Choosing a home loan in a tighter market

Written by in Buying

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The Australian property market is constantly in flux, but since house prices began to balloon following 2010 (in the five years to 2017, Sydney house prices reportedly jumped by 75 per cent, and double their value for those who purchased their homes prior to 2009), there has been the clear sentiment that the unaffordable market was also irreversable.

As is inevitable, the market began to show signs of slowing in late 2017, with Sydney leading the charge in house value declines. There are a host of reasons why the market began to see this downturn, but one significant contributor was the tightening of credit following increased regulatory measures by APRA (Australian Prudential Regulation Authority) first announced in March 2017. Investor lending more than halved over the following months after the regulator restricted year-on-year investor credit growth to 10 per cent while honing in on interest-only loans as a main cause for Australian households’ growing financial stress.

With an increasingly prudent mortgage environment, what does this mean for those looking to secure a loan in the future? When choosing a home loan, how do they avoid entering into the sorts of arrangements that place families at risk of entering financial stress following a rise of interest rates?

Here are some important considerations to  understand before you go shopping around for a mortgage. The more of an expert you are, the more likely you will secure the right mortgage for your situation, avoiding some of the common pitfalls unaware buyers fall into.

Do you need Lenders Mortgage Insurance?

The type of home loan you need depends on your financial situation. With it now taking couples potentially seven or more years to save the money for a deposit in Sydney, it is understandable that many are jumping onto the LMI bandwagon.

If you have a deposit of under 20 per cent, you can take out Lenders Mortgage Insurance (which protects your lender, not you) and add the cost of that to your mortgage. It is a method for entering the property market sooner rather than later, with the incentive of significant capital gains outweighing the added cost of the LMI to your mortgage. But remember, that is in a market that is experiencing significant capital gains. 

You need to be aware that if you can only put together the money for a deposit of less than 20 per cent, you may not have considered the hidden costs of buying a home. Try lowering your budget so that you can take out a mortgage without LMI and also have money for both the administrative costs of buying a home as well as a healthy cash flow once you move in.

Avoid interest-only loans as a homeowner

You ideally want to enter a loan where you pay both the principal and the interest on the loan, rather than an interest-only loan. Interest-only loans have been favoured in the past by investors, especially those negatively gearing their properties. The surge of investor lending as a result of this was a cause for alarm in the Australian economy in 2017 and a key driver of APRA’s increased regulations.

Creditors are less likely to provide interest-only loans to first home buyers following the crackdown by APRA in 2017, so try to budget for the ongoing costs of paying both principal and interest in your financial goal setting. You will pay the loan off sooner, enjoying the benefits of long term gains in your later years, as well as an increased opportunity to refinance if this suits your investment strategy.

Variable vs. fixed-rate home loans

One major threat to the financial security of many Australian households comes from the consequences of any major increases to interest rates.

Fixed-rate home loans usually come with a use-by date (often five years), which can catch some home buyers unawares. Following this use-by date, interest rates can jump up. Without proper financial planning, this poses a threat for sloppy home owners.

On the other hand, fixed-rate home loans can provide stability and a chance for buyers to get a head start on paying off their loan. If you go down this road, investigate whether there is an annual limit to extra payments that you can make, and whether there is a fee for those who pay off their mortgage before the agreed longterm shelf life of the mortgage.

The fine details of a loan

Remember to research those parts of a loan that many people do not consider. For instance, how portable is the loan? The culture of home ownership is changing in Australia, and staying in the one place for 40 years isn’t as common as it once was. A portable loan allows you to transfer a loan when you move house, and is common in many loans, but remember to check whether yours is one of these loans.

Lastly, take stock of the administrative fees of a loan, such as establishment, ongoing and exit fees. Budget for these as you prepare yourself for buying a home. They may seem like costs that you don’t have to worry about now, but you don’t want to find yourself in a position that a good proportion of Australians find themselves today, where a slight increase in interest rates and increased household costs place them in financial stress.

The mortgage restrictions that have followed APRA’s 2017 regulations reflect a lack of public literacy about mortgages, but also a failure in the financial sector to provide the right products to the right people. With so much information at your fingertips, it is up to you to be as informed as you can be about your financial decisions, and question all advice you are given before signing on any dotted line.