How to find a home loan you can genuinely afford

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Given the number of home loans available today, you should be able to find a product that fits your circumstances. Just be prepared to look under the hood so you can avoid some common, costly mistakes.

The main types of home loans
  • Principal and interest (P&I) loans: where your repayments are going towards both the interest and the principal for the agreed term of the loan – so when you read your statements you’ll see the balance of the loan slowly decreasing.

    Your P&I loan can have a “variable” interest rate, which means your interest rate goes up or down according to changes in the official cash rate (or sometimes when your lender decides to raise or lower it).

    Or you can choose a “fixed” rate loan, which might attract a higher rate than the variable option at the time that you fix it, but it won’t change over the term, which is usually two to five years. That gives you predictability over the period.

    Or you can choose a split loan, where part is variable and part is fixed.

  • Interest-only loans: you’re only paying off the interest (no principal) for a set period, which usually makes your repayments lower during this time. However, you will pay more in interest over the life of the loan because you’re not reducing your debt at all during this period.

  • Line of credit loans: where a credit limit is set and you can spend up to that credit limit.
Other loans for specific circumstances

If you’ve bought a new property before selling your old one you might need what’s called a bridging loan, and there are special construction loans if you’re building from scratch. Vendor finance is another (sometimes risky) option, often used by people who don’t qualify for a traditional home loan for various reasons.

Extra features of some loans

Redraw facility – your loan may give you the ability to withdraw any extra money you’ve paid into your loan account over and above your minimum repayments. Your statement will tell you what is available for redraw.

Offset facility – where you link a savings or transaction account to your home loan and the account balance of that is taken off the amount you owe on your home loan when interest is calculated.

Common pitfalls

Whichever type of loan you’re considering, there are hidden traps that can cost you thousands. Here are some to avoid:

Interest-only loans - Regulatory requirements in Australia have pushed up interest rates on interest-only loans until they’re higher than P&I rates on average. If you’re buying an investment property then you can claim the interest as a tax deduction, but if you’re an owner-occupier, no such luck.

Also, if you’ve gone for an interest-only “honeymoon” period, will you be able to afford the potentially higher–than-average P&I interest rates that will kick in once the period’s over? Remember, there’s no such thing as a free ride with lenders; paying less at the start means it will cost more later on.

There’s no such thing as a free ride with lenders; paying less at the start means it will cost more later on.

Redraw facility - This option can give you the confidence to put extra money in, knowing you can withdraw at a later date. However, there may be extra fees for having the redraw option, or there may be fees charged per redraw; you might have a limited number of redraws per year, and maximum and minimum amounts you can redraw. Do your homework – and be 100% sure you’ll actually use the facility.

Offset accounts - While it may save you thousands in interest over the life of your loan, the offset may have higher annual fees, higher interest rates and/or account-keeping fees.

Basically, you need to be sure you’ve got enough cash in the offset account to outweigh any extra costs.

Fixed rate loans - There may be limits as to how much extra you can put into these loans, to save interest. And there may be thousands to pay in penalties if you want to break the fixed term, should you want to pay it out early, refinance or switch to a new, lower variable rate.

If you go with a fixed rate loan that is quite low, then after the period is over you will revert to the lender’s standard variable rate which could be up to a full one per cent higher. Meaning potentially hundreds of dollars more a month in repayments, depending on how much you’ve borrowed.

To find out more, speak to a mortgage broker or visit independent blogs and sites like MoneySmart. For more useful articles that will help you better manage your finances, check out our blog.