In your lifetime you will encounter many significant milestones which are exciting or even life changing. Whether you’re getting married, buying a new property, building a new home, or embarking on a new business venture, these huge milestones will in most cases, require the assistance of a loan for them to come into fruition.
Applying for a loan should be an easy process; however, the jargons surrounding loans make it increasingly complex when you’re trying to compare different options. Without some guidance from a financial broker, you might end up taking on too much debt or getting into financial hot water, like paying more than you expected. We have provided some insights below into what you should look out for when applying for a loan:
The Loan Type
Taking on a loan is a big responsibility; therefore, it’s essential to understand the different types of loan that’s available and choose one that you can comfortably take on the responsibility for.
Loans vary in type. There are basic loans with an affordable rate and minimum features, for example, a basic home loan comes with a range of financial products. On the other hand, some loans come with extra features like the Line of Credit loans that gives you access to money like a credit card.
When applying for a loan, below are some examples of what you can choose from:
- Basic loan: a loan with affordable rates and minimum features.
- Standard loan: a loan that offers more flexible features than a basic loan at higher rates.
- Home loan package: a combination of a standard loan and other financial products, usually a transaction account and/or a credit card.
- Line of credit loan: a loan that provides you access to funds whenever you need a certain amount. This is similar to a credit card.
- Low doc loan: loan plans that require minimum documentation on the borrower’s part.
- Interest-only loan: a loan that allows you to pay only the interest, rather than both the interest and the principal amount, for a certain set period.
In addition, below are two different loan repayment options:
- Principal and interest loan: repayments are made regularly on the amount borrowed, plus the interest on that amount.
- Interest-only loans: repayments are made only on the interest of the amount borrowed. The principal borrowed won’t be paid off; therefore, the debt isn’t reduced. Repayments may be lower during the interest-only period, but they will go up after that.
The Interest Rates
When it comes to comparing interest rates, you will most likely gravitate towards the cheapest option; however, the cheapest option alone might not be the most appropriate option for your financial circumstances. Most loan interest rates are fixed or variable and sometimes both. Therefore, it’s worthwhile investigating further and consider how each could benefit you based on your circumstances.
Fixed interest rate
A fixed interest rate stays the same for a set period, for example, five years where you will make the same amount of interest repayments for those five years. The rate then changes to a variable interest rate after the set period, and your interest repayments will fluctuate according to the market’s interest rate. However, after the set period, you have the option to negotiate another fixed interest rate.
Advantages of fixed rate:
- A fixed interest rate will make it easier to plan out your budget because you know exactly how much your repayments will be.
- A fixed interest rate often comes with fewer loan features, and this could cost you less.
Disadvantages of fixed rate:
- You won’t get the benefit of lower interest repayment if interest rates go down; instead, you will continue to pay the fixed interest rate until the end of the set period.
- It may cost you more to switch loans later as will be charged a break fee.
Variable interest rate
A variable interest rate can go up or down as the lending market changes. When you choose a variable interest rate, it means that your interest repayments will go up or down according to the market changes.
Advantages of variable rate:
- A variable interest rate offers more loan features which could mean greater flexibility for you and your finances.
- With a variable interest rate, it’s usually easier to switch loans later if you find a better deal.
Disadvantages of variable rate:
- A variable interest rate usually makes budgeting harder as your interest repayments could go up or down. If you have a casual job with a somewhat unstable income, then this will make it even more difficult.
- A variable interest rate often offers more loan features, but this could cost you more.
Partially fixed interest rate
If you’re still undecided between a fixed and variable interest rate, the good news is you can have a bit of both! The third option is a partially fixed rate, also known as a split loan. This option means that a portion of your loan will have a fixed rate, and the rest will have a variable rate. You can decide how to split the loan, whether that’s 50/50 or 20/80 or other arrangements.
The Comparison Rate
A comparison rate is designed to provide a close estimate of the total cost of a loan per year. It is expressed as an annual percentage rate and takes into account the following:
- Interest rate: including any revert rate that applies to the loan after a set period.
- Fees and charges: including upfront costs like establishment fees and valuation fees and ongoing costs such as monthly or annual fees.
- Repayment frequency
The comparison rate is one of the most useful tools borrowers can use to efficiently compare different loan products as it calculates a close estimate of their true costs. However, beware that some comparison rates might be “polished” not to include variable fees.
The Fees
When applying for a loan, there are several fees charged on different features of a loan. Below are some fees you will need to consider:
- Application fees are also known as an establishment fee.
- Property valuation fees
- Ongoing fees such as annual fees
- Late payment fee, also known as default fee. This is charged if you make a required repayment later than the due date.
- Early exit fee. This is charged if you repay your home loan in full and close the loan before the end of the loan term.
- Discharge fee is also known as termination fees or settlement fees. This is charged when you pay out your mortgage in full.
- Break fees, also known as break costs. This is charged if you switch loans during a fixed rate term.
- Redraw fees if you use a redraw facility.
- Account-keeping fee for an offset account. This is charged if you have an offset account attached to your loan.
- Lender’s Mortgage Insurance (LMI). This is charged if you only have a small deposit on your home loan. In our previous blog, we dive into the most frequently asked questions about LMI, read it here.
The fees above can make a big difference to how quickly your loan can be paid back and how much spare cash you have available to spend. Be aware that some fees are also hidden and can give you an unpleasant surprise down the track. Therefore, don’t be afraid to ask your broker about all the charges associated with the loan, including but not limited to:
- Upfront costs: application fees, valuation and legal fees, establishment fees, Lender’s Mortgage Insurance, stamp duty.
- Ongoing costs: monthly or annual fees, administration fees, redraw fees, extra repayment charges.
- Exit fees: early exit fees, break fees, discharge fees.
The Features
Generally, loans with more features come at a higher cost; therefore, when comparing loans, consider your lifestyle and what features you 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.
Below are some loan features you might want to be aware of:
- An offset account
- A redraw facility
- Ability to make extra repayments
- Ability to make lump sum repayments
- Ability to split the loan between fixed and variable
- Ability to get home loan pre-approval
Loans with features are recommended as they give you more options within the term of the agreement. They will provide you with a range of flexible options, but their interest rates will be higher, and they take longer to pay back than standard loans.
There are multiple aspects to consider when choosing a loan and it can be overwhelming. If you require assistance with your loan comparison, the team at FutureNow Finance are here to help. We can help assess your current financial position and assist you in finding a loan that suits your need. Call 1300 013 730 or email hello@futurenowfinance.com.au.