A home loan is a big commitment, and deciding which home loan suits your needs and requirements can be an overwhelming decision if you don’t know what you’re looking for.
The interest rate on your home loan, the principal, loan term, and the amount of your repayments determine how much you end up paying over the life of your loan. We break down the most important things to consider when it comes to financing your home.
Interest rates options for home loans
When applying for a home loan one of the biggest decisions you’ll need to make is what type of interest rate meets your needs: a variable interest rate, a fixed interest rate, or a mix of both (a split loan).
Variable rate home loan
Variable rate home loans are the most common in Australia, as the interest rates are generally lower than a fixed rate loan. The interest rate on a variable loan may go up and down throughout the term of the loan. The rate can be affected by factors such as: the Reserve Bank of Australia changing the cash rate as well as higher or lower funding costs for the lender.
The benefits of a variable rate home loan include:
- Unlimited free repayments so you can pay your loan off faster
- Access to additional repayments (redraw) you have made
- Lower interest rate when the interest rate is decreased.
The downside can be that interest rates can go up which means your repayments can go up. There is no certainty about when this may occur.
Fixed rate home loans
The main benefit of a fixed rate home loan is you lock in your interest rate for a certain period, and have set repayments for this term, usually around one to five years. This means you won’t benefit from any interest rate drops, but won’t be affected by hikes either.
During the fixed period:
- It’s common that you’ll only be able to make limited additional repayments per annum
- Some institutions may not allow you to redraw any additional repayments you have made to the loan
- If rates fall or increase your interest rate will not change
- If you want to pay your loan out early or want to revert back to a variable rate you will be charged a fee. This amount will vary depending on how long you are into the fixed loan term.
Split home loans
A split loan is usually a combination of a variable and fixed loan. One part of your loan will have a variable rate, while the other part has a fixed rate. This allows you to enjoy the benefits of both fixed and variable interest rates.
Home loan repayments
While there are many types of home loans with different interest rates and features, they all share two common terms: principle and interest. Principle is the amount of money you borrow, while interest is the main cost charged by your financial institution to borrow the money.
Principle and interest repayments
A home loan where you pay off the principal and interest over a period of years, until the loan is repaid, is the most common type of loan. With this type of loan you generally pay less interest and have lower repayments over the life of the loan, than if you were paying interest-only repayments.
An interest-only repayment involves just paying off the interest. The principal will not be paid off. The interest-only period is generally up to 5 years. The benefit of this is that you have lower repayments while you are paying interest only repayments. The downside is that you are not reducing you principal balance, and you generally pay a higher interest rate. Your repayments will be higher once the interest-only period ends. This type of loan is better suited to customers with investment objectives.
Making extra repayments onto your home loan reduces the amount of principal, and the interest you will be charged. This means you can pay off your loan sooner. To ensure you can take advantage of this, read the fine print on the home loan features to see if you can make extra repayments.
Interest rates aren’t the only thing to consider when deciding which home loan to take out. Establishment fees and annual fees can make a significant difference to your monthly payments. To work out the overall cost of a loan, look at the comparison rate. This takes all fees into consideration, so will give you a clearer idea of what you’ll actually be paying each month.
Rates are usually slightly higher on interest-only loans than on principal and interest loans. However, if an interest-only loan is the only way you can afford to buy a property and make repayments, it may still be worth paying a slightly higher rate in order to do this.
You can also get a package home loan, which reward you for using other products from the same bank by giving discounts on insurances or credit card rates. As well as allowing you to access discounted rates.
Redraw facilities give you access to any additional funds you’ve paid in to your home loan, so you can use them if needed.
An offset account is a great way to reduce your interest payments. It works in exactly the same way as a transaction account; you can use it for all your everyday banking needs but the money in there ‘offsets’ the amount on your loan, so you pay interest on a smaller amount of principal. If you deposit your salary in to an offset account, you’re constantly reducing the amount of interest you pay.
Check out our home loans that offer competitive rates and features.