For first home buyers, getting that all important home loan can feel like you’re at a job interview. Lenders will ask you about your spending habits, your credit score and your employment history to help them decide if you’ll be a responsible borrower.
But just like a job interview, remember that it’s not all one way. You’re interviewing them as well. With thousands of mortgage products on the market, it’s important to choose the one that suits you the best.
One of the biggest decisions you’ll need to make when you’re comparing home loans is whether to choose a fixed rate loan, a variable loan or a mix of the two.
Debbie Ettridge, head of Elders Home Loans, says that this is why you should talk to a broker early.
“We have access to a huge range of mortgage products across multiple lenders. If you go to your bank, they’ll probably offer you a few choices. We can give you significantly more.
If you talk to us early, we’ll be able to discuss your goals and your current situation so that we can match you with the best lender. We’ll discuss the pros and cons of a fixed versus a variable rate. We’ll also be able to help you make any changes you might need to make your application stronger.”
To help make the decision about what kind of loan to choose, it’s important to understand how each option works.
Fixed rate loans
A fixed rate loan guarantees you a set interest rate for a set period of time. It follows that your repayments will be the same amount every month during that period.
Effectively, both you and the banks are betting on whether you think interest rates will go up or down.
If the cash rate goes up during your fixed-rate term, you benefit because you keep the lower rate. If it goes down, the bank benefits because you stay on the higher rate.
The term of the fixed rate is usually somewhere between one and five years. “Right now, we’re seeing a lot of four year terms at very attractive rates,” says Debbie. “That’s a sign that lenders think the rate will stay at record lows or even drop further.”
Fixed rate loans offer security. Your repayment amount stays the same, which can be helpful if you’re on a strict budget. “Fixed rate loans are often a really great option for first home buyers,” Debbie explains. “You can budget with certainty because you know what your repayments will be, and you don’t get stung if rates suddenly go up.”
Fixed rate loans usually offer slightly lower rates than their variable counterparts. As long as interest rates don’t go down, you can enjoy some significant savings over the term.
Fixed rate loans are less flexible. They usually don’t allow you to make extra repayments into the mortgage. If you want to change lender, or end the loan term early, there are often costly ‘break fees’ involved.
If rates go down, you’re stuck at the original higher rate.
Variable rate loans
Variable rate loans mean your interest rate varies along with the RBA cash rate. Banks set their rates higher than the cash rate, so if the cash rate is 0.25% you can expect to see interest rates around 2-2.25%. However, if one falls (or rises) so does the other.
If you think interest rates are going to go down, it makes sense to choose a variable rate loan rather than locking yourself in at a higher rate. But that’s not the only reason to choose variable.
Variable rate mortgages also allow you to make extra repayments to pay off the loan faster. “For people who want to steamroll their mortgage quickly, I often advise a variable loan,” says Debbie. “You can make extra repayments to pay off the loan faster without paying a penalty.”
It’s also easier to switch loans and find a better deal, since there’s no break costs. “Lenders compete with each other to try and get you to switch. New borrowers can often get better interest rates than existing customers. There are also a lot of generous cash back deals out there for people who switch. Banks don’t reward loyalty, unfortunately. If you already have a home loan, talk to your broker about refinancing. You can usually get a better deal.”
Repayments can change frequently, especially when the cash rate is volatile. That can make it harder to budget.
And of course, if the rate does go up, you might be wishing you’d locked in at the lower rate.
What is a split loan?
A split loan is a product that allows you to split your home loan into two parts. One part is a fixed rate loan, the other is variable.
You can choose to split your loan into whatever proportions you want. This could be 50% fixed, 50% variable. It could be 90% fixed and 10% variable. It’s up to you.
But how do you decide? It all depends on how much flexibility you need. Debbie advises a chat with your broker to get clear on your goals.
“One of the things we do is we’ll sit down with a client and look at their budget with them. That helps us to see how much money they have available for repayments, and where they can make some cuts if they need to.
We do that early on, before we put the home loan application in. But it also helps us to decide what kind of loan works best. A couple who are on a really tight budget, we’d probably advise them to fix most of their loan so that they have that certainty. An investor might have more money to play with so they can make extra payments, and they might want to stay completely variable or just fix a small portion.”
Whatever you decide, don’t wait too long to get into the market.
“Interest rates have never been lower,” says Debbie. “All you have to do is jump on board. We’re seeing some really long term fixes, so you can get in now and be sure that you’ll stay on a great rate for years to come. Investors are enjoying a great environment, as well. Capital growth is going gangbusters, and the low rates mean it’s easier to get positive cash flow from your investment”