Buying a home is a big financial commitment and is going to impact your life for a good part of your adult life. And usually we don’t have enough money to go out and buy a home. So we need to finance this. What’s this? It’s a loan. When you buy a home you usually need to put in a deposit – either money you’ve saved or equity from another property. The more you can put in the better, because it reduces the amount you need to borrow. Most lenders will ask you to put in at least 10-20% yourself as a deposit.
You can usually take out a home loan for up to 30 years (this is called the loan term). Most lenders will charge you a fee to set up your loan.
Principal and interest
The money you owe is called the principal. With most loans you make fortnightly or monthly repayments and the money is split so that some goes to repay the principal, and some to pay interest to the bank.
Interest is what you pay the lender for the use of their money. It’s always an annual percentage, for example 7% p.a. (p.a. is short for per annum, meaning a year). It’s usually worked out each day and charged to your loan every fortnight or month.
With a long-term loan you often end up paying more in interest than the amount you borrow. But you can make big savings by paying your loan off as quickly as possible.
You can save a lot in interest if you
- pay half your monthly loan payment every fortnight (it means you make two extra payments a year)
- make your payments as big as you can and increase them whenever you can
- keep your payments the same if interest rates go down
- pay off extra when you have spare cash.
To make the most of these suggestions you’ll need some of your loan on a floating rate.
Different types of interest rates
There are three different types of interest rates – floating, fixed and capped, or you can get a loan with a combination of these.
Floating interest rate – this can go up and down when the market changes, so you pay the going rate. This type of rate gives you more flexibility to actively manage your loan, for example you can pay off some or all of the loan without having any extra costs to pay.
Fixed interest rate – this type of rate is fixed at a set level for a certain time. It’s good for people who need certainty about how much their payments will be. If you want to change a fixed rate loan or end it early a ‘break cost’ may apply.
Capped rate – the interest rate can go up and down – but it can’t go over a set level for a certain time. It gives you some certainty about payments and you won’t get caught on a high rate if rates go down.
Combination of rates and terms – you can have the best of all worlds by having part of your loan on a floating rate (an amount you think you can pay off quickly) and the rest on a fixed or capped rate so you have more certainty about how much your payments will be. Or you might want to combine several fixed (or capped) rate terms so not all your loan is due to be ‘refixed’ at the same time. This can help you manage the risk that interest rates are higher when your fixed rate ends.
What types of loans are there?
There are several different ways of paying off your home loan. Most people choose a table loan because it gives more certainty about payments, or a transactional loan because it’s more flexible.
With a table loan your regular payments are the same each time (unless interest rates change). At first most of the money goes towards the interest you owe, but as your loan starts to go down more of each payment goes towards repaying the loan itself. This is the most popular type of loan because it gives more consistency to your payments.
Interest only loan
An interest only loan is where you pay all the interest owing each fortnight or month, but nothing off the loan itself. These are usually short-term loans (up to 3 years) to help keep payments low while you are building, or if you need bridging finance while you try to sell another home. You have to repay the whole loan at the end – or get another loan. An interest only loan will cost you more in interest than a table or reducing loan because the principal isn’t going down.
Transactional and revolving loans
With a transactional loan your loan and everyday banking are combined into one account. There are usually no set repayments as long as your loan balance goes down a certain amount each month.
A revolving loan is where you can keep taking the money out again – so it’s like a large overdraft. There’s usually a set date when you have to repay the loan by.
With a reducing loan you pay a set amount off the loan each time plus all the interest you owe. So your payments are a lot higher at the start than later on. This can save you interest because you pay more off the loan earlier on.