Home loans play a vital role in helping Australians own their own home.
For most people, the upfront cost of owning a home is out of reach, well for at least 20-30 years, and that's where home loans come in.
NOTE: Applying for a home loan can be extremely complex, and that's why mortgage brokers exist. So give us a call on (07) 3461 6499, no matter where you are in Australia, we can help with all of the below - we'll save you hours upon hours.
A home loan, also known as a mortgage, is a loan provided by a bank or other financial institution to fund the purchase of a property. The borrower agrees to pay back the loan amount, along with interest, in regular instalments over a specified period of time.
Understanding how home loan works is crucial when you're buying a home, getting to know what terms like "interest rates, loan types, and repayment schedules" mean. By understanding the different components of a home loan and the options, we're hoping you can make more informed decisions, every step of the way.
At Zest, we're mortgage brokers (home loan experts) that work with over 60 Aussie lenders, so we know a thing or two about home loans.
So let's dive in to how home loan works!
Key Highlights
- Home loans let you gradually pay off the upfront cost of a home over time.
- Banks and lenders make money on the loan interest.
- The key factors to consider when applying for a home loan the loan amount, interest rate, your financial situation and lifestyle.
- Mortgage brokers like Zest Mortgage Solutions provide valuable assistance in finding the best loan for your needs.
- If you are looking for Home Loan Calculators, we've a handy guide here: Mortgage Payment Calculators, Simple 2024 Tools.
What Are The Different Home Loans in Australia?
In Australia we're lucky to have a few different loan options.
We're also lucky to have options when it comes to going directly to a bank, or using an expert mortgage broker. We break down these options in this article but also further below - so stay tuned. For now, let's look at how home loan works:
- The loan amount is the total amount of money you borrow from the lender to purchase your property. It is typically determined by the purchase price of the property, minus any deposit or equity you initially bring.
- The loan type, as mentioned earlier, includes variable-rate loans, fixed-rate loans, interest-only loans, and line of credit loans. There are also some other types of home loans, like low doc when needed for people like those who are self-employed.
- Each loan type has its own features and considerations, and you need to carefully consider which option best suits your needs. Fixed interest rates remain the same throughout the loan term, while variable interest rates can fluctuate based on market conditions.
Let's expand on these loan types really quickly:
1. Fixed-Rate Home Loans
Fixed-rate home loans are a popular option among Aussie borrowers who prefer predictable loan repayments. With a fixed-rate loan, the interest rate is set at the time of application and remains unchanged for a set period, typically between one and five years.
One advantage of a fixed-rate home loan is that you can accurately budget their repayments, as the interest rate remains constant.
However, it's important to note that fixed-rate loans may come with some limitations.
For example, you might not be able to make additional repayments or refinance during the fixed period, or breaking a fixed-rate loan before the end of the fixed term may also incur break fees.
When considering a fixed-rate loan, you should carefully assess your financial circumstances and future plans to determine if a fixed rate is the right choice. We would also recommend talking to a mortgage broker, as a mortgage broker will have a deeper understanding of where the market rates are headed.
NOTE: Please see here if you are looking for a loan repayment calculator.
2. Variable-Rate Home Loans
When to comes to how home loan works, variable-rate home loans are the most common types of Aussie mortgages.
With a variable-rate loan, the interest rate can fluctuate over time, depending on various factors such as changes in the official cash rate set by the Reserve Bank of Australia and the lender's decisions.
One advantage of a variable-rate loan is lower interest rates if the market rates decrease, that result in lower monthly repayments and potentially save money over the life of the loan, even though in 2024 rates are increasing.
However, it's important to consider that variable-rate loans can also be subject to rate increases too, which has been something a lot of Aussie home owners are having to manage this year, coming off record low fixed-rate mortgages.
The big benefit of variable-rate loans, is that in general, they have much more flexibility than fixed-rate loans, allowing you to make additional repayments without penalties or access features such as offset accounts or redraw facilities - for times when you need this cash flow.
NOTE: Please see here if you are looking for a loan repayment calculator.
3. Interest-Only Home Loans
When it comes to how home loan works, interest-only home loans are a specific type of loan where you only pay the interest on the loan for a specified period, typically between one and five years. During this period, you are not required to make principal repayments.
