Your outcome or your interest rate, what’s more important?
When taking out a mortgage it’s common to focus on the interest rate and weigh this heavily, positioning this single piece of data as the deciding factor when choosing a lender. After all, the lower the interest rate, the more money you save. Getting the lowest interest rate possible is what everyone is doing, and it is the simplest way to save money on your home loan, right?
Well… not necessarily.
There are many factors to consider when choosing a home loan product and a lender, and it pays to do this research right from the get-go because your relationship could last decades. If you use the interest rate as the sole indicator when deciding on a loan, you may find yourself locked into a product where you pay more in costs and stress than you’ll save in interest.
Furthermore, from the 1st January, 2021 Mortgage Brokers now have a regulatory duty called RG273 which is a “Best Interests Duty” that means we must put a client’s “best interests” first before anything else.
This duty binds all mortgage brokers – not banks as they simply sell their own products – to seek and achieve all clients’ “best interests” in providing advice and recommendations to clients’ particularly as mortgage brokers have many options to consider.
I think this is a great piece of legislation that allows all consumers peace of mind that they will receive their best interests, but what does best interests and a clients chosen outcome really mean?
Let’s explore this in more detail.
What do you really need?
Deciding which lender and product is right for you will be impossible unless you understand your own financial goals and your plans as a borrower.
Do you plan to hold the property for the long term, or is this a medium-term investment? The length of the term is important, as is the way you plan to make repayments. Are you looking for a product that offers some flexibility? If you expect financial windfalls throughout the year (a tax return perhaps, or a great side-hustle that gets periodically busy?), then you need a product that will allow you to make extra repayments without penalty.
Or you might need a fixed rate and some rate certainty but this comes with restrictions that you also need to understand.
And the property you have purchased may have plans to improve or develop and then having the right lender to match those needs is very specific to achieving the right outcome for your goals.
Many of our clients also use trusts or other borrowing entities and understanding these requirements is a key to achieving the right outcome as well.
It’s important that you spend time thinking about your future in detail. A professional finance advisor and an experienced mortgage broker can prove valuable at this stage.
Fixed, variable or a split
As a gross generalisation, when comparing fixed and variable rates, the variable is often lower. Variable rates generally (but not always) move when the RBA decides to alter the cash rate.
Choosing a variable rate may suit your needs early on in the term of the loan because it offers flexibility. There’s the option for an offset account, and the capacity to redraw or make extra payments is available in most instances.
Choosing a fixed rate might be best if you’re anxious about the repayment schedule at the beginning of your loan. Knowing exactly what your repayments will be, and being immune to any rate rises, might give borrowers some peace of mind.
Splitting your home loan gives you the best (and worst) of both worlds – a portion of your loan will be fixed, while a portion will remain on a variable rate.
It’s important to understand that when you lock into a fixed rate, you will generally be locked in for a minimum of five years, and there can be high break fees attached if you want to exit early, so think carefully about this option.
Forgetting to check all the fees attached to a product can be an easy mistake for inexperienced borrowers. An establishment cost and just a couple of regular monthly fees could make a huge different to the repayment of the loan, costing you additional thousands.
Keep an eagle eye out for the following terms which can add costs to your bottom line:
- Application fees or establishment fees: Try asking the lender to waive these fees or at the very least, consider a hefty discount.
- Valuation fees and lender’s legal fees: In some circumstances the bank may want a valuation done on the property and they will pass this cost on to you. There may be scope to negotiate on this, but home loan brokers will be able to advise you according to your particular circumstances.
- Lender’s mortgage insurance: This can be tens of thousands of dollars and is applied if you have less than 20 per cent deposit. Avoid this by saving a bigger deposit.
- Monthly or annual fees: This should be spelled out clearly (but often isn’t) so make sure you understand all the contingency fees and standard fees attached to your loan product so you can budget accurately.
- Exit fees: Lenders are getting used to customers shopping around and moving their mortgage to other providers, so to lock in their customers some add high exit fees to certain products. Make sure you understand this and are confident that it is right for you if you are agreeing to this condition.
Things to consider in the product and the provider you choose:
It’s important that your loan works for you. When you’re considering products, here are some features that may help you pay off your loan sooner.
- Extra repayments: From time to time a financial windfall may materialise and it’s often a good idea to put that extra money towards paying off your mortgage. Make make sure the lender allows for this in the loan product you choose.
- Redraw facility: If 2020 has taught us anything it’s that life is unpredictable. Being able to redraw on your home loan may be useful in helping you navigate uncertain times – make sure you have this facility on your loan and that you aware of any fees attached to drawing down on your mortgage.
- Repayment holiday: The economic uncertainty brought on by COVID has meant our job stability is more fragile than ever before. At some point you may need to take a repayment holiday. What are the conditions in your home loan product around this?
- Interest only: Many investors who buy property for rental purposes choose to pay interest only for a period and then sell the property for an appreciated price that pays off the loan and delivers a profit. This would be a feature that an experienced investor explores, or someone with a great mortgage broker advising them and it is more typical in a fast-growing housing market. Interest only terms are often only available for five years, although sometimes this can be extended to 10 years.
- Mortgage offset account: An offset account is an account attached to the mortgage where your money is deposited (salary/income) and gives you a reduction in the interest on your loan. Offset accounts are a very popular way of reducing the size of repayments.
- Purpose of the Property purchase: If the property has a specific use i.e. to renovate or improve, then you need to be sure that your chosen lender can accommodate these purposes. Not all lenders do construction loans or renovation loans and then of those that do, not all do them well. Building or constructing can be a stressful enough time in any case, so the last thing you want or need is a lender that makes this more stressful.
- Is a Trust or other legal entity involved: Again, the more complex you get with legal entities, then generally, the less lenders that are available to lend to. Understanding this and then achieving the right outcome for the client that maximises their options, borrowing capacity at the minimum of costs and effort is a very key reason as well.
In the end, interest rates are just one piece of a complex finance puzzle. There are multiple loan products in the market and finding one that has both the lowest interest rate AND terms and conditions that suit your personal circumstance is relatively rare.
It’s important that you understand your own goals clearly and in great detail before you take out a loan, so that you can make an informed decision about the type of product that’s right for you. An experienced broker can help you navigate the myriad decisions and ensure you find a loan that suits your individual needs.
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The information provided in this article is general in nature and does not constitute personal financial advice. The information has been prepared without taking into account your personal objectives, financial situation or needs. Before acting on any information you should consider the appropriateness of the information with regard to your objectives, financial situation and needs.