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 there will be costs charged known as a Break Cost. This amount will vary depending on how long you are into the fixed loan term.
When choosing a fixed rate loan with Australian Unity, you need to know that if you decide later to switch your loan or to repay it early, then a fixed rate loan may not be suitable to you as it does have a Break Cost. You should also consider a variable interest contract prior to accepting a fixed rate offer to see what is most suitable for you and your circumstances.
A Break Cost can be very large and may vary in size from day to day. Before making an early repayment (or varying a fixed interest rate) during a fixed rate term, you should ensure that you have an understanding of the likely Break Cost.
Understanding Break Costs
The purpose of applying the Break Cost is to compensate a lender for the loss incurred as a result of the effective termination of your contract. It is neither a penalty nor a fee, but an adjustment to recover that loss. It is a recognized industry practice to recover that loss.
When the Break Cost is applied:
At Australian Unity, we will charge you a break cost adjustment on the day that you:
- switch or repay the loan in full before the expiry of the fixed rate period;
- make pre-payments (payment of an amount that is more than the regular payment amount specified in the loan repayment table) exceeding $10,000 in any 12-month period; or
- fail to rectify any breach of the loan contract by the expiration of the time limit we specify in a default notice to be served on you, and the wholesale market swap rate for the term equal to your remaining fixed rate period is less than the wholesale market swap rate for the fixed interest period on the date the interest rate was fixed for your loan.
When you take out a fixed rate loan, we lock in our funding costs at a fixed rate for an equivalent period. If you decided to switch or prepay your loan early, either partially or in full, we then need to unwind, or reset, our fixed rate funding, which may result in a cost to Australian Unity.
How the Break Cost is calculated at Australian Unity:
[Your loan balance] x [remaining fixed term of your loan] x [change in our cost of funds]
We calculate the Break Cost by assessing the movement in our funding costs, verified by comparing the movement in the wholesale market swap interest rates. This calculation assesses the difference between the fixed term wholesale market swap rate at the date that your loan originally was taken out, and the rate applying for the remaining term of the loan from the date specified above ("When the Break Cost is applied").
Say you borrowed $300,000 on the 6 January 2014 with the annual percentage rate fixed for 5 years and, on that date the wholesale market swap rate for 5 years fixed was 3.79%.
Then, on 6th January 2016, you want to repay the fixed rate loan in full, and at that date you have paid off $45,000 of the principal, so the loan balance is $255,000 and you have 3-years of your fixed rate term remaining. The wholesale swap rate for the remaining three years (the remaining term of your loan) is now 2.18%.
The difference between the fixed rate at the beginning (3.79%) and for the remaining term of three years (2.18%) is 1.61%.
We therefore apply the rate of 1.61% to your loan balance of $255,000 over a three year term, which equates to $12,312.68. However, the calculation must also reflect the time value of money, by a present day value, resulting in a Break Cost to you of $11,908.68.
If you are considering paying out a fixed rate loan, making additional repayments or switching to a new interest rate, a quote of Break Costs can be obtained from Australian Unity on 1800 288 300.
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: principal and interest. Principal is the amount of money you borrow, while interest is the main cost charged by your financial institution to borrow the money.
Principal 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 your 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.
Offset available on the Health Wealth Happiness Home Loan and Package.
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.