Sally:
Welcome back to Pocket Money. Hey, Marc.
Marc:
Hey, Sally.
Sally:
So on Pocket Money, we've spoken about buying a home and property and investing quite a lot, and it's a topic that we'll continue to chat about, I'm sure, you know, there's so many pieces of the puzzle. But today we're actually going to focus on home loans.
Marc:
Yesh, so this is a 101-style episode. We're going to be going into everything that you want to know about home loans, but are too afraid to ask. And to help us, we're actually talking with Finder's very own home loans expert and writer, Richard Whitten. Richard spends his days digging into the latest property news, writing helpful educational content and making sure Aussies are armed with everything they need to research and find the right home loan for them.
Sally:
So yeah, I guess this is useful whether you're at this phase in your life already, or even if, you know, you just don't really know how home loans work and it's something that you will probably need to know about in the future. But of course, it is just one piece of the puzzle, you know, you can also think about mortgage brokers, how to find the right place, inspections, auctions, you know, there's a lot of stuff to cover. So welcome to Pocket Money, Richard!
Richard Whitten:
Hey, how are you going?
Sally:
I'm well, how are you?
Richard Whitten:
I'm very well indeed, very well.
Sally:
So we're going to start at the very top: What exactly is a home loan?
Richard Whitten:
Yeah, I guess home loans are a little bit unique because you're buying a property and the property acts as a kind of security, it's value, right? So the bank will lend you money, and if you somehow can't pay it back, the bank knows that you've got a property that's worth something that they can sell in the event that you can't repay it. That's called a security. So that's why a home loan interest rate is a bit lower than most other financial products because there's a security factor to it, to the different, to say like a car loan or credit card interest rate. But the downside is, you're borrowing probably a huge amount of money, so, you know, you are paying back a lot of money with the interest as well.
Marc:
And you touched on interest rates. So walk us through the anatomy of a home loan and all the major features that you'll see.
Richard Whitten:
Yeah, the interest rate really is the key part of any home loan. It's the most important thing. When you're looking for a home loan, you've gotta really start by looking at that interest rate. It's probably the closest thing to, say, like a price tag, I guess, if you're thinking about other products. It determines how much you end up paying. And the general rule is a higher interest rate means you pay more interest and a lower interest rate means you're paying less interest.
Sally:
When we're talking about home loan interest rates or mortgage interest rates, you hear a lot about, you know, like variable, fixed, split. What are the differences between these?
Richard Whitten:
Yeah, that's where it gets a little bit more complicated, because you've got choices, I guess. When you look at a home loan, you can generally pick either a fixed or a variable interest rate. The same principle applies, the difference is that a variable rate obviously can vary. A variable interest rate can change at any time. Anytime your lender wants to increase or decrease the rate, they can and they will, and there's not really anything you can do about it. Whereas a fixed rate, you can actually agree to the interest rate and you lock it in for a certain time, usually between one and five years. So you can fix your rate, it doesn't change for the whole period, which means your repayment doesn't change. Every month, you have the same repayment for that fixed period. When the fixed period ends, you go back to a variable rate and it can be higher or lower, it can change. Yeah, so they do operate a little bit differently. Fixed, you know exactly what you're getting, variable can change at any time. Although, to be fair, most lenders aren't raising or dropping their rates up and down, you know, every month or every whatever. It's not a constant change, but it can change. Variable rates tend to be a bit more flexible. Usually, you're able to make extra payments or you can switch to a different loan or different lender without any kind of penalty more easily. Whereas a fixed rate loan, sometimes there might be some kind of breaking costs or extra fee for doing that. So variable gives you a bit more flexibility, I think. And the majority of Australians do use variable rate loans. It changes all the time but it's roughly about 80% of the market is variable and 20% is fixed.
Marc:
And Richard, you touched on the fact that variable rates move and they fluctuate, and one of the components behind that is the RBA. Maybe you could just quickly explain how that works and why rates would change because of the RBA. And even what the RBA is?
Richard Whitten:
Yeah, it's very relevant at the moment. So basically the Reserve Bank of Australia, they set some different interest rates that affect the bank's sort of borrowing and funding costs for home loans. And this year, the Reserve Bank has actually cut the cash rate three times down to the record low of 0.75%. And what that means is that it becomes cheaper for banks to borrow money to fund home loans, specifically variable mortgages. And what lenders typically do is, when their costs get cheaper, they will pass on some of that cut on to their customers in the form of lower interest rates. It's never been lower, and the result is that home loan interest rates have gotten a lot cheaper, because lenders are passing on – usually not all of the cuts, but a lot of the cut – they pass it on to borrowers in the form of lower rates, which is good news for anyone who has a mortgage or is thinking of getting one. It just means that your repayments will get smaller. And that's for variable rates, although, it should be mentioned that fixed rates are pretty low at the moment too. So whatever type of mortgage you're looking at, it's a really low, it's a low rate environment.
