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Home Loans: Finding the one that fits

With over 3000 home loans on the Australian market it would be easy to dismiss them as marketing overkill – and you'd probably be right. But many of these loans are tailored for different segments of the market, giving home buyers the chance to find a product that best suits their needs.

That means smart borrowers can choose a loan that will help them manage their finances better and own their home sooner.

But how do you find the loan that fits?

Here are some suggestions.

Young and single – the cash-strapped first-home buyer

Don't be sold on lots of bells and whistles.

If you fall into this category, the odds are that you won't have a lot of disposable income left after you make your loan repayments, so you'll have little need for features such as redraw facilities or offset accounts.

Look at either a basic home loan with a low variable rate or a home loan that comes with an introductory offer where the interest rate is fixed for six months to two years.

Introductory offers can help by keeping your monthly repayments down for as long as two years,but the rate the loan reverts to may be higher than the rate on alternative products so you'll need to check the AAPR.

The AAPR, or "comparison rate as it's also known, measures the annual costs of the loan over the first seven years and includes upfront and ongoing fees as well as the interest costs.

Another feature to consider is the ability to structure your loan over 30 years instead of 20 or 25 to reduce your monthly repayments.

While you may cringe at the idea of a loan that lasts that long, most home loans now are paid out or refinanced within seven years few run their full term.

You might also shop around for the lender who will provide you with a high loan-to-valuation ratio (LVR) if your deposit is small.

Many lenders will lend up to 95 per cent of the value of your home but they will insist on mortgage insurance if the LVR exceeds 75 to 80 per cent.

You should also ensure you get a full refund of your application fee if your loan is rejected.

If your income is fixed, or unlikely to rise much in the next few years, you may want to look at fixing your rate for the first few years, says Rankin.

This may also be an option if your finances are so tight that you couldn't cope with an interest rate rise.

He says first-home buyers in this group should also be looking to the future and whether they can switch to a more flexible loan when their finances are less stretched.

Subscribers can apply online for a free home loan eligibility assessment or a refinance comparison ... and an offer of the best available home loan options from a selection of Australia's leading home loan specialists.

Young couples – the more affluent first-home buyer

Your major priority will probably be to pay off your loan quickly, says Rankin. You'll have some extra disposable income and you'll want to reduce your loan if you can.

A low interest rate is still a priority but the loan should have features such as the ability to make extra repayments and maybe a redraw facility or offset account where you can park your savings and reduce your home loan interest bill.

That probably means looking at a standard variable loan although you shouldn't rule out basic home loans entirely.

Some have extra features or some lenders will allow you to split your loan so that part of it is a basic home loan and part is a standard variable loan with those extra features.

A couple of years ago basic home loans were just that.

But a lot now have features like redraw, though they may be offered at a cost or there may be limits on how you can use them.

Borrowers should also ask about banking packages.

If you're eligible they can reduce your banking costs as well as provide a discount on your home loan rate.

If you're considering a standard variable loan there's sense in taking one with an introductory interest rate offer to minimise the costs in the early days.

If you take out a capped or discounted variable rate introductory offer you can generally make extra repayments even during the introductory period.

Many buyers in this group are looking to build up equity in their home then upgrade to a better property so the home loan should be portable and should allow for "top-ups if you want to extend or upgrade.

More expensive fixed rates are less attractive to many borrowers in this group (as they have extra cash if interest rates rise and are more concerned with reducing their loan fast) but the ability to split the loan can be attractive.

If you were concerned interest rates were going to rise you could fix the rate on part of your loan while keeping the rest in a variable rate loan for the added flexibility.

Young family – upgrading to a bigger home

This is typically a time when your finances tighten up again.

Your mortgage repayments may increase and you may have to get by on a single income.

If this is the case, features such as an offset account will be less important as you'll have less opportunity to save.

You may be able to get by with a loan that offers a limited redraw facility instead, if it gives you a lower interest rate.

If your disposable income is lower, this will make you more vulnerable to interest rate changes so you should have the option to fix part or all of your loan.

