Home loans explained
Borrowing money to buy property can be a confusing exercise. There are so many home loan products on the market it's hard to know where to start and what to consider.
That's why using a finance broker like Grow Consulting is useful. We can access a wide choice of loan products from a variety of lending institutions. Our qualified brokers can determine what is best for your situation and identify a loan that will suit your needs. Using us can save you the trouble of doing your own research and ensure you have an appropriate loan for your needs.
Discover the basics of home loans
Before you talk to your bank or finance broker, it's useful to understand some of the basic points of borrowing money to buy a property.
Basic #1 - key requirements of a lender
Basic #2 - fixed vs. variable interest rates
Basic #3 - principal & interest vs. interest only repayments
Basic #1 - Key requirements of a lender
Most banks and other lenders require you to have a minimum 10% deposit of the purchase price plus available funds to cover the associated fees and charges involved in the transaction.
They will also want to know that you can make repayments on your home loan so will ask you to provide information on your income, your existing assets, any existing liabilities (e.g. personal loans, credit cards, HECS etc.).
Your income is a key factor in assessing your loan application but lenders will also look at how long you have worked in your jobs and the time you have lived in your homes. They are interested in job and housing stability.
Lenders will also have different lending policies for job categories, income types, postcodes and types of properties.
To work out your living expenses, each lender has its own loan servicing formula. This determines affordability of the loan for you taking into account the percentage of all your income that is used to service the debt. As each bank has a different formula for determining affordability, some may lend you more than others.
Basic #2 - Fixed vs. variable interest rates
In general, there are two types of home loans 'fixed' rate and 'variable' rate. There are advantages and disadvantages to both options.
Fixed rate loan
- Locks in the interest rate for a nominated term (1-5 years)
- Repayments during the loan term remains the same
- You can budget with certainty knowing that the repayments will remain the same regardless of economic conditions affecting official interest rates
- Provides peace of mind because you know what to repay and for how long.
- Not very flexible; e.g. you cannot make any changes to the loan during the term and can be limited to how much in extra repayment you can make
- Higher penalty fees may apply for early payout of loan
- Interest rate does not fall in line with falls in official market rates
Variable rate loan
- More flexible than fixed rate loan; features such as redraw facility and offset accounts can help reduce the amount of overall interest you pay on a loan
- You can usually make additional payments and deposit lump sums
- Interest rate falls in line with official interest rate
- Exit fees generally low.
- Repayments increase in line with rise in official rates (but repayments will also fall in line with falls in official rates)
Basic #3 - P & I vs. Interest only
Principal and interest versus interest only
When you set your loan you will be given the choice of principal and interest repayments or interest only repayments.
A Principal & Interest Loan (P&I) is a traditional mortgage in that your repayments cover both interest and principal. The bank works out the minimum payment you need to make over the term of the loan to own the property outright and repay the money you originally borrowed (principal). A standard loan term is 30 years.
With an Interest Only Loan (IO), the minimum repayment only covers the interest charge not the principal amount. This loan type was originally designed for investors although home buyers can request this type of facility. The main advantage of this type of loan is that the repayments are lower (compared to the P&I payment). The disadvantage is that you will never pay off the principal amount unless you make additional repayments.