Purchasing a home can be an exciting yet daunting prospect. It’s one of the most significant financial commitments you’ll ever make, so it pays to be informed before signing on the dotted line.
From what a home loan is and how it works, to the different costs that make up your mortgage and the types of mortgages available, here’s everything you need to know about mortgages.
What is a home loan?
A home loan is money borrowed from a bank or other lender that you can use to purchase property or refinance existing debt associated with real estate. A home loan includes:
- The principal - the amount of money you borrow from the bank.
- Interest - the cost charged by the lender to borrow this money, stated as a percentage of the loan amount.
- Any fees charged by the lender.
Your lender will also provide you with monthly repayment statements detailing these costs along with any additional fees due such as late payment penalties or early repayment charges.
How does a home loan work?
When you take out a mortgage, you agree to pay back your loan over an agreed period of time at an agreed interest rate. Your monthly repayments consist of both principal and interest payments and are usually paid in regular instalments over the life of the loan.
As you make repayments on your mortgage each month, your equity in the property increases as your debt decreases. When you reach the end of your loan term, you will have fully paid off your mortgage and will own your property outright.
The different costs that take up your home loan
There are three main components: the principal, interest rate and fees and charges. These make up your immediate costs and ongoing loan repayments.
- Principal, which is the amount you are borrowing from the lender.
- An interest rate is the rate charged by the lender for your loan, often expressed as a percentage of the principal. Generally speaking, if you have a big deposit, you’ll pay a lower interest rate and have lower repayments.
- Application fees - Application fees, also sometimes called establishment fees, are charged by the lender to cover the cost of the documentation and admin services associated with setting up your new mortgage. It is a one-off payment, usually under $1000.
- Valuation fees - Valuation fees cover the cost of a valuation of the property you’re purchasing. Lenders do this to ensure the house is worth the amount that you are borrowing plus your deposit. Some lenders offer this service free of charge.
- Stamp duty - Stamp duty is a state government tax charged for some kinds of transactions, including buying a new home. Stamp duty costs can differ depending on whether or not you're a first home buyer, what state you're in, and the cost of the property. See how much you may need to pay using the stamp duty calculators to learn more.
- Conveyancing - When a property is sold its’ title must be transferred from the seller to the home buyer. This is known as conveyancing and is usually handled by an accredited professional who charges a fee. Conveyancing fees can run into the thousands.
- Legal fees - Those applying for a home loan need a contract to be drawn up by a lawyer. Legal fees cover these legal services and the preparation of documents.
- Service fees - Monthly service fees are charged by the lender to cover the loan administration.
- Annual fees - Lenders usually charge annual fees on package home loans, which come with promotional discounts or lower interest rates. Annual fees are also sometimes initially waived.
- Redraw fees - Some home loans offer a redraw facility, allowing you to access any extra repayments you have made. Many lenders will charge a redraw fee every time you withdraw money, while others offer free redraws.
Fixed-rate home loans
Fixed-interest rate loans offer stability in terms of monthly payments as they remain fixed for an agreed period (typically 1-5 years). Fixed-interest rates can also help protect borrowers against potential rate rises during their fixed term period; however, they may mean higher upfront costs due to higher initial rates compared with variable options.
Variable-rate home loans
Variable-rate home loans provide flexibility in terms of repayments but come with risk due to potential fluctuations in market rates over time; however, they generally come with lower initial rates compared to fixed options. Variable-rate home loans (sometimes called adjustable-rate mortgages) generally allow for additional services such as an offset account or a redraw facility. These services offer alternative ways for you to reduce the overall cost of a home loan through extra repayments.
Blended or split-loans
Many home lenders offer the option to ‘split’ your loan—with a portion with a fixed interest rate and a portion with a variable interest rate. This can allow you to benefit from a blended interest rate which offers both flexibility and stability at the same time.
Interest-only home loans
These types of home loans are more common among investors who rent their properties and use the rental income to cover mortgage repayments. Many lenders offer a short-term interest-only option to owner-occupiers in certain circumstances, such as cases of financial hardship.
How often do mortgage rates change?
