Guide For First Time Home Buyers: Part 2 - Getting a Home Loan

(credits to Domain.Com.Au)

 

Unless you have hundreds of thousands of dollars in the bank, you’ll need a home loan from a bank or lender to pay for your home. The money loaned by a bank is used together with your savings to pay for your new property.

 Banks have specific requirements around who they lend to and how much, so it’s best to apply for a loan before going too far down the track so you know where you stand.

 

What is the difference between pre-approval and unconditional approval?

Pre-approval, also known as conditional approval, is an indication of how much you can borrow based on information about your income, debts and liabilities. It may also depend upon certain conditions, such as additional documentation, or a valuation of the property. Different lenders have different definitions, so you’ll need to confirm exactly what pre-approval means with your chosen lender.

 

Pre-approval can help you establish your budget, and should be arranged as soon as you’re serious about buying a property, and definitely before making an offer or bidding at auction. But even if you have pre-approval, a lender is not obliged to provide a loan.

Unconditional approval is different and occurs later in the buying process, normally after exchange. To receive unconditional approval, buyers will need to complete a formal loan application and may need to provide additional information about a specific property, a valuation or proof of insurance. Once unconditional approval is provided, loan offer documents are distributed and your loan application can progress.

 

How to get pre-approved for a home loan

Buyers can apply for pre-approval with a lender online, over the phone or in person at a branch. Buyers can also use a mortgage broker or loan comparison service to make the process easier.

Pre-approval isn’t binding and if your circumstances or lending conditions change, your bank might not loan as much, or may not offer you a loan at all.

 

What do banks look for when providing pre-approval?

When assessing a loan application, lenders will ask for certain information and examine your finances to determine the level of risk posed to them by loaning you money.

 Lenders analyse savings, income, expenses, debt, and financial history to paint a picture of your financial health and decide whether you qualify for a loan, and if so, how much they are willing to lend.

When actually approving a loan for a specific purchase, banks will also assess the value of the property to ensure the loan-to-value ratio is within a safe range.

Income and Expenses – Income includes wages and any additional income such as dividends from investments or business income. Expenses include bills, groceries, transport and leisure.

Banks use these figures to determine if you can afford the ongoing repayments of a home loan. Repayments are assessed at two to three percentage points higher than the current rate to ensure you can make repayments even if interest rates increase.

Debt – This can include credit card debt, personal loans, car loans, business loans and student loans such as HECS-HELP. More debt means the bank will be less willing to loan as much, and reducing the number of credit cards and lowering limits will make you a more favourable applicant.

Savings – Not only do banks want to see that you have an ample deposit ready for your purchase, but enough surplus money available to continue meeting repayments if circumstances change, such as increased child raising expenses, or loss of employment.

Financial history – Banks also want to see a history of recent savings activity, with most lenders looking at savings accumulated and held for at least three to six months.

Lenders will also examine applicants’ credit history, looking for defaults on loans or credit cards in the past. These incidents aren’t necessarily deal-breakers, provided applicants can explain why defaults occurred and why they won’t happen again.

 

Should you use a mortgage broker or go to a bank?

Buyers have a wider array of lenders to choose from than ever before, which benefits buyers as lenders are quite competitive on rates and inclusions. On the other hand, the choice can make it difficult for buyers to decide which lender to go with.

Mortgage brokers can assist with the process by assessing a wide range of lenders based on rates, fees and suitability for the applicant. They can then provide a shortlist of recommended lenders for the applicant to choose from, and help with the pre-approval and approval processes.

Apart from helping buyers get a loan with the best rate, brokers may also offer guidance to early-stage buyers on saving for a deposit, and can explain the confusing terms and features of mortgages.

Best of all, a mortgage broker’s services are technically free. Mortgage brokers are paid a commission by the lender you choose, and are obliged by law to disclose this information and the amount. Commissions vary minimally between lenders, meaning there is little reason to push buyers towards certain products apart from the ones that are most suitable.

 

How to get a loan if you’re self-employed

If you’re self-employed, you may find that your best option is to choose a low doc home loan. These loans are specifically designed to accommodate individuals who don’t have the kind of documentation and certainty provided by an employer.

Unfortunately, they can also carry a higher interest rate than other options. If you’re able to show a lender that you have your income in order, you may be able to secure a standard mortgage at a lower rate.

Self-employed applicants won’t have payslips from their employer, and will need to crunch the numbers and provide the appropriate information. Before you approach mortgage providers, work out exactly what your income is.

It’s not enough for you to tell your potential lender what you make – you need to prove it too. Collect as much evidence of your spending power as you can, including bank statements, financial statements and accountant declarations.

You’ll also need to be able to show your two most recent personal tax returns. If there is a big difference between them, be aware that the lender is likely to take the lower of the figures, even if it’s not the more recent one. If this is the case, ask your broker to consider any special circumstances, such as money spent on training or equipment.

 

Which loan is best: interest-only or principal and interest?

When arranging a home loan, buyers can choose between interest-only or principal and interest loans. It’s wise to discuss both options with your lender to help determine which is right for you.

 

Principal and interest loans:
  • are the most common type of loan
  • mean the buyer pays off the principal (the amount borrowed) and the interest together in regular repayments
  • mean the borrowed amount will eventually be repaid in full, usually over a long period such as 25 or 30 years.
Interest-only loans:
  • allow buyers to pay the interest only for a fixed period of time
  • are useful in the short term as they allow smaller repayments
  • are helpful if you are buying an investment property
  • mean your total repayment will be greater.

 

Which loan is best: variable rate, fixed-rate or split?

One of the biggest questions when taking out a loan is whether to choose a variable or fixed-rate loan. Variable rate loans are linked to the RBA cash rate, meaning interest rates can go up or down. Fixed rates are locked in for a set term, normally one, two or three years.

 

Variable rates:
  • provide the most flexibility and the least restrictions – you can usually make extra repayments at no cost if you come into some spare cash
  • mean you will reap the benefits of any interest rate drops
  • mean you must be able to work an interest rate rise into your budget.
Fixed rates:
  • give you certainty regarding the amount of your regular repayments
  • mean you won’t pay more if interest rates increase
  • mean if something changes in your personal life and you need to reduce payments, make extra repayments, redraw, or even sell the property, you could be facing high break-costs and other penalties and fees.
Split rates:
  • offer the best of both worlds, designating a certain amount with a variable rate and an amount on which rates are fixed.

(photos credits to Domain.Com.Au)