According to Reserve Bank of Australia (RBA), the ratio of household debt to disposable income was recorded at 193.7% at the end of June’17. It also says that the most household debts were housing related.
So home loan or mortgage is the biggest debt component on most of the Australian’s financials. And a cheap interest rate may slash down hundred of dollars from liabilities.
However, for many, the cheapest rate may not serve their objective and not suitable in their overall circumstances. So be cautious before entering into the gimmick world of cheapest rate
As a starter, it is wise to do some pre-work on your present financial circumstances. This should include but not limited to identifying your objective. Remember, defining objective is not only about obtaining a loan to buy your own home or investment property. Rather the bigger picture of your financial objective over a period of time. Also consider other factors such as your borrowing capacity, deposit, tax benefits and the features you want on your home loan. If you are satisfied with the outcome, then the next step is to hunt down the cheapest rate.
Here we have set out a guideline and identified the following factors that you may reflect on to get a home loan with the cheapest rate –
Understanding the Interest Rate:
There are a number of types of interest rate in a home loan. If you want to set the cheapest rate, an understanding of these types is a must.
Standard Variable Rate: The most common type of interest rate. It is variable in nature and moves based on the cash rate set out by the RBA. The standard variable home loans have the highest repayment faculties. In general, standard variable rates are lower than other types of interest rate.
Fixed Rate: This kind of interest rate is fixed for a certain period of time. Usually minimum one year to maximum five years. Both the interest and principal will be fixed in the agreed period. The fixed rate can reduce the risk of any hike in interest rate. However, it cannot bring the benefit if the interest rate moves downward. Look at the other economic factor before opting for a fixed rate.
Discounted Rate: A special or promotional discounted interest rate than the regular rate. You can get this kind of offer with the package home loan products where the lenders may need you to open transaction accounts and other products e.g. credit cards. Be watchful with the fees associated with this type of offers.
Honeymoon rate: Also known as introductory rate where the lender may reduce the rate 1-1.5% below than the standard variable rates for the first 1 or 2 years of the loan. The idea is to bring the new borrower on board and can be a good choice if you are a first home buyer. After the end of the honeymoon period, the rate will revert to higher variable rate. However, likewise fixed rate the borrower can be disadvantaged if the variable rate falls during the honeymoon period.
You can also consider “Partially Fixed Rate” or “Split loans” for your home loan. It means to fix a portion of your loan while keeping rest on SVR. Therefore, you can have both the certainty of repayment while enjoying other additional features.
Remember, it’s smart to look at the fees and rates together to save thousands of your dollars. The cheapest interest rate may not be cheapest in terms of upfront fees, ongoing fees and discharge fees associated with them.
The benefits of Added Features:
A careful selection and mix of the added features in the home loan align with your objective may help you to save some money. Before selecting a home loan just based on the interest rate only, look at the available features associated with it. Below are some of the popular features that can benefit you to pay less of interest in actual dollar value in a longer term:
Offset accounts. It’s a savings account linked to your home loan. An offset account is helpful as the interest earned by the money in the savings account reduces the interest payable on the home loan account. An offset could be 100% or partial. Let’s say, you have a home loan of $500,000. An additional $50,000 is in a 100% offset account. So your interest payable will be only in the amount of $450,000. There is also flexibility to use the amount kept in the offset account if needed. An extra fee may be applicable to maintain an offset account.
Extra Repayments: A feature to pay an extra amount on top of the normal monthly repayments towards your mortgage and pay off the mortgage faster. Some home loan packages may have the flexibility while other may need to pay extra fees to avail this feature. Most of the lenders may allow paying variable rate home loans off early. However, a break cost may apply for fixed terms loans.
Interest Only loans: This type of feature is mostly popular who wants to keep the monthly repayments low during the initial terms of home loan. While you only need to pay the interest but potentially makes the loan more expensive in long run. Many investors opt for this type of feature for their investment purpose as to gain tax benefit.
Watch out the Fees:
Another major factor to consider while selecting a cheaper option is to the ongoing fees. A number of fees are associated with a home loan. Application fees, Establishment fee, Extra repayment fees, Break free, Monthly account fee are naming few. The additional features of a home loan may come with additional fees.
It is wise to check the Comparison Rate than an Interest Rate to know how much you will be paying in total. The Comparison rate includes both the loan’s interest rate and any associated fees and charges and expresses this as a single percentage figure. Therefore, the cheapest interest rate may not represent the actual payment.
Depending on your objective, sometimes paying extra fees for the added features may potentially give you better value and give you more flexibility to pay-off debt smoothly and faster.
Selecting the loan term:
Another way to reduce your overall interest payment is through the loan term. The standard loan term for a mortgage is 30 years. But it can be less and by reducing the term you can actually pay less total interest on your loan amount. Below is a simple example of the repayments in two different loan terms.
Let’s say you want to take a home loan of $500,000 at the standard variable rate of 4.5%. So here is how the loan would look like in 30 years and 25 years of loan term-
Monthly Repayments: $2,533 (principal and interest)
Total amount repayments during the term: $912, 034
Total interest charged: $412, 034
Monthly Repayments: $2,779 (principal and interest)
Total amount repayments during the term: $833,749
Total interest charged: $333, 749
So, by paying an extra amount of $246 a month, you are saving interest of $78,285 in the 25 years of loan term agreement and making yourself free of mortgage loan 5 years ahead.
If your financial holds a better cash-flow, then opting for a shorter term loan would be smart in a way to save your money for paying extra interest on home loan.
The above-mentioned tactics are easy to avail if you can do a proper comparison of the available loan products in the market. With the presence of big banks and non-bank lenders, it’s now comparatively easier to get the cheapest interest rate.
But remember, there is more to a home loan than the interest rate. Depending on your circumstances, a plain, simple and cheap home loan may serve you for a couple of years but may lack behind if things change. Keep it in mind that a home loan with the cheapest rate may save dollars in short-term but failed in flexibility to add value and address other needs.
So, we suggest, before locking into a home loan, talk to a specialist to understand and find out your financial well being. Our mortgage broker and expert team can help you to make an informed decision.
Contact us to get a free initial consultation!