Marc:
And that also means that the rate cuts might not always be passed on in full, when you're talking about variable rate loans.
Richard Whitten:
The most competitive lenders will often pass the full one on, but a lot of them will pass on a certain percentage of that cut. So it's always good to be, especially nowadays, if you have a home loan already, is to look at your rate and think about like, is this rate still competitive, have other lenders cut by more? Yeah, especially with the variable rate, you've got to always be checking what's on the market and, yeah, seeing if there's better things out there.
Marc:
So how should you go about choosing between a fixed or a variable rate and which is better?
Richard Whitten:
It's a tough one. There's no way of saying which is better. It's very much down to almost a sort of a personal preference or a kind of a personality thing in some respects. If you really value stability and certainty, then a fixed rate is good because you know exactly what your repayments are. So you can budget them exactly for that fixed period, and it gives you a kind of peace of mind and you're not really worried about things going up and you haven't got to constantly watch interest rates. But then the downside of a fixed rate is, especially if you, let's say, if you fixed your rate two years ago at like, let's say, 4% or 3.8%, which was a competitive deal, you know, probably a year or two ago, but now that rates have fallen below 3%, you're actually paying a lot more, and you're kind of missing out on the savings of a lower interest rate, because you're on that fixed period. Whereas with a variable rate, there's a high chance your rate would drop too, especially with the RBA cash rate cuts. But even if it didn't change, you could probably more easily switch to a better deal on a variable rate. That's a pretty important point. And variable rate loans tend to be lower than fixed rates. Although at the moment they're almost the same, they're very very close. And in fact, sometimes fixed rates are lower, but historically, a variable rate is going to be lower in the long run, I think, you'll end up probably paying slightly less.
Marc:
Yeah, so it seems like preference really factors into your choice of interest rate, and I am one of the people who locked in an interest rate before it dropped recently. So uh, yeah, I know exactly what you're talking about.
Sally:
You're not a gambling man, Marc?
Marc:
Well, I split, so I'm half a gambling man.
Richard Whitten:
Can we talk about splitting? Because you've mentioned that one, yeah, splitting is simply when you have, many home loans allow you to divide your loan into portions, so you can have a fixed portion on a fixed rate and another part on a variable rate, so you get a little bit of the benefits of both, kind of hedging your bets.
Sally:
I didn't even know that splitting was possible. I thought you just had to choose one of each, which I guess is good to know, because what you're describing, it would be difficult for the average person to predict what's going to happen. So let's talk about when you're, you know, looking for a home loan and how much you can and need to borrow. So can we break down some of those costs?
Richard Whitten:
So I think most people have probably heard the word deposit before, that's a pretty basic concept. But basically, you break down a home loan into two parts: the deposit, which is the money you save up yourself, and then that goes immediately into the purchase, and then the rest of the money you borrow from the bank, that's the loan amount. Typically, the traditional deposit size is 20% of the purchase price. So if you're looking at, say, a million-dollar home, 20% is $200,000 you have to save up of your own money, and then you borrow $800,000, which is called the loan principal.
Sally:
So would it be better if you can save for a bigger deposit then, if the interest is being calculated on how much you're borrowing rather than the total amount of the property?
Richard Whitten:
It can be a lot of money to save up. So, like a lot of buyers, especially, you know, first home buyers, have struggled to actually build up that big deposit. So there are many lenders that will let you have a smaller deposit, as low as 10% or even 5% in some cases, therefore you borrow up to 95%, which means you save a bit less money and you borrow more, but the upside is you're buying your home sooner.
Sally:
Is that the case just because like prices are rising and people are struggling to save up so lenders are actually trying to get, probably young people or first home buyers especially, like just into the game.
Richard Whitten:
Yeah, basically, yeah, they've realised that it's pretty hard to do the 20% deposit, so they will lend you, and usually the interest rate is equally competitive and you can have a smaller deposit. There is a downside though: if your deposit is under 20%, so if you're borrowing more than 80% of a property's value, the lender will also charge you a thing called Lenders Mortgage Insurance, which is a premium you have to pay. It's called insurance but it doesn't protect you. It protects your lender if you can't repay your loan. So if you've got a small deposit below 20%, the lender sees you as a bit more of a higher risk, they will charge you this extra cost as well.
