How do I choose the right home loan?

One of the challenges of taking out a home loan is figuring out how fluctuations in the broader economy might affect your repayments and whether this should influence your decision to go fixed rate or variable.  

Fixed

For example, when the official cash rate is low, as it is now (1.5%), it can be tempting to lock yourself into a fixed rate loan. On a fixed rate, the amount of interest you pay will stay the same for the term that you commit to – although it’s worth noting this term will typically expire before the end of your loan, at which point you may be able to select a new fixed period or move across to a variable loan.

Variable

By contrast, a variable rate will see your interest repayments increase or decrease in line with market movements. In other words, as the official cash rate goes up or down, your lender may adjust the interest they charge on your home loan accordingly.

A variable rate loan sometimes offers additional features or flexibility, however, which may not be available with a fixed rate product. This is often one of the reasons why some buyers choose a variable rate even in a low interest rate environment.

Split

Many people hedge their bets and opt for a split mortgage, where they’ll typically fix a certain percentage of their mortgage and make the remaining portion variable.

Regardless of the type of mortgage you take out, it’s crucial to consider the impact of a rate rise before you commit.

Given it can be hard to predict rate changes and ‘beat’ the market, the best approach is usually to think about your own needs and behaviours when trying to find the right loan.

For example, someone who is worried about future financial obligations and is taking on greater responsibilities, such as having kids, might benefit from the budgeting certainty that a fixed rate loan can provide.

On the other hand, a person who’s anticipating an increase to their salary might prefer a variable rate loan, which often gives borrowers more flexibility to make extra repayments and pay off their loan faster.

Think about your needs

I once asked Canstar finance editor, Justine Davies, about picking the right rate and she said borrowers should weigh up where they think interest rates are headed but also know that lenders are continually analysing this and have factored their predictions into the current rates.

So, no matter what, you should always factor in a 2–3% rise in interest rate when you’re deciding whether or not a loan will be affordable.

“To be honest, home loan interest rates are so low at the moment in historical terms that there’s very little risk either way,” Davies told me. “Choosing between a fixed, variable or split mortgage is mostly about deciding what’s right for both your lifestyle and budget. 

“Personally I think it’s more important to make a considered decision that suits your household budget and priorities, and leave it at that.”

What’s the crowd doing?

As some lenders have lowered rates on their fixed loans of late, there’s been a spike in demand for these loans, says broker Mortgage Choice.

Its data found fixed rate home loans accounted for about 30% of all loans written throughout July.

“This is the highest level of demand we have seen for fixed rate home loans since December 2013, when fixed rate home loans accounted for 33% of all loans written,” says Mortgage Choice chief executive officer John Flavell.

“The surge in popularity in this type of product does not come as much of a surprise when we look at what’s been taking place in the market in recent weeks.”

Many options

Of course, there are many other types of loans and packages available but before choosing it’s important to consult a financial expert.

These are some of the types of loans listed on the Australian Parliament website:

  • Fixed rates of 1 10 years
  • Honeymoon and introductory rate products
  • Split loans
  • Lines of Credit
  • Longer term loans (up to 40 year terms)
  • No deposit finance (100 to 107 per cent of the property price)
  • Credit impaired loans (so called subprime or non conforming mortgages)
  • Low or no documentation loans
  • Cocktail loans (combinations of personal and home loans for first time buyers)
  • Shared equity loans
  • Reverse mortgages.

Always keep in mind that the rules around these products change, depending on broader economic conditions. For example, earlier this year the Australian Prudential Regulation Authority (APRA) warned against lenders selling too many interest-only loans.

Where did long-term mortgages come from, anyway?

After the failure of short-term loans in the US at the onset of the Great Depression, during which time thousands of mortgages foreclosed, President Franklin D. Roosevelt stepped in. In 1933, he explained why the government shouldn’t just sit by in its state of deflation:

“Even before I was inaugurated, I came to the conclusion that such a policy was too much to ask the American people to bear. It involved not only a further loss of homes, farms, savings and wages, but also a loss of spiritual values — the loss of that sense of security for the present and the future so necessary to the peace and contentment of the individual and of his family.”

Roosevelt signed the National Housing Act into law on June 27, 1934. The purpose of the law was to “encourage improvement in housing standards and conditions, to provide a system of mutual mortgage insurance, and for other purposes.”

It also created the Federal Housing Administration (FHA) and the Federal Savings and Loan Insurance Corporation (FSLIC).

*NOTE: This information is simply a guide and not comprehensive. Buying a home requires proper research and it’s always best to talk to a financial expert first.

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