortgage lenders must show a comparison rate which is calculated on a loan size of $150,000 and a loan term of 25 years. In reality, however, most loan sizes are larger than this, and most mortgages are over a term of 30 years.

What this means, is that the standard comparison rate may not always be a good way to compare one loan with another. For example, imagine you are comparing two loans – and for simplicity’s sake, let’s assume that one of them has no fees whatsoever (loan A), whilst the other (loan B) has a $300 annual fee. Because Loan A has no fees, its comparison rate is the same as its interest rate – let’s say 5.00%pa. Loan B has an advertised interest rate of 4.80%, but because of its fees, the comparison rate (on a loan of $150,000 over 25 years) is higher, at 5.09%pa. It appears from this that Loan A is better value (assuming all other features were the same).

However, if you were looking at a loan size of, for example, $300,000 over a loan term of 30 years, the comparison rate would change substantially on Loan B. It would, in fact, drop to 4.94%, and thus would be lower than that of Loan A.

So it’s important to be aware that if you are using standard comparison rates to compare loans, that depending on the size and term of your loan, they may not be relevant. Be aware that the above example is a very simple one, and in reality most loans will have a number of different fees. You should also be aware that in the multitude of loans available in the market there are many differences in loan features, so you won’t always be comparing apples with apples.

Ask about extra features

While it’s important to understand the fees and charges associated with a loan, there are other features you should consider. You want your loan to be as flexible as possible, so find out if there are any limits to the amounts you can redraw or make in extra repayments. As you’re likely to move before the term of your loan is up, also make sure your loan is portable.

Some lenders also offer financial packages which include discounts on home and contents insurance, or a fee-free credit card or transaction account. Every little bit helps, so ask whether any of these extras are offered – and if not, maybe negotiate with your lender so that they are.

Will Keall, iMortgage’s general manager, has a wealth of marketing and business development experience gained in Australia and the United Kingdom. These include high level roles in a range of sectors such as financial services, insurance, travel and tourism, motoring and professional services.

Will played a pivotal role in the successful establishment of iMortgage. His dedication and passion for the mortgage industry have won Will the utmost respect as an integral part of the iMortgage brand.

A self confessed “numbers and brand geek”, Will calls himself a conservative investor with a long-term philosophy. He also believes it’s important to “love where you live.”

Will is a cricket and football tragic, who also enjoys running.