Why home loan interest rates aren’t everything

All things being equal, a lower interest rate beats a higher one. But all things are rarely equal.

Plenty of other things matter when you choose a home loan, and some of them will cost you far more than a small difference in rate ever will. Here are the questions worth asking before you commit.

How much can I afford to borrow?

Lenders look at your income, assets, debts and living expenses to work out your borrowing power. That number is not the same as what you should borrow.

Get an estimate before you start looking at properties so you are shopping in the right price range. Leave yourself room as well. If rates rise or your income changes, the repayment you could just manage at the top of your capacity becomes the repayment you cannot.

What is the comparison rate, and why does it matter more than the advertised rate?

The advertised rate tells you what the lender charges on your balance. The comparison rate folds in most of the fees as well, so it gives you a truer picture of what the loan actually costs.

• The loan’s interest rate
• Most fees and charges, including one-off costs like establishment and valuation fees, and ongoing monthly or annual fees
• Repayment frequency

It is not perfect. Comparison rates are worked out on a standard loan amount and term that may not match yours. But it is a far better starting point than the headline number.

Should I choose a fixed or variable rate?

Fixed means your rate will not move for a set period, usually one to five years. Variable means it moves with the market. Both have their place.

Fixed gives you certainty. You know exactly what the repayment is, which makes budgeting easier and protects you if rates rise. The trade off is flexibility. Break costs can be significant if you sell or refinance during the fixed period, and many fixed loans cap how much extra you can repay.

Variable gives you flexibility. You can usually make unlimited extra repayments, use redraw, and refinance without break costs. The trade off is that your repayment can go up.

Some borrowers split the loan, fixing part of it and leaving part variable. That gives you some certainty and some flexibility rather than all of one and none of the other.

What loan features should I look for?

This is where a slightly higher rate can beat a lower one.

Offset account. A transaction account linked to your loan. Every dollar sitting in it reduces the balance you pay interest on. Keep $30,000 in an offset against a $500,000 loan and you are charged interest on $470,000. How offset accounts work.

Redraw. Lets you pull back extra repayments you have already made. Useful for emergencies, though redraw is generally less flexible than an offset, and some lenders charge for it or limit how often you can use it. More on redraw facilities.

Extra repayments. The ability to pay more than the minimum without penalty. This is the simplest way to cut the interest you pay across the life of the loan.

Portability. Lets you move your existing loan to a new property instead of refinancing when you move. It saves the cost and paperwork of setting up a new loan.

A loan with a slightly higher rate but a genuine offset account can easily cost you less overall than a cheaper loan without one. It depends on how much you keep in the account, so it is worth doing the sums on your own numbers rather than assuming.

What repayment options do I have?

Principal and interest is the standard. You pay down the balance and the interest together, so you build equity and the loan is repaid by the end of the term.

Interest only means you pay just the interest for a set period, usually one to five years. Repayments are lower during that period, but the balance does not reduce. When the interest only period ends, repayments jump, sometimes sharply, because you now have to repay the full balance over a shorter remaining term. It suits some investors and some short term situations. It is rarely a good idea simply because the repayment looks cheaper.

Most lenders offer weekly, fortnightly or monthly repayments. Paying fortnightly rather than monthly means you make the equivalent of one extra monthly repayment each year, which quietly shortens the loan.

How does the loan term affect what I pay?

The loan term is how long you have to repay. A shorter term means higher repayments but less total interest. A longer term means lower repayments but more total interest.

There is a practical approach here worth knowing. Take the longer term for the lower minimum repayment, then make extra repayments while you can afford to. You get the interest saving of a shorter term, but if your circumstances change you can drop back to the minimum, because you are already ahead. If the loan has redraw, those extra repayments stay available to you.

For most borrowers that flexibility is worth more than locking into a shorter term they cannot adjust.

How big a deposit do I need, and what is LVR?

Loan to value ratio is the size of your loan measured against the value of the property. Borrow $400,000 against a $500,000 property and your LVR is 80%.

Most lenders want a 20% deposit, an LVR of 80%, to avoid lenders mortgage insurance. LMI is a one-off premium that protects the lender, not you, if you default. It can add thousands to your costs.

A higher LVR is not automatically a bad thing. Saving a full 20% can take years, and prices may move faster than you save. LMI can usually be added to the loan rather than paid upfront, which means a higher LVR can be the difference between buying now and buying much later. Whether that trade off is worth it depends on your numbers. Work out your LVR.

What fees should I watch for?

• Upfront: application or establishment fees, valuation fees, legal and settlement costs
• Ongoing: monthly or annual account fees, package fees
• Exit: discharge fees, and break costs if you leave a fixed rate early

Watch for the reverse trap as well. Plenty of no fee loans carry a higher rate, and that higher rate can cost you far more across the life of the loan than the fees you avoided. A $300 application fee is cheap next to thousands in extra interest.

The Key Facts Sheet a lender must give you shows the total you will pay over the full term. It is the quickest way to compare two loans honestly. More on home loan fees.

Does the lender matter as much as the loan?

More than most people expect. A lender with a slow or disorganised application process can cost you a property. In a competitive market, a delay in getting finance approved is the difference between your offer being accepted and someone else’s.

• How long approval realistically takes
• Whether they offer genuine pre-approval, and how long it lasts
• How they handle hardship if something goes wrong
• Whether you can reach a person when you need one

Reviews are worth reading, but be selective about where. Curated platforms such as ProductReview and Trustpilot verify reviewers more thoroughly than open review sites do.

Should I consider a non-bank lender?

Non-bank lenders fund their loans differently to banks, generally through securitisation rather than customer deposits. They are regulated under the same credit laws and carry the same Australian Credit Licence obligations.

They often have lower overheads, which can mean sharper pricing, and they can be more flexible with borrowers who do not fit standard bank criteria, such as the self-employed or people with a less conventional income history.

Restricting your search to the big banks means you are comparing a small slice of the market. How non-bank lenders work.

What if I do not have a big deposit?

A family guarantee, sometimes called a guarantor loan, lets a family member use equity in their property as additional security. That can get you into the market with a smaller deposit and can avoid LMI entirely.

It is not a small ask. The guarantor is legally responsible for the guaranteed portion if you cannot pay. It works best when everyone understands exactly what is being guaranteed, for how long, and what has to happen for the guarantee to be released.

Can I consolidate other debts into my home loan?

You can, and it can genuinely help. Credit card and personal loan rates are far higher than home loan rates, so rolling them into your mortgage can cut your monthly repayments substantially.

The catch is the term. Spreading a five year personal loan across 25 years of mortgage can mean paying more interest overall, even at a lower rate, unless you keep the repayments up rather than dropping to the new minimum. How debt consolidation loans work.

How might my circumstances change?

Worth thinking about before you commit rather than after. Becoming a parent, changing careers, going from two incomes to one, or taking on study all change what you can comfortably repay.

Leave yourself breathing room. And if you do end up struggling, tell the lender early. Lenders have hardship obligations and will generally work with borrowers who come to them, far more readily than with borrowers who go quiet. What to do if you are struggling with repayments.

The short version

The cheapest rate and the best loan are not always the same thing. Work out which features you will actually use, add up what the fees come to across the full term, and check whether the lender can move at the speed you need. Then compare rates.

Common questions