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Buying a house is usually the biggest financial commitment of our lives and applying for your first home loan can be quite daunting. The current economic crisis has only made everything more confusing with banks, mortgage brokers and other lenders trying to capture the new wave of first home buyers with enticing mortgage offers. Added to this, cash interest rates are at 3.25%, the lowest they've been in almost 50 years, and experts are predicting that there is room for more cuts possibly bringing interest rates down as low as 2% over the coming months. This has had a huge effect on home loans and competition is becoming increasingly fierce for your business amongst the major mortgage lenders. If you have a little money put by and feel your job is fairly secure, there has never been a better time to investigate getting a first or even second mortgage and becoming a home owner or developing an investment property portfolio.
In the following paragraphs we will explain a little about some of the mortgage rate options open you at present in the hope that we can help you make an informed decision about which type of home loan is best for you.
Fixed Rate Mortgage
A fixed rate mortgage does exactly what it says on the packet – you pay a set rate, agreed by yourself and the lender when you sign the home loan agreement, and that fixed rate is 'locked in' and remains the same, no matter how interest rates may subsequently go up or down.
Advantages of a fixed rate home loan.
In periods of high interest rates, or when interest rates are expected to rise, many people choose the security of a fixed rate mortgage. Obviously, if you feel that home loan rates could go up within the life span of your loan, it makes sense to try to protect yourself from future hikes by locking in a comparatively lower rate.
Even if you are unsure whether lending rates are going to rise or fall, many people choose a fixed rate mortgage purely because it holds no surprises. With such a loan you know exactly how much money you will need to repay each month, regardless of what else is happening in your financial world. This takes the guesswork is out of budgeting right from the start.
Disadvantages of a fixed rate home loan.
Of course, interest rates can go down as well as up, and if you are willing to take the risk of riding the financial roller coaster that determines such things, you could do better by declining a fixed rate mortgage. Recent months have seen an unprecedented drop in interest rates in Australia, but this would have done you absolutely no good at all if you had bought into a fixed rate home loan. The downside of the fixed rate in a period of decreasing interest rates is precisely what makes it so attractive in an increasing phase – it is locked in. True, there is usually a clause in your home loan contract stating that you may break the fixed rate agreement if you wish, but doing so will cost you a penalty fee and the expense of that penalty fee usually outweighs the financial rewards of escaping the fixed rate.
A word of warning.
Don't just see the initial fixed rate, decide it's a good deal and sign the contract. The fixed rate will vary for each year of the mortgage agreement and you need to be fully aware of that before you take the plunge. Usually, the opening fixed rate is very reasonable, for the very reason that the lender wants you to take their home loan. However, as the years pass, the fixed rate will almost definitely increase, regardless of what is occurring with interest rates in the rest of the economy. Again, this could still be to your financial benefit and may well be what you are looking for in a mortgage, but it is still best to be fully appraised of all the facts.
Variable Rate Mortgage
A variable mortgage rate is one where the interest rate on the home loan is tied to whatever is happening in the greater economic sphere. Hence, if the Reserve Bank lowers interest rates, the cut will be passed on to mortgage borrowers with a variable interest rate, and the reverse if its raises them.
Advantages of a variable rate home loan.
The plus side with the variable rate mortgage is exactly as stated above. Should the general financial situation result in a fall in interest rates that would be reflected in the repayments demanded by your mortgage lender and you could find your monthly bills dropping by a pleasing amount. In unusual times such as we are experiencing now, where interest rates are at their lowest in decades, those who were brave enough to choose a variable rate home loan last year are now laughing. However, deciding to sign for a variable rate mortgage is not without risk.
Disadvantages of a variable rate home loan.
There are 2 main problem areas with a variable rate home loan. The first is that all is good if the interest rate falls, but of course it could also go up. At the moment we are expecting the Reserve Bank to announce further rate cuts, but this is the first time that we have been in a period of economic activity such as this for many years. In normal circumstances, it is more common for the interest rates to stay steady, or even possibly increase a little every once in a while. If you have a variable rate mortgage, you are not protected against any future rises.
Secondly, the unpredictability of future interest rates means that it's hard to budget long term on a variable rate home loan. The money that you have to find for repayments in the second year maybe totally different to what you paid in the first and if interest rates do rise suddenly and unexpectedly, you could find yourself in financial trouble very quickly.
Split Loans
A split loan, at it's most basic, tries to give you the best of both worlds by allowing you to borrow some of the money for your mortgage at a fixed interest rate and the rest of it at a variable rate. There are numerous ways in which your bank or mortgage broker can break up the loan, with some offering more than one fixed and variable interest rate within the same mortgage.
Advantages of a split loan
In many ways, this is the most flexible borrowing option as it allows you quite a lot of control over how you'd like your home loan to be drawn up. You may believe that interest rates are due to rise and so wish to lock most of your home loan into a fixed rate, leaving just a small percentage to float with a variable rate, in case you are wrong and rates drop. Alternatively, you might choose to have most of your loan at a variable rate, but decide to minimize your risk by going for 2 different fixed rate loans for the rest of your mortgage.
Disadvantages of a split loan
Again, no matter what happens to interest rates at large, the chances are that part of your money will be in the wrong kind of interest repayment arrangement at any one time. On the upside, by splitting your home loan you can be confident that at least part of your mortgage will be in the right place at the right time.
Advice
Whether you feel that a fixed rate home loan is right for your or not, there are a few things that it is always worth considering.
• Seek professional financial advice – buying a property is a massive decision and you should be fully aware of every pitfall, bonus and possibility before you sign anything. Talk to your bank, mortgage brokers and any other lenders you fancy and see what they have to say. But remember, many of those people want your business and may not give you an objective view of things. Ideally, seek independent financial advice to get a clear and unbiased opinion.
• Shop around – there are dozens of reputable companies who can give you the financing for a mortgage and in times of economic uncertainty like this, there are some great deals to be found.
• Check the small print – be sure you know exactly what you are agreeing to. How long is the home loan for? If the interest rate is fixed, how long for and how much does it increase by as the years go by? What are the penalty charges if you decide to break the interest rate agreement? All these things should be weighed carefully.
• Check the fees – you're lender may be keen to get your home loan application, but they are unlikely to give it to you for nothing. Be sure you know what the signing and ongoing administration costs are on your mortgage as it's important that you factor them in to your budget.
• Check the loan size – you may find that there is either a minimum or maximum amount of money that you can borrow (or even both) and that could seriously affect which kind of mortgage you apply for.
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