Marc:
And like you touched on, Rich, an interesting thing that you'll have to weigh up when you're borrowing is, does it make sense to buy something now with a smaller deposit and pay the higher fees, or does it make sense to wait and save up a larger deposit, and where are property prices during all of this as well?
Richard Whitten:
It's very interesting, yeah, and if you wind the clock back, say, five years, especially in Sydney or Melbourne or even in most places in Australia, property prices are jumping up really quickly. So if you're the average person, you're saving, you're trying to save a 20% deposit, but every month, every year, the prices just keep jumping up, therefore, the deposit that you need gets bigger as well, you're chasing a constantly moving target. It was very very hard for people to jump in. Whereas if you'd actually taken the plunge and got yourself a 5% deposit, borrowed more money, pay the Lenders Mortgage Insurance, but then you buy a property that suddenly, you know, in a booming market is rising in value, you're actually probably in a better position. Because, yeah, your property is rising in value as you're paying it off, you've got your foot in the door and you're there. That decision actually makes a lot of sense. But then the reverse is also true if you take the plunge, 5% deposit, buy a property, but if you're in a falling market and prices are going down, you could end up with a property that's worth slightly less than what you've paid for it almost, and you're almost owning the whole amount of the property to the bank and prices are falling. The market pricing does have a big sort of impact on that. The key thing to note is whatever decision you make, just to make sure that you're comfortable with the repayments that you're looking at, regardless of what happens to the property price, up or down, and you're buying a home that you want to live in, that you're happy with, you're paying it off and you can afford it, and it's a place that suits your needs, then you don't have to worry so much about, you know, the price going up and down. You shouldn't focus too much on that kind of imaginary loss of value, because you've got your own house. If you're an investor, on the other hand, then it's a different story, because you're trying to make money.
Marc:
Mortgages have a lot of other features. So what features should borrowers look for?
Richard Whitten:
Mortgages are pretty standard products, so most mortgages have kind of similar features. I think the main one that borrowers should look at that not every home loan has, but lots of them do, is the offset account or 100% offset account as its sometimes called. It's actually an Australian financial innovation. It's basically a bank account that's attached to your home loan, a bit like a normal savings account, you can put money into it and you can spend it as you like or you can save it. But the difference is that you don't gain any interest on the money in this bank account, but instead, as long as the money is in your offset account, it offsets your loan amount. So it acts like a kind of temporary reduction on the money you've borrowed. So as long as it's there, the bank home loan amount is actually a bit smaller, and therefore you're paying interest on a smaller amount of money. Your interest costs go down as long as the money is in the account.
Sally:
Does that mean that the monthly repayments get smaller?
Richard Whitten:
Good question. No, it doesn't actually. Your repayments stay the same, but you're paying off more of the loan principal and less interest. Usually, we're paying interest and principal together on a lot of home loans. You're essentially paying off the home loan faster, but it looks like you're still repaying it the same way. Let's say your home loan is a 30-year mortgage term, but if you have some money in the offset account, it will actually end up shrinking that time down and you'll actually finish the loan faster and therefore pay less interest. So monthly stays the same, but over time, you end up with less money. It's about the long game, I guess.
Sally:
And what about redraw facility? I've heard of that one as well.
Richard Whitten:
Actually, let me explain a separate feature first that relates to redraw, which is extra repayments. So a lot of home loans allow you to make extra repayments on top of your compulsory, you know, monthly repayment. If you put more money on top of that, that's called an extra repayment, and most mortgages allow you to make those repayments without penalty, but some loans don't. But if you're loan does, you can pay off extra and then the redraw facility allows you to pull out that extra money that you've paid off if you need to spend it. So, for example, let's say you've got a home loan, you're paying it off, you come into a bit of extra money and then you put $10,000 of extra repayments onto your loan to pay off a bit more, but then all of a sudden, your car breaks down and you need to spend some money on repairs, but you've got no cash in the bank. You can pull out a few thousand dollars through your redraw to cover your costs. Yeah, it gives you a bit of that same sort of offset account flexibility. You made an extra payment and you can pull it back out as you need to. It's not quite as free or as flexible as an offset account. Any money in an offset account is your money, 100%, you can do whatever you like with it. Whereas a redraw, it's the bank's money and they're letting you take it back out to a certain degree. So there's often fees involved, or there's minimum amounts that you can redraw, or there's limits. So an offset account gives you a lot more flexibility, but redraw, yeah, it's also quite useful if you've made extra repayments, but if you haven't made extra repayments, then the redraw doesn't really help you.