Interest-only loans are usually used by for investors, or individuals looking to minimise their loan repayments during a specific period, such as when they anticipate a change in their financial circumstances.
However, it's important to note that interest-only loans may result in higher overall interest costs over the life of the loan, as the principal amount remains unchanged during the interest-only period. Once the interest-only period ends, you will need to start making principal and interest repayments, which can result in higher monthly repayments.
If you are considering an interest-only loan, please do get in touch with the Zest team, a second opinion on this type of loan can never hurt, as the potential future downsides need to be very carefully considered.
NOTE: Please see here if you are looking for an interest only calculator.
How Much Home Loan Do I Qualify For?
One of the questions when it comes to how home loan works, especially for first home buyers, is "How much home loan do I qualify for?"
NOTE: If you are at this stage, please reach out to us on (07) 3461 6499 or here (not matter where you are in Aus), we've over 300 Google reviews and a 99% loan success rate. A big part of that is helping you understand not only how much you qualify for, but what is a good loan amount for your lifestyle.
Because knowing this, requires taking into account a few factors, including:
- Your financial situation, like annual income, current expense etc.
- Your credit score, which is based on prior lending and other factors.
- The lender's criteria. Each bank and lender has different needs.
We also need to emphasise, that your mortgage needs to work for you - and not stop you from doing the things you love, for example, travelling or building a family. One thing you need to be very careful about, is not defaulting on your mortgage, and that's where brokers help.
By evaluating your financial situation and consulting with a home loan specialist like Zest, you will know where you stand from the get-go, and this may even changing the "kind of properties" you're looking at.
How Much Deposit Do You Need For A Home in Australia?
Another question with how home loan works, is how muchdeposit do you need.
That because in Australia, the deposit required for a home purchase can range from 5% to 20% of the property's purchase price - so how do you know what deposit you need?
We'll, the exact amount depends on the lender's requirements, the type of mortgage, and whether you're eligible for any government schemes or incentives.
Here's a general overview - but again just call us on (07) 3461 6499 or email us here, it's a lot easier!
1) Standard Home Loans:
For most standard home loans, you'll need a deposit of at least 20% to avoid paying Lenders Mortgage Insurance (LMI). However, some lenders may accept deposits as low as 5% if you're willing to pay LMI (explained in the next section below).
2) First Home Buyers:
First home buyers may be eligible for government schemes, such as the First Home Loan Deposit Scheme (FHLDS) or state-based grants, which can help reduce the deposit required. For example, the FHLDS allows eligible buyers to purchase a home with a deposit as low as 5% without paying LMI.
3) Investment Properties:
The deposit required for an investment property is generally higher, often around 20% or more, as lenders consider them to be higher risk than owner-occupied properties.
What is LMI?
When it comes to how home loan works, Lenders Mortgage Insurance (LMI) is an insurance policy that protects the lender (not you, the borrower) in the event that you default on your mortgage, and the sale of the property is insufficient to cover the outstanding balance.
LMI is typically required by lenders when the borrower's deposit is less than 20% of the property's purchase price. It is a one-off, upfront payment, but it can also be capitalised into the loan amount, increasing the total amount borrowed and the ongoing interest costs.
While LMI protects the lender, it can benefit you if you are in a position to purchase a home with a smaller deposit, enabling you to enter the property market sooner which matters when the market is fluctuating weekly, as it seems in 2024. However, it is an additional cost that you need to consider when calculating the overall cost of purchasing your property.
How Is Home Loan EMI Calculated?
EMI stands for "Equated Monthly Instalment" when it comes to how home loan works, and refers to the amount of money you needs to repay every month for your mortgage. EMI is not a widely used term in Australia, but we are sometimes asked about it, so this is perfect time to answer this question. EMI is just your "monthly repayments".
NOTE: Applying for a home loan can be extremely complex, and that's why mortgage brokers exist. So give us a call on (07) 3461 6499, no matter where you are in Australia, we can help with all of the below - we'll save you hours upon hours.
Where Do You Get A Home Loan In Australia?
When it comes to applying for a home loan, there are really 2 options:
- Work directly with a bank.
- Enlist the services of a mortgage broker.
While both options have their merits, over 70% of Australians now use a Mortgage Broker.
One of the biggest reasons with how home loan works, is that mortgage brokers have access to multiple lenders. At Zest, we work with over 60 lenders, which means, instead of you having to personally deal with 60 lenders to get the best rates and terms, we do that for you.