People are more likely to split their loan because they still need some of the flexibility that comes with variable rate loans.

Again, loan portability, the ability to make extra repayments and a redraw or offset facility can be useful.

If you are both working now but plan on living off a single income later it makes sense to be able to make extra repayments now so that you have a buffer against possible interest rate rises later.

Another important loan feature for young families is the ability to top up or extend the loan to pay for renovations or extensions.

Empty nesters – comfortable borrowing to change homes

Older borrowers who have high levels of equity in their homes are a key target for home equity lenders.

As many of these people have surplus income, the idea is that they can borrow more and use the extra money to build wealth elsewhere such as by buying shares or managed funds.

They want access to their funds to do extra things with their money.

Home equity loans are much like overdrafts.

You get an approved credit limit, secured against the value of your home, and can repay and redraw it at will.

Most also allow you to deposit income such as salary into the loan and have a linked credit card for daily spending, which is paid off each month from the loan.

Home equity funds used to be much more expensive than standard home loans but now you should be able to get one for a similar interest rate, you shouldn't pay a premium. It's not necessary.

However, as most of these loans are structured as revolving lines of credit you need to be sure they suit you before you sign up.

There is concern that the lender reviews the loan each year and can ask for its money back at any time.

If you know you might have difficult times coming up you would be better to have a term relationship with the lender through a standard variable loan.

You also have to consider that your partner could run off with 80 per cent of the equity in your home simply by taking the linked credit card.

You also need to be disciplined as there is no requirement to pay off the loan.

If this doesn't appeal a better option may be a standard variable loan with an accessible redraw facility or an offset account, he says.

Tax is also a consideration as you can claim a tax deduction for interest on investment loans but not for interest on your home loan.

If the loan is intended to cover the two, you'll need to consider how you will keep your investment and private borrowings separate.

Investors – have cash, will borrow

If you still have non-tax-deductible debt owing on your home loan, there's no point in using your savings to pay off the interest on your tax-deductible investment loan.

You're better off taking out an interest-only loan for your investment and using your savings to pay off your non-deductible debt.

Some investors who do own their own homes like to pay off principal, as well, he says, "but there's no real right or wrong.

Investors could look at fixing their interest rate to help with budgeting.

They should look for a loan that allows the interest to be paid annually in advance (usually offered in May and June each year), which provides them with a discount on the interest rate and an immediate tax deduction.

If you prefer a variable rate, he says, it's better to look for a basic loan with a low interest rate as you don't need the additional features available on standard home loans.

You want a clean loan account that allows you to calculate the interest in a simple manner for tax.

The only feature you may want is loan portability and you can get that with a basic product.

Some basic home loans are only available to owner-occupiers, though.

You usually don't want them because there's no reason to pay the loan off quickly.

But what may be useful is an offset account where your savings can reduce your interest bill but the money is kept totally separate to your investment loan.

You can then spend that money in any way you want without running into tax problems.

Investors should also look at how much of the rental income from the property the lender will allow to be counted as potential income in assessing your loan application.

While some will allow as much as 80 per cent or more of the rent to be counted, others are less generous.

There can be differences of $100,000 between lenders in how much you can borrow.

The lender's ability to accommodate you over the years is important.

Irregular earners – self-employed and casual workers

People on irregular incomes can find it difficult to borrow but this often depends on their ability to negotiate and to present themselves as a good lending risk.

If you have a problem it may be worth hiring a mortgage broker to present your case.

They will know which lenders to approach and how to present your case.

As a last resort, you could try a lender who offers non-conforming or low-documentation loans.

These are typically more expensive than normal home loans both in the interest rates and fees charged but are available to many people who fall outside the mainstream lenders' criteria.

They are good loans for people who can't find a lender and who are prepared to pay a premium.

More people opt out of traditional employment, mainstream lenders are getting better at dealing with casual and self-employed workers.

There's also a wide range of low-documentation products which are offered by more traditional lenders.

If you use a non-conforming lender, you'll need to do your homework as interest rates can vary depending on things like the risks involved and the LVR.

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