When looking for a good deal on a home loan (mortgage), the interest rate matters. A home loan is a long-term debt, so even a small difference in interest adds up over time.
Home loans come with different options and features. These can offer flexibility or let you pay off your loan faster. Some options could cost you more, so make sure they’re worth it.
Principal and interest will pay off the loan
Principal and interest loans
Most people get this type of home loan. You make regular repayments on the amount borrowed (the principal, plus you pay interest on that amount. You pay off the loan over an agreed period of time (loan term), for example, 25 or 30 years.
For an initial period (for example, five years), your repayments only cover interest on the amount borrowed. You aren’t paying off the principal you borrowed, so your debt isn’t reduced. Repayments may be lower during the interest-only period, but they will go up after that. Make sure you can afford them. See interest-only home loans.
Get the shortest loan term you can afford
Your loan term is how long you have to pay off the loan. It impacts the size of your mortgage repayments and how much interest you’ll pay.
A shorter loan term (for example, 20 years) means higher repayments, but you’ll pay less in interest.
A longer loan term (for example, 30 years) means lower repayments, but you’ll pay more in interest.
Aim for the lowest interest rate
An interest rate even 0.5% lower could save you thousands of dollars over time.
Check the average interest rate
Choose your loan and repayment types to see the average interest rate for new home loans in September 2020
Loan type Owner occupier Investment
Repayment type Principal and interest Interest only
Avg interest rate September 20202.62%
Weigh up the pros and cons of fixed and variable interest rates to decide which suits you.
Fixed interest rate
A fixed interest rate stays the same for a set period (for example, five years). The rate then goes to a variable interest rate, or you can negotiate another fixed rate.
Makes budgeting easier as you know what your repayments will be.
Fewer loan features could cost you less.
You won’t get the benefit if interest rates go down.
It may cost more to switch loans later, if you’re charged a break fee.
Variable interest rate
A variable interest rate can go up or down as the lending market changes (for example when official cash rates change).
More loan features may offer you greater flexibility.
It’s usually easier to switch loans later, if you find a better deal.
Makes budgeting harder as your repayments could go up or down.
More loan features could cost you more.
If you’re not sure whether a fixed or variable interest rate is right for you, consider a bit of both. With a partially-fixed rate (split loan), a portion of your loan has a fixed rate and the rest has a variable rate. You can decide how to split the loan (for example, 50/50 or 20/80).
Mortgage features come at a cost
Home loans with more options or features can come at a higher cost. These could include an offset account, redraw or line of credit facilities. Most are ways of putting extra money into your loan to reduce the amount of interest you pay.
Weigh up if features are worth it
For example, suppose you are considering a $500,000 loan with an offset account. If you’re able to keep $20,000 of savings in the offset, you’ll pay interest on $480,000. But if your offset balance will always be low (for example under $10,000), it may not be worth paying for this feature.
Avoid paying more for ‘nice-to-have’ options
When comparing loans, consider your lifestyle and what options you really need. What features are ‘must-haves’? What are ‘nice-to-haves’? Is it worth paying extra for features you may never use? You may be better off choosing a basic loan with limited features.
Work out what you can afford to borrow
Be realistic about what you can afford. If interest rates rise, your loan repayments could go up. So give yourself some breathing room.
Work out your home loan repayments and compare different rates.
Compare home loans
With the amount you can afford to borrow, compare loans from at least two different lenders. Check the loan interest rates, fees and features to get the best loan for you.
Comparison websites can be useful, but they are businesses and may make money through promoted links. They may not cover all your options. See what to keep in mind when using comparison websites.
Compare these features:
Interest rate (per year)
Comparison rate (per year)
Using a mortgage broker
With many lenders to choose from, you may decide to get a mortgage broker to find loan options for you. See using a mortgage broker for tips on what to ask your lender or broker.
Mai and Michael get the best deal on a home loan
Mai and Michael are looking to buy a $600,000 apartment. They’ve saved a 20% deposit and want to borrow $480,000 over 25 years.
They check a comparison website to compare:
interest rates — variable versus fixed
fees — application fee, ongoing fees
features — basic versus extra (redraw facility, additional repayments)
Ticking different boxes on the website, they look at loan options to see how the cost varies. Given interest rates are low, they decide to go with a variable rate. Plus they want to be able to make additional repayments. Using these as filters, they review loan options.
They repeat the process with another comparison website.
Then, using the mortgage calculator, they compare the impact of different interest rates over 25 years.
Based on their research, they shortlist loans from two lenders. They approach each lender to get a written quote personalised for their situation, then choose the best loan.
Please contact us on 0438 334 334 if you seek further assistance on this topic.
Reproduced with the permission of ASIC’s MoneySmart Team. This article was originally published at https://moneysmart.gov.au/home-loans/choosing-a-home-loan
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