A mortgage is a type of loan that you use to purchase a home or investment property. You make a legally binding agreement with a bank or other financial institution that lends you money over a period of up to 30 years in exchange for charging interest at a fixed or floating (variable) rate.
There are different types of mortgages including a table loan, revolving credit loan, offset loan, reducing loan or interest-only loan. Each has its pros and cons, with varying features and repayment structures to suit the needs of different individuals or investors.
A deposit is required before you can take out a mortgage. Typically, your deposit should be 20% of the value of the home you want to purchase, but it’s possible to obtain a mortgage with 5% or 10% depending on the circumstances and the lender. Some major banks give more favourable interest rates to borrowers who have at least a 20% deposit.
Once you have bought a property, it is used as security against your mortgage and is technically owned by the bank until you pay off your loan. If you default on your payments, the lender has the legal right to take ownership to recoup their loss.
The interest rate is the most important part of the loan because it affects your repayments.
However, if you want to compare mortgages, there are also a few more questions to answer first:
Are you a homeowner or an investor?
If you’re borrowing money to buy a home to live in, you need an owner-occupier mortgage. If you’re buying an investment property, you’re looking foran investment loan.
Investor mortgages have slightly higher rates but are otherwise more or less the same. It’s the purpose behind the mortgage (what you’re using it for) that matters.
If you already have a mortgage but want to switch to a new one with a new lender there’s nothing to stop you. However, you do need to apply all over again with the new lender. It’s a bit of work but switching to a lower rate can save you a lot of money.
Fixed versus floating?
It’s important to decide whether you want afixed or floating interest rate. Floating rates have more flexibility but your rate can go up (or down) at any time.
Fixed rates let you budget your repayments more accurately because you know your repayments in advance. However, they’re less flexible. Plus, if you want to refinance a fixed-rate loan during its set period there is afixed loan break cost.
What repayment type do you need?
Another decision you have to make is your loan’s repayment type. Principal-and-interest mortgages require you to pay off the money you borrow plus interest at the same time.
Interest-only mortgagesoffer you an early period where you only pay the interest, not the loan amount itself, which makes repayments lower early on, but they end up being higher later. It’sa popular option for savvy investors, but be aware that it isn’t the best option for everyone.
How do I compare mortgage interest rates?
A good mortgage comparison starts with a careful look at interest rates, as it’s the key component.The lower the rate, the lower your repayments are. If you’re borrowing a lot of money, even a small difference in the rate can add hundreds or even thousands of dollars to your repayments. Here’s the difference in repayments between a 3.50% and a 3.00% interest rate (on otherwise identical loans, with 20% deposits and principal-and-interest repayments).
Savings (life of loan)
Over 30 years, that little 0.5% difference in the interest rate could save a borrower an enormous $39,600 in interest charges.
How do I compare mortgage features and fees?
Beyond the interest rate, comparing mortgages means looking at fees and the various features they come with. A loan with the right features gives you more control over your money and unlocks new ways to use your mortgage to your advantage.
Thecomparison ratedoes what its name suggests: it helps you compare a mortgage. This rate is a home loan’s interest rate, plus the cost of fees taken into consideration. It is a legal requirement to be displayed on all loans, but it’s only a hypothetical calculation.
Not every mortgage comes with the same features. However, here are the standard, useful ones:
Offset accounts.A100% offset account attached to your mortgageis a bank account that lets you save and spend money like a normal savings account. However, any dollar saved in the account, temporarily offsets your loan amount, meaning you are charged less interest. This feature allows you the flexibility to save cash while having a similar benefit you see from making extra repayments. Not every loan has an offset account.
Extra repayments.If your loan allows you tomake extra repayments,then you can pay it off faster, which saves you in interest charges. These days most loans allow extra repayments, although some fixed-rate loans do not.
Redraw facilities. Aredraw facilityis common on mortgages that allow extra repayments. It’s a feature that allows you to withdraw your extra repayments from your loan and spend them if you need them. It’s helpful in financial emergencies, but less flexible than an offset account.
Portability.If yourloan is portable,that means you can sell your property and buy a new one with the same mortgage. You won’t need to refinance, which makes life easier.
Split facility.Some loans allow you to split your mortgage into both fixed and floating portions, which lets you create a flexible loan that offers the best of both fixed and floating rate types.
Loan-to-value ratio (LVR)
Loan-to-value ratio (or LVR) is another way of saying minimum deposit. Most loans have a maximum LVR of 80%, meaning you need a 20% deposit.