The other value mortgager brokers provide, is assistance with every step of the process, from pre-approval to yearly check-ins to make sure your home loan is working for you.
The best part - mortgage brokers like Zest are 100% free. We take a commission from the lender, which has no impact on your mortgager or fees at all. And when you consider that dealing with some banks directly has fees, this service can be invaluable. Be sure to see our 300+ Google reviews here, or follow us on Instagram or Facebook to see what other people say!
NOTE: Mortgage brokers also provide personalised advice and guidance throughout the application process, helping to gather the necessary documentation, navigate any complex requirements and removing the stress of getting a mortgage, saving you time and effort, and providing access to a broader range of loan options.
Where Do I Start To Understand Interest Rates?
Interest rates play a major role in the overall cost of a home loan. But sadly they are not all that straight forward (we wish they were).
The obvious part is that, with higher interest rates there are higher repayments. When interest rates are low, your monthly repayments may also be lower and potentially save money over time.
Let's dive into interest rates a bit further:
How Home Loan Interest Rate Is Decided?
When it comes to how home loan works, interest rates are determined by multiple factors, including:
1) Reserve Bank of Australia (RBA) Cash Rate:
The RBA sets the official cash rate, which influences the interest rates that banks and lenders offer to borrowers. Changes in the cash rate can lead to changes in home loan interest rates. You can always find the cash rate on the RBA website here if interested. But when the cash rate goes, most lenders rates follow suit - otherwise this would eat into their profits.
2) Cost of Funds:
This is where it gets confusing, because Banks and lenders borrow money to lend to borrowers. The cost of these funds, including interest paid to depositors and other lenders, affects the interest rates they offer on home loans.
So let's say the RBA cash rate is 4%, well your lender (lets say a big four bank) will add their 2% on, and so you pay 6%. Another lender may only add 1.5%, and this is where comparison shopping comes into play!
3) Market Competition:
As indicated above, competition among banks and lenders can heavily influence interest rates, and it's why we work with over 60 lenders, and their rates are always changing! Lenders may adjust their rates to attract borrowers or match competitor offers, and some more modern lenders have lower rents and administrative expenses. These costs are ALL factored into the interest rates they charge on top of the RBA cash rate for your home loan. Interesting isn't it!
4) Loan Features and Your Risk Profile:
Now we get to the specifics, which are the features of your specific home loan that can also change your interest rate. In general, loans that are considered "riskier" may attract higher interest rates, for example if you have bad credit history or are self employed.
A loan with more feature may also have a slightly higher interest rate, such as an offset account or no repayment restrictions. There are thousands of factors when it comes to know how home loan works - which is another reason it's best to talk to a broker like Zest!
5) Economic And Regulatory Requirements:
We are diving into the nitty gritty now, but economic factors, such as inflation, unemployment, and economic growth, all influence interest rates too. Much of this is led, or controlled by the government such as regulatory requirements, capital adequacy ratios and more.
Overall, home loan interest rates are influenced by a bunch of factors, but we hope this simple explanation helps!
What Are Some Tips for Getting the Best Interest Rate?
When it comes to how home loan works, securing the best interest rate can result in significant savings over the life of the loan.
Here are some tips to help you get the best interest rate:
1) Improve Your Credit History:
All banks and lenders consider your credit history when determining your borrowing capacity and often interest rate of the home loan product you take out. Paying bills on time, reducing existing debt, and maintaining a good credit score can help secure lower interest rates.
2) Shop Around:
Comparing options from different lenders to find the best deal is everything when it comes to how home loan works. Consider factors such as interest rates, loan features, and fees, and be sure to talk to a mortgage broker before you take any mortgage out - we may be able to leverage a better deal from the same lender, or a competitor!
3) Use A Mortgage Broker:
Like we mentioned earlier, over 70% of Aussies now use a mortgage broker instead of going to a bank directly (or multiple banks which is a nightmare). Mortgage brokers like Zest are the experts can assist in finding options from many lenders and negotiate on your behalf. We also help clients every single day with their applications, and at Zest, we've a 99% loan success rate!