Mortgage lenders have costs associated with providing home loans, made up of their operating expenses (staff, offices, marketing etc.) and the interest rate that they pay the central bank. This interest rate is often called the ‘Cash Rate’. The RBA meets each month to decide upon the cash rate. If the cash rate goes up, it’s likely your loan’s interest rate will too. If it goes down, it’s likely your rate will too!
How to get a home loan
Getting a home loan is often the first step towards homeownership!
Save for a deposit
When buying, your deposit is the amount you’re able to pay upfront for the home. The rest of the purchase price is normally borrowed in the form of a home loan.
Generally, you need to have at least a 20% deposit to buy a property. Lenders like to have a loan-to-value ratio (LVR) under 80%, meaning your deposit is 20% of the property’s value based on the bank's valuation.
For example, if a lender values the home at $500,000, you’d need at least $100,000 for your deposit. Plus, you need to have money saved for stamp duty and other costs.
Don’t have a 20% down payment? You have a few options:
- Try to get a low-deposit home loan and pay Lenders Mortgage Insurance (LMI). Many lender’s will require LMI when your LVR is over 80%. Although expensive, you can pay this cost on top of your deposit or include it in your home loan amount.
- Get help from the bank of mum and dad. Consider a family guarantor, loan or parental gift.
- Continue to save more towards a deposit. Our deposit and upfront cost calculator helps you estimate how much you need.
Check your credit score
Your credit score is an important factor when deciding whether or not to approve your home loan application. Loan providers use credit scores to assess how reliable and responsible you are when it comes to bills and debts.
Your credit report will contain a history of your personal loans, credit cards and any buy-now-pay-later products, as well as any other defaults or bankruptcies. In general, your credit score needs to be above 600 in order for most lenders to consider approving your application, but this varies.
Refinancing your new home loan
Once you’re settled into your new home, the home loan journey still continues! You can often get a great deal on your home loan (joining perks, additional services or reduced rates) if you refinance your loan to another lender. In general, those who don’t refinance a loan pay more than those that do. You may also want to consider private mortgage insurance (or PMI) too.
With all this information now under your belt it’s time for action! There are many things first-time buyers need to consider before signing on that dotted line, so make sure to do plenty of research beforehand and seek professional advice from a mortgage broker or via online calculators if necessary.
Remember: knowledge is power when it comes to home loans.
Once your deposit is in the bank and your credit score is looking good, the next step is to secure pre-approval from a lender. Pre-approval applies to you, not the house—so organise it before putting in an offer with real estate agents.
To get pre-approved, simply submit some basic information about yourself to your chosen lender (such as employment details) along with documentation confirming the amount of money available in your savings account(s). The lender will usually then perform a credit check. If you are self-employed then you will likely have to provide additional documentation.
The lender will then assess this information and determine your eligibility for their loans; if they do then congratulations! You're one step closer towards owning your own home.
Make an offer and secure full-approval
With pre-approval secured, it’s time to get property hunting. Buying a home can be hard work, so you may want to consider getting help from a buyer's agent and a conveyancer.
Once you’ve found your dream home, you need to make a bid at auction or directly to the real estate agent that is then accepted. Once that’s done, it’s time to exchange contracts, meaning sign the legal documents which commit you to the sale, and seek full loan approval from your lender.
At this point the purchase price is final. Generally speaking, this involves further assessments being carried out by bank representatives who will then review any outstanding documents needed before issuing final approval (at which point all legal documents must also be signed).
Settlement on your new home
Settlement typically occurs 42 days after the contracts have been exchanged. Assuming the the mortgage is approved, all then parties meet - usually at the bank - and transfer of ownership documents are exchanged between the buyer and seller. Then there is a transfer of funds between financial institutions, completing the transaction.
Upon completion, both parties sign off acknowledging successful exchange (this usually takes between 1 - 2 hours depending on complexity). When you settle, you can expect to pay the closing costs which account for mortgage registration, lender application fees and others.
If you're a first home buyer, this guide to settlement and a checklist for moving and settlement may be helpful.
Congratulations - You're now officially a homeowner!