CHOOSING THE “BEST HOME LOAN” – TOP TEN QUESTIONS

We’re often asked about how to go about choosing the best home loan. This can seem like a daunting task, but it’s worth putting in the effort because choosing your “best” deal can save tens of thousands of dollars over the term of your mortgage.

We’ve developed a “top ten” guide to bring some discipline into the task. It’s in the form of a questionnaire. Consider each question carefully. By the end of the process, you should feel satisfied that you’re armed with the knowledge to sensibly choose a loan that suits your unique circumstances.  

Question 1: What type of loan do you need/want?

The principal types of loans are:

• Variable Rate – this is the main type of home loan in Australia. The interest rates on these loans rise and fall with the market, principally driven by the state of the economy and decisions by the Board of the Reserve Bank.
• Fixed Rate – the interest rate remains the same for the loan period. This may be good if market rates increase, but when they drop, extracting yourself from a fixed rate loan can be expensive (penalties may apply). These loans often transfer to a variable rate at the end of the term.
• Interest-only loans – as the name implies, you’re not paying down the principal, so while your regular payments are lower (helping with cashflow) you’ll be expecting/hoping for a short term capital gain. This type of loan is typically used for investment property purchases.  
• Split – partly a variable rate, partly a fixed rate, these are often used when borrowers want to have some insulation from rate increases. Some people split their loans between variable and fixed (say 50/50) in order to balance risk and savings, although you shouldn’t assume that your lender will always allow you to do this.
• Low-Doc / Non-Conforming – for self-employed people or non-standard applicants. Typically, these will attract a higher interest rate to compensate the lender for accepting higher risk.
  
  Your choice of loan depends on your risk tolerance and financial stability, and the willingness of lenders to do business with you. Note that ADF members are, generally speaking, very attractive prospective customers for lenders due to their stable employment, job security and regular fortnightly income. So take your time to get the best deal.

Question 2: Have you compared interest rates on offer?

The so-called comparison rate is the most important number in making this comparison because it should include most fees/charges and it will show the real cost of the loans you’re contemplating (not just the marketing spin).

Therefore, don’t just focus on the headline rate because alow rate with high fees may end up being much more expensive in the long run, for example, a variation of only 0.5%pa can add up to huge savings or extra costs over 30 years.

Question 3: Do you understand the fees and charges on the various loans on offer?

Common fees/charges include:

• Up-front fees – application, valuation and settlement
• Ongoing fees – monthly/annual account fees
• Exit/Break costs – especially for fixed-rate loans
• Redraw/Extra repayment fees

The comparison rate takes most of the fees/charges into account allowing you to compare the true cost of different loans. It’s especially important to understand the components of the comparison rate, so take your time, do your research, make the comparisons and don’t sign up until you do.

Question 4: What are some of the positive extra features that matter in a loan?

These can help you pay off your loan faster and/or save you a considerable amount of interest:

Offset account – reduces your interest by linking your savings
Redraw facility – offers access to additional payments you’ve made
Extra repayments – make additional payments without penalty
Portability – transfers your loan if your moving house

Remember that some low-rate loans limit these features, so in reality, the loan might not be quite as attractive as it appears. So think carefully about what matters most to you.

Question 5: Have you assessed your financial situation?

Before applying for a loan, do your preparation. Ask yourself the “what if?” questions and take some time to analyse:

• Your budget and cash flow
• Your deposit size
• Your ability to tolerate interest rate rises
• Your ability to repay the loan in the event of the loss of income in the family
• Whether you plan to sell, refinance, or rent out in future.

Question 6: Have you thought about the impact of the term (length) of the loan?

Remember that longer terms will lower regular repayments (there has been media talk of 50 year mortgages!), but can cost considerably more in total interest; whereas shorter term loans cost less overall, but typically require higher repayments.

Question 7: Have you shopped around?

Qualifying ADF members have the unique opportunity of arranging their mortgages through the Defence Home Ownership Assistance Scheme (DHOAS). You should certainly consider using this scheme which provides a welcome interest rate subsidy through your employer.

However, do yourself a favour and look at all the options in the market place.

You might also consider using the services of a mortgage broker who may save you time and may be able to source attractive deals that you’ve missed. But remember that brokers are generally speaking paid by commission, so satisfy yourself that the advice is offered in your best interests (which mortgage brokers are required to do by law).

Question 8: Have you read the small print?

Have a very clear understanding of the small print in the mortgage document. You can do this by requesting a copy of the Product Disclosure Statement (PDS). Typically, these documents are long, technical and somewhat confusing to the inexperienced borrower. Nevertheless, if you take your time and ask questions, having a PDS for each of the loans you’re considering is an important and reliable tool for making “apples vs apples” comparisons.

The bottom line here is that if anything is unclear, don’t hesitate to ask questions of the lender and get in writing anything on which you require clarification (e.g., are there any early repayment/refinancing penalties? What’s the process if interest rates change? Are there any conditions for special rates, such as mandatory use of direct debits to make repayments?).

Question 9: Should I get Pre-Approval of the loan before I buy?

Generally speaking, the answer is yes. Pre-approval shows what you can afford and substantially strengthens your offer when buying any property.

Question 10: Should I regularly reassess my current loan?

In a word, yes.

Financing a property is no longer a case of “set and forget” with the same bank/lender for 30 years. The market is ever changing and highly competitive. Astute borrowers are always on the lookout for better deals that can save them thousands of dollars. Therefore, we recommend that you:

• Review your loan every 12–24 months
• Carefully monitor interest rate movements/new offers and refinance if you can save money by doing so.

There is a wealth of resources in the public domain that can help you to better understand the world of borrowing and property finance.

For a solid start, our website offers the foundational document that will help you to get on top of your finances, set goals and work out how to achieve them. We’re referring here to our pro forma budget calculator. 

There’s also an excellent resource (including a mortgage calculator) at the Australian Securities and Investments Commission website Money Smart.

There’s no doubt that going through the process we’ve outlined in this article requires discipline. But the key point is that we’re not talking about saving a few dollars here and there. We’re talking about saving many thousands of dollars, so investing your time in considering our questions and acting accordingly is well worth the effort.