Marc:
That's an interesting distinction. So I have an offset account on my home loan and I just treat it like my savings account. So all my extra cash goes in there, and then like you said, Rich, if something happens or if I need to get that money, you know, it's literally linked to my Visa, like a Visa debit card, so I just like, for better or worse, can easily access that cash whenever.
Sally:
Shopping spree!
Richard Whitten:
You've gotta be disciplined, Sally! As long as you leave it there, as long as the money's in the offset account, it's helping you pay less interest. And then when you need it, you pull it out. So a lot of people just put all their extra cash and savings in the offset account, or they even get their salary paid directly into it. And then they just are disciplined with how they use it, as with any money, and they just get as much benefit as they can from having money in that account.
Marc:
Rich, let's talk about eligibility when it comes to home loans. How does a lender decide if you're eligible for a home loan?
Richard Whitten:
Yeah, this is something that's gotten a lot more attention, especially in the last two years with the banking Royal Commission and the authorities cracking down on lenders and making sure that they are lending responsibly, it's had the effect of making eligibility a bit more of an issue. So basically, you apply for a home loan and the lender will look at your finances in a fair amount of detail, and, increasingly, a lot more detail than they have been. A lender will always look at your income, so how much money you're earning through salary, your assets, if you have, say, shares or other investments. They'll look at all your debts, so if you've got personal loan debt, credit card debt, even HECS or student debt. They will look at all your debts and they'll also look at your monthly spending habits. Typically now, a lender will look at the last six months of your spending, and they will go through, sometimes line by line, and query some of your, sort of, let's say, more egregious or more kind of unusual expenses, they'll start looking at those, and you might have to either explain them or, if you're spending too much, they might reject you for a loan or lend you less money.
Sally:
So we've spoken quite a bit about interest and whatnot. But what about fees?
Richard Whitten:
No one likes paying fees, obviously. I sort of tend not to focus on fees that much just because the interest rate really really is the key thing. This is what affects your repayments hugely. But yeah, fees can definitely add up. A lot of loans have an application fee, which can run up to $600 as a one-off cost. There can be settlement fees. A common one is legal and valuation fees. Those are all upfront kind of one-off costs. A while ago, we worked out in Finder's database, across all our loans, the average, upfront, sort of, fees can end up running about $600 or $700. It's a fair amount of money and you need to factor it in, so it is worth considering. And some loans now have basically no fees at all, whereas some have quite a few. It's worth thinking about when you're looking at a home loan. Why pay a fee if you can avoid it? There are also ongoing fees. Some loans will charge a monthly or an annual fee, especially ones with an offset account, or package home loans that combine credit card and savings accounts with a home loan. They sometimes have those kinds of fees. It can be worth it, if the product is good and works for you, a small fee can be worth it. And there's also, at the end of a mortgage, there can be discharge fees or exit fees. So there's all these different, you know, costs that can come into it. And it's worth mentioning too, some loans will say no fees, but there might be third-party fees for legal and valuation fees, which is the lender's cost of having a lawyer check the contract and then having a professional valuer to estimate the value of your property. Those can sometimes be charged. A lender might not actually tell you what those fees cost exactly, because they're not charging you, it's the third party that's charging to do the valuation or handle the legal side of the contract. So it's just worth asking the lender, you know, what's an estimate of those fees beforehand so you can have a clear idea of your costs.
Marc:
So let's go through a timeline of a typical home loan and what you can expect during the whole process from when you start researching to when you settle.
Richard Whitten:
Yeah, it's a fairly long process, and I think until you do it, like most people don't really have much of an idea about it, but there's plenty of information online. But really, yeah, you start, obviously, with deciding to buy a property and you start looking for properties, and that can take months and months. But it is really good to have the home loan side of things sort of squared away as much as possible, you know, when you're actually looking for a property. Because if you find the right property, you're ready to buy, but you haven't looked at the financial side of things, you're really in a big kind of disadvantage. So I think it's wise when you start looking for properties to buy, to start comparing loans, start looking at lenders, and then find one that you think looks okay, and then go and get pre-approval. It's kind of the first step towards getting a home loan. It's a non-binding kind of estimate, I guess. It doesn't mean the lender is obligated to lend you that much money, but it gives you sort of more of a certainty of what you can actually expect. So once you've got pre-approval, then you can look more closely, find a place that you want to buy, and then you have to actually apply for the home loan once you're drawing up the contract and things like that. So the pre-approval is the first step of the home loan, but ultimately, a full application involves, yeah, all your expenses, all your income, all that information, and the lender will go through it and then they will approve your home loan, hopefully.
