How to Use Mortgage Calculators
One of the questions our Mortgage Brokers get asked first by nearly everyone is ‘What is your lowest interest rate’?
In this post, I’m going to show you why your first question should be ‘What will my repayments be?’ I'll go on to show you how you should use mortgage calculators to accurately compare your options.
To understand why you should focus on the mortgage repayment amount when you compare loans, you need to understand the components of your mortgage, and how they affect how much you pay for the total length of the loan.
Structure of a Home Loan
A Home Loan is constructed from a few basic elements:
- The borrowed amount (principle)
- The interest rate
- Fees and Charges
- The Loan Term
- The features of the home loan
As you pay off your home loan, you increase the equity - how much of your home you own - and the principle - the amount left to repay- is reduced.
When you read advertisements and use online mortgage comparison sites, you’re presented with a comparison of the interest rates on the home loans. The comparison rate advertised is calculated by law to include the fees associated with the loan as well as the interest rates you'll pay.
The only problem with this is that it doesn’t really tell you very much about what you will really be committing to each month.
How to use mortgage calculators for a true comparison
A home loan is a huge financial commitment. This means that it is absolutely essential to know exactly how much of your everyday budget will need to be allocated to the home loan. This way, you know exactly how the loan repayments are going to affect your everyday life.
Usually, a loan with more features will have associated fees or a higher interest rate, but it might be offset by other advantages, which you’ll want to understand. Some of the features might include:
- Offset account - where the balance of the account is counted towards your total loan account when repayments are calculated each month.
- Additional repayments
- Redraw facility
- Repayment holiday
- Fixed rate term
- Top up
To compare home loans we look at how much it’s going to cost you to borrow the principle, over the lifetime of the mortgage. The first step is to calculate how much you can borrow. Once you have a figure, you can compare how much it will cost to borrow the money from different lenders, by comparing the total costs of the mortgage over the loan term.
The cost of borrowing money is broken into two components: the fees the lender charges you, and the interest that you pay to borrow the money.
Costs = Fees + interest
Comparison rates were introduced by government legislation on 1st July 2003 to provide a true comparison of the costs of a loan.
What is a comparison rate?
Comparison rates for home loans are calculated for a 25-year term, for a principle and interest loan with secured credit of $150, 000.
It doesn’t take into account:
- fees and charges for optional loan features like early repayment or redraw
- fees and charges which are not available at the time the comparison rate is updated
- savings from fee waivers or interest offset arrangements.
Comparison amounts are calculated using the legislative principle amount of $150,000. This is smaller than most Australian home loans. For a realistic home loan of, say, $400,000, you’ll find that the fees and charges are a higher dollar value, but a smaller percentage of the loan costs.
This means that the comparison rate might not be a true reflection of what your loan situation will be. Even if you select to refinance your current home loan with a home loan that has a lower comparison rate, you can’t be certain that you’ll be better off.
So how should I compare different mortgages?
The best way to compare mortgages is to compare what your monthly repayments are going to be.
Don’t just take our word for it: if you look on the ASIC website - the peak government regulator - you’ll find that when you want to know ‘How to Compare Interest Rates’, you’ll be directed to a mortgage calculator that will calculate what your repayments will be.
Focus on Mortgage Repayments to Compare Home Loans
Why do we focus on the repayments?
The monthly repayments include your interest and your loan fees. They also show you clearly exactly how committing to the mortgage is going to impact your budget. This means you get a true comparison of the financial commitment that each of loan option represents.
You can calculate mortgage repayments once you know your:
- interest rate
- loan term
- borrow amount
- monthly fees
When you compare home loans, you should compare your monthly repayments and the total repayments that you will make over the lifetime of the mortgage. You will also need to keep in mind that any annual fees will be charged separately to your transaction account, and you’ll want to consider these as well when comparing mortgages. You can do this quickly and easily with the Home Loan Comparison Calculator for an outcome that makes a lot of sense.
You’ll also need to keep in mind that if you have a variable rate loan or a split rate (partly fixed and part variable) loan, your repayments will fluctuate with the Reserve Bank Cash flow rate.
If you make extra repayments over the life of the loan, you can reduce the total amount of interest you’ll pay. Remember to check your loan structure for any fees that might be incurred by extra payments.
Fixing Your Rate and Repayments
If you choose to fix your home loan rate, it’s easier to budget each month because you know the exact amount of your repayments for the 3-5 year duration of the fixed term.
The downside of this will be that your loan will have less flexibility in the features that it has, including fees for making extra repayments.
Variable Repayments and Rates
One of the main benefits of a variable rate loan is the ability to make extra repayments. For example, when you get your tax return or a cash bonus, you can put it towards your home loan and reduce the amount of interest you’ll pay in total.
Your repayments will change over time as the Reserve Bank cash rate fluctuates, so you don’t have the certainty of a fixed rate to budget too. If you do get used to paying extra off your home loan when the rates are low, you’ll find it’s not a shock if rates do rise.
There are also home loans that have the option to apply a fixed rate to part of your loan and have a variable rate apply to the other part. A mortgage broker will be able to show you the options that you have, or you can read more about how different types of home loans compare.
What Do I Do Next?
Now that you know how to fairly and accurately compare mortgages, the next step is to speak to a mortgage broker, who will be able to find a selection of loans that you will be eligible for, so you can compare your choices.
Of course, if you have a clean credit history, stable employment and residence, and a large deposit saved, you’ll have the choice of a wider range of competitive mortgages across major lenders.
If your credit history isn’t so good, you’re in casual work, or you only have a small deposit, we can still find home loans for you to choose between.
Whether you’re buying a home to live in, an investment, or you’re looking to refinance, a mortgage broker will have access to a range of lenders and can negotiate a loan to suit your circumstances.
If you'd like some more information, get in touch with a mortgage broker, and they'll be able to answer your questions. You can also find a lot of information on this website - if there's something you want to know and you can't find it, let us know by email or call 1300 366 287 by and we'll add it.