4) Have A Larger Deposit:
Sometimes, and pending the lender, a larger deposit can demonstrate financial stability and reduce the loan-to-value ratio (LVR), potentially resulting in lower interest rates. This is a not common practice and it's best to chat with a broker about this to see what deals lenders have on offer based on your LVR.
5) Consider Loan Features:
Even with all of the above, sometimes features, such as offset accounts or the ability to make extra repayments, can help reduce the interest payable over time. So basically, the outright interest rate will only paint half the picture. You need to know the ins-and-outs of the mortgage and look at it over the lifetime of the loan, not just stated interest rate figures.
By implementing these tips when it comes to how home loan works, you can increase the chances of securing a favourable interest rates for you home loan.
NOTE: Applying for a home loan can be extremely complex, and that's why mortgage brokers exist. So give us a call on (07) 3461 6499, no matter where you are in Australia, we can help with all of the below - we'll save you hours upon hours.
How Do You Best Prepare For A Home Loan
When it comes to how home loan works, preparing includes evaluating your financial situation, gathering the necessary documents, and knowing your credit score. The steps below will help you streamline your application process and increase the chances of loan approval.
NOTE: Applying for a home loan can be extremely complex (see below). That's partly why mortgage brokers exist in the first place, so give us a call on (07) 3461 6499, no matter where you are in Australia, we can help with all of the below - we'll save you hours upon hours:
Step 1. Know Your Financial Health
Assessing your financial health is an important step in preparing for your mortgage, be it your first home or your fifth. This "assessment" involves evaluating your overall financial situation, including income, expenses, and assets when it comes to how home loan works.
The best place to start is creating a monthly budget to understand your monthly income and expenses, which will give you an idea of how much you can comfortably afford to repay on your home loan.
Here are some tips:
- Paying off any outstanding debts: such as credit card balances or personal loans, will improve your debt-to-income ratio. Every Australian lender looks at this ratio when assessing your ability to repay the mortgage.
- Consider your assets: including savings and home equity. Having a higher deposit or existing home equity can increase your chances of loan approval and potentially secure better terms.
- Understand your income vs expenses: For many people budgets are not the most fun, but when it comes to a mortgage this is essential. At Zest, we've some great tools to make budgeting easy!
By assessing your financial health, you can determine your borrowing capacity and make more informed decisions when applying for a mortgage - being sure to not overextend.
Step 2. Know What Government Grants Your Entitled To
In Australia, when it comes to how home loan works, there are several government grants and schemes available to assist home buyers. Here are some of the current grants in 2024 for home buyers:
- First Home Owner Grant (FHOG): This is a national scheme that provides a one-off grant to first home buyers who are purchasing or building a new home. The grant amount and eligibility criteria vary between states and territories.
- First Home Loan Deposit Scheme (FHLDS): This is a federal government scheme that helps eligible first home buyers purchase a home with a deposit as low as 5% without having to pay Lenders Mortgage Insurance (LMI). The scheme is administered by the National Housing Finance and Investment Corporation (NHFIC).
- HomeBuilder Grant: This grant is a federal government initiative designed to stimulate the residential construction sector. It provides eligible owner-occupiers (including first home buyers) with a grant to build a new home or substantially renovate an existing home.
- Stamp Duty Concessions and Exemptions: Many states and territories offer stamp duty concessions or exemptions for first home buyers. This can result in significant savings when purchasing a property.
- First Home Super Saver Scheme (FHSSS): This scheme allows first home buyers to save for a home deposit inside their superannuation fund, which may help them save faster due to the concessional tax treatment of superannuation.
- Regional First Home Owner Grant: Some states and territories offer additional grants or higher grant amounts for first home buyers purchasing property in regional areas.
To determine which grants you may be entitled to, you can follow these steps:
- Research State Government Grants: Each state and territory in Australia, like the Queensland first home owners grant has its own set of grants and schemes for home buyers. Visit your relevant state government websites to find information about the grants available in your area.
- Check Eligibility Criteria: Review the eligibility criteria for each grant to determine if you meet the requirements. Criteria often include factors such as income limits, property value limits, and whether you're a first home buyer.
- Speak with a Mortgage Broker: Mortgage brokers like Zest are familiar with the various grants and schemes available and can help you understand which ones you may be eligible for based on your circumstances.
- Contact State Revenue Office: If you're unsure about your eligibility or need more information, you can contact the State Revenue Office in your state or territory. They can provide guidance and answer any questions you may have about government grants.
