Home Finance: Research your needs

In order to end up with the home finance best suited to your needs, you have to clearly understand what you are looking for and what options are available to you. This is done by researching in two areas.

Firstly, you research the market to find out what kinds of home finance are available, familiarizing yourself with the different features, styles and price ranges etc. Secondly, you examine your own unique requirements in home finance.

Research the market: Home Finance essentials

The first part of the research step is to investigate just what's available in the home finance market. The range of options can seem daunting, but you can make a good start by understanding the following major features:

Type: Discount, capped, fixed-rate or standard variable rate mortgages sound complex but simply describe the way the interest rate changes over time. Some follow the stock market; some will be at a set rate for a period of time and then may jump to a rate higher than the stock market rate. Other mortgages use a life policy, stock investment or a pension scheme to pay off the mortgage but carry the risk of poor performance and may need to be topped-up at the end of the period.

The most common loans are fixed or adjustable (variable) rate loans. Fixed rate home loans are generally fixed for a specified period of time, such as 2, 3, 5, 15, 30 or 40 years. Adjustable rate mortgage loans (also known as ARM loans, standard variable home loans or tracker loans) mean that the interest rate can move up and down over the course of the loan. Some adjustable rate mortgages might have a fixed rate period for the first three or five years before changing to a variable interest rate. While some mortgages might have conversion or switching option that allows you to switch from a variable (adjustable or tracker) rate to a fixed interest rate, without paying break-costs.

Some loans may allow you the flexibility of changing the amount of your monthly repayments. If you have overpaid your mortgage payments, then the additional money can be used as a way of reducing your future monthly payments. This is particularly attractive for people who might change from a two-income to a one-income household, or need some financial respite for other reasons.

Interest-only repayments are available where the purchase is an investment vehicle and tax benefits can be realized. However, these types of mortgage are often the most risky, since they can leave a huge amount to pay at the end of the loan period, since the overall cost of the property isn't being reduced, just the interest. There are also mortgages available specifically for those with bad debt - however, these are usually high interest due to the risk factor involved.

Some loans may have higher interest rates, but offer more flexibility with the loan. These types of loans may offer a mortgage offset account or redraw facility. A mortgage offset account allows you to reduce your mortgage loan amount by whatever balance you have in the offset account, therefore reducing