However, many loans also have a maximum insured LVR of up to 95%, which means you can get the loan with a smaller deposit. However, you need to paylenders mortgage insurance(LMI) when your deposit is under 20%.
It’s hard to go through the mortgage process without paying some fees. You should alwaysfactor fees into your home loan comparison.
Examples of home loan fees include:
Application fee. A one-off fee many lenders charge during the application stage.
Ongoing fees.Some loans come with a monthly or annual fee.
Valuation fee. This covers your lender’s cost to have your property valued by an expert.
Legal fees.These pay your lender’s conveyancing costs.
Discharge fee.A discharge fee is only charged when you end a mortgage, either by refinancing or paying off the loan.
How much can I borrow with a mortgage?
The amount that a lender offers you depends on multiple factors:
Your income and expenses
Your debts and liabilities
The value of your property
Your credit history
To maximise your chances of having a mortgage approved, or borrowing more, you shouldcheck your credit scorein advance, minimise your spending in the months before applying for a loan and focus on paying down any outstanding credit card or personal loan debts.
How do I apply for a mortgage?
The mortgage application process seems complex and scary. However, once you break it down it’s not that hard. Preparation is key:
Is your credit file in order? Find out how to get a copy of your credit file and make sure there are no errors on it. If you have defaults or late repayments on your file, make sure you can explain them. Close any credit cards you’re no longer using.
Are you getting a joint loan? Think about how strong your relationship is with the other party. Changes to your relationship could make it hard if one party wishes to sell their share of the property.
Are you eligible for the loan? Borrowers typically need to be over 18 years of age. There are other requirements too, but those depend on the lender. Some want you to have a good credit score, while others might not allow you to buy inner-city apartments. Always read the eligibility criteria before applying.
If you provide all the required information, your lender can approve your loan in 2 – 3 business days, while some lenders even advertise that they can provide a decision in as little as 60 minutes. Remember that the more complicated an application, the longer approval can take.
Pre-approval means your lender “conditionally” approves you for a specific mortgage amount. It takes into account your income, debts and liabilities when deciding this. It’s usually extended for a few months, allowing you to look for a property with a bit more confidence. It’s important to note that pre-approval conditions can differ depending on the lender.
What paperwork do I need when applying for a mortgage?
Your lender wants to work out whether or not you can afford a loan. They ask for a lot of information from you, including:
Personal details. Your full name, driver’s licence number or some other form of photo ID, phone number and address.
Employment details. Your mortgage provider wants to know about your job, how long you’ve been in your position and may even ask for your employer’s contact information to confirm these details.
Financial details. Your lender wants to know how much you earn and spend, which means they want to see recent payslips, plus details of your expenses and debts including personal loans or credit cards.
Information about your property. The exact paperwork required depend on the type of property you’re buying. You need to tell your lender the property address, the type of property, number of rooms and more. They also want to know if you are going to live in the property or are purchasing as an investment.
Your credit history is important when your lender evaluates your application. Lenders want borrowers who have a good track record of paying back credit cards and loans, which can be a good sign that they’ll repay the mortgage. Some loan providers auto-decline those with defaults, while others might give you a chance to explain them. Specialist lenders may consider borrowers with credit impairment issues. Be aware that they might raise the interest rate to accommodate the extra risk they’re taking on.
Most lenders allow you to switch from a fixed rate to a floating rate or vice versa but some may charge a fee for this. If you’re switching from a fixed-rate loan, be aware that you usually have to pay a break cost. If you want to switch your mortgage to another bank, additional fees apply.
The mortgages market is competitive, so negotiating and asking for a better rate is a good idea. Before you do, make sure your credit file is in order and know what other offers are available in the market.
Your lender wants an independent appraisal to find out what the value of your property is. They then use this valuation to work out how much they will lend to you.
Buying a house is among the biggest investments most of us make. Set yourself up for long-term success by narrowing down the type of mortgage that fits your needs, budget and property. A strong rate and term can provide peace of mind and save you thousands over the life of your mortgage.
Richard Whitten is a senior writer at Finder covering home loans and property. He helps everyone understand the ins and outs of mortgages so they can make smarter property decisions. He has written for Money Magazine, Homely, and for multiple banks and lenders. Richard trained as a high school teacher but found it easier to manage personal finances than a classroom full of kids. Before joining Finder, he edited textbooks and taught English in South Korea. Richard has a Bachelor of Education, a Graduate Certificate in Communication and is currently studying a Certificate IV in Finance and Mortgage Broking.
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