- Apply for The Grants: Once you've identified the grants you're eligible for, follow the application process outlined by the relevant government agency. Be sure to provide all necessary documentation and information to support your application.
By researching the grants available in your area and understanding the eligibility criteria, you can determine which government grants you may be entitled to for your home loan.
Step 3. Gather The Required Documents
When knowing how home loan works, there are several documents you will need to provide. These documents help lenders assess your financial situation and your eligibility for the loan.
Some documents required for a home loan application include:
- Proof of identification: This can include a driver's license, passport, and/or birth certificate.
- Proof of income: This can include recent pay slips, tax returns, and bank statements showing regular income deposits.
- Bank statements: Lenders may request several months of bank statements with incomings and outgoings to assess your spending habits and financial stability. This is where your budget matters.
- Employment information: Proof of employment, such as a letter from your employer, may be required to verify your income and job stability.
- Credit history: Lenders will check your credit history to assess your creditworthiness. This may require obtaining a copy of your credit report.
Having these documents ready before applying for a home loan can help streamline the application process and increase your chances of loan approval.
Step 4. Get Pre-Approval
For this stage of how home loan works, you will need to talk to your bank or mortgage broker, and please feel free to get in touch with us if you are at this stage - or still in research mode. This is our expert team!
Your pre-approval will be vital when it comes to making an offer on a home, as people with pre-approval will often be chosen over those who don't, even if your offer is lower!
Step 5. Submit Your Home Loan Application
Once you have researched options, checked your eligibility, and gathered the necessary documentation, it's time to submit your home loan application. Here's what you should do within how home loan works:
- Complete the application: Fill out the application form accurately and provide all required information. Double-check for any errors or missing details.
- Provide supporting documents: Attach all the required documents to support your loan application. Ensure they are organized and easily accessible.
- Review and sign the contract: Read the contract carefully, including the terms and conditions, interest rates, and any associated fees. Seek professional advice if needed. Once you are satisfied, sign the contract.
- Submit the application: Send the completed application and supporting documents to the lender through the preferred method (online or in person). Retain copies of all submitted documents for your records.
After submission, the lender will review your application and may request additional information if necessary. The approval process can take some time, so be patient and follow up with the lender as needed.
Step 6: Property Valuation and Loan Approval
After submitting your home loan application, the lender will undertake a property valuation and review your application for approval. Here's what you can expect during this step:
- Property valuation: The lender will assess the value of the property you intend to purchase. This is to ensure that the property is worth the amount and serves as collateral for the loan.
- Loan assessment: The lender will review your application, including your financial situation, credit history, and the property valuation report. They will assess your eligibility and determine whether to approve it or not.
- Approval: If your application meets the lender's criteria, they will approve your loan. You will receive an offer letter outlining the terms and conditions.
- Legal documentation: Once you accept the offer, the lender will prepare legal documents, such as the mortgage contract. Review these documents carefully and seek legal advice if needed.
- Settlement: The final step involves the settlement process, where the loan funds are transferred to the relevant parties, and you become the legal owner of the property.
Remember to stay in regular communication with the lender throughout the process and provide any additional information or documents they may request.
Summary: Guide For Applying For A Home Loan
To quickly summarise the above steps for how home loan works, this is the basic version:
Step 1. Know Your Financial Health
Step 2. Know What Government Grants Your Entitled To
Step 3. Gather The Required Documents
Step 4. Get Pre-Approval
Step 5. Submit Your Application
Step 6. Property Valuation and Loan Approval
Or, just talk to a broker like Zest, we help with every one of these steps!
NOTE: Applying for a home loan can be extremely complex, and that's why mortgage brokers exist. So give us a call on (07) 3461 6499, no matter where you are in Australia, we can help with all of the below - we'll save you hours upon hours.
What Home Loan Fees and Charges Are There?
Finally, when it comes to how home loan works, taking out a mortgage, you need to be aware of the fees and charges that may be associated with it. These fees can vary depending on the lender and the specific loan product you choose.
With Zest, there are zero fees, but some common fees and charges you need to be aware of include:
- Upfront fees: These fees are paid at the beginning of the mortgage and can include application fees, valuation fees, and legal fees.
- Ongoing fees: These fees are charged throughout the life of the loan and can include monthly or annual account keeping fees.