Marc:
Yeah, I personally found the pre-approval stage was really helpful for me because you have to get all those documents ready before you start applying, so all your income and your assets and, you know, your debts and all that sort of stuff, you've got to start thinking about that at that stage, so it almost takes the burden off you having to make an offer and get your home loan and apply for your home loan and get all this stuff ready. Pre-approval almost like helps you start getting ready for that earlier as well.
Richard Whitten:
Yeah, that's exactly right. And if there are any problems, if you've got a credit history problem or something you hadn't realised was an issue. Yeah, you'll be more likely to get that sorted out in the pre-approval stage rather than have it all fall apart at the last minute, which can be very stressful and time-consuming, and you could miss out on a property that you really want to buy, especially if it's a competitive market or it's a really desirable property. Yeah, that pre-approval can really make the difference.
Marc:
And I think it's also a great idea, if you haven't bought a property before. So when I bought my first property, I had no idea how much I could borrow. It basically helped me limit down what I was looking at to something that I could actually afford, rather than look at these properties, these great properties, that I could never afford anyways, and waste my own time.
Sally:
Yeah, and do it in reverse.
Richard Whitten:
Yeah, don't just look at properties and get excited, start thinking about the finances too, and it will help you make a better property decision when it comes to purchase. As you say, it gives you a clear idea of what you can actually get.
Sally:
So when you're shopping around to find a lender, how do you choose? What are some of the things that we should be comparing when we're looking?
Richard Whitten:
Most Australians really do stick with the Big Four banks, and a lot of it is just out of habit, I think. A lot of people ask me, does the brand make a difference? Can I trust this small online lender that I've never heard of? And it's interesting because, actually, when you're borrowing money for a home, the lender is the one taking all the risk, because they're giving you a huge amount of money and trusting that you can pay it back. Like no one talks about their home loan or their lender like the brand actually matters once you've got it, so I do think that focusing on the interest rate is the key thing. Getting a low interest rate will save you money and that's the most important thing to focus on. All the lenders, whether they're big or small, they're all regulated by the same authorities. They're all governed by the same sort of laws, they all have a credit licence. So you haven't got to worry too much about the brand, I guess, if that makes sense. Big or small, it's really more of an issue about finding a home loan that is competitive with the interest rate and that has features that you need. That's probably the main thing to think about.
Marc:
Excellent. Well, that covers all of our questions. I feel suitably informed. I think I could apply for another home loan confidently. Thank you so much for your time, Rich!
Sally:
Yeah, that was so helpful. I think breaking down the timeline especially, it just, yeah, there are a lot of steps that need to be taken in this process, but I guess breaking down each step, you know, makes it seem a little bit simpler. So there you go. Now we know all the steps that we need to take to get a home loan.
Marc:
Yeah, don't be afraid.
Sally:
I am still really afraid, okay? I don't care, I'm panicking. I know Richard told me not to panic, but I am literally panicking.
Marc:
It's like when someone says to relax, and then you can't relax.
Sally:
My heart rate immediately peaks. Yeah, pretty much. No, but definitely learned a lot. So much information. So we'll make sure to put a bunch of really helpful resources in the show notes at finder.com.au/podcast, so make sure to check those out.
Marc:
And as always, you can find us wherever good podcasts are sold or handed out. So be sure to subscribe or follow us if you're on Spotify. And oh, follow us on Instagram.
Sally:
Yes, please send us all the Insta love. If you have any topics that you would like us to discuss or any questions about any of the episodes, feel free to send us a DM.
Marc:
Yeah, Sally and I obsessively check the DMs every morning to see who's messaged us.
Sally:
Thanks for listening to Pocket Money from Finder. Head over to finder.com.au/podcast for the show notes for this episode. The Finder podcast is intended to provide you with tips, tools and strategies that will help you make better decisions. Although we're licenced and authorised, we don't provide financial advice. So please consider your own situation or get advice before making any decisions based on anything in our show. Thanks for listening!