- Exit fees: These fees may be charged when you pay off or refinance your mortgage before the end of the loan term.
- Stamp duty: This is a government tax paid when purchasing a property. The amount of stamp duty varies depending on the value of the property and the state or territory in which it is located. Here is a good stamp duty calculator you can use to calculate this figure. Warning, stamp duty is not cheap.
- Lenders mortgage insurance (LMI): This may be applicable if you have a high loan-to-value ratio (LVR), typically above 80%.
Additionally, when you are moving, you need to factor in these fees too:
- Legal and Conveyancing Fees: You'll need a solicitor or conveyancer to handle the legal aspects of the purchase, including property searches and contracts. Costs can vary depending on the complexity of the transaction.
- Building and Pest Inspections: It's advisable to get a professional inspection to check for any structural or pest-related issues. Costs can vary depending on the size and location of the property, but it always best to allow a few thousands if you need pest treatment.
- Home Renovations: These costs can be a simple as a hot water system, or a major renovation. If you are buying a reno home, it's best to not underestimate these costs.
- Moving Costs: Don't forget to budget for the cost of moving your belongings to your new home, allow a few thousands just to be safe.
- Home Insurance: You'll need to arrange building insurance to protect your new home against damage or loss. Note, these insurances will need to be in place on the property change over, which is before you actually move in.
- Council Rates and Strata Fees: You may need to pay these fees if you're buying a property that is part of a strata scheme or community title.
How Do You Minimise Home Loan Fees and Charges?
While some fees and charges are unavoidable when it comes to how home loan works, there are strategies that can help minimise these costs.
One strategy is to use an offset account, which is a transaction account linked to your mortgage. The balance in the offset account is offset against the loan balance, reducing the amount of interest charged on the loan. By keeping a higher balance in the offset account, you can potentially save on interest costs.
Making extra repayments or more on your payments, you can also save you tens of thousands over the course of your home loan and pay it off sooner, saving on interest costs.
If you are after some strategies to reduce your costs, just chat to the team at Zest mortgage solutions team today, or give us a call.
FAQs
How does borrowing a home loan work?
When it comes to how home loan works, you borrow a specific amount of money from a lender to purchase a property. You then repay the loan over a set period of time, known as the term, with interest.
How do home mortgage rates work?
Home loan interest rates can be either fixed or variable. A fixed interest rate remains the same for a specified period of time, providing borrowers with certainty over their repayments. A variable interest rate can change over time based on market conditions. The comparison rate takes into account both the interest rate and any associated fees and charges, providing a more accurate representation of the total cost of the mortgage.
How much home loan do i qualify for?
When it comes to how home loan works, the amount you qualify for depends on your financial situation, including your income, expenses, and credit score. Lenders also consider factors such as the type and the loan-to-value ratio (LVR). It is advisable to consult with a lender or mortgage broker to determine the maximum loan amount you may be eligible for.
how much home loan insurance cost?
The cost of home insurance, such as lenders mortgage insurance (LMI), depends on factors such as the loan amount and the loan-to-value ratio (LVR). LMI is typically a one-off payment or added to the loan amount. The cost of LMI can vary between lenders, so it is important to compare different options to find the most cost-effective insurance.
Can I switch between fixed and variable rates?
Yes, it is possible to switch between fixed and variable interest rates. This can be done through a split home loan, where a portion of the loan is on a fixed interest rate and the remaining portion is on a variable interest rate so you can benefit from the security of a fixed rate and the flexibility of a variable rate.
How can I pay off my home loan sooner?
There are several strategies to pay off your home loan sooner. Making extra repayments can help reduce the principal amount and the interest charged over the life of the loan. Utilising an offset account can also help reduce interest costs. In addition, considering a shorter loan term can result in higher repayments but can help pay off the loan faster.
Conclusion
Understanding how home loan works is crucial when navigating the Aussie property and mortgage market.
From different types of mortgages to interest rates and fees, being well-informed can save you money in the long run. Whether it's fixed or variable rates, knowing all of your options is key. By following this step-by-step guide and comparing loan options, you can educate yourself on the process and ensure a smooth home loan journey.
And of course, a mortgage broker like Zest can make life a lot easier. So just get in touch with us today on (07) 3461 6499 or email us here, we're always happy to help and our services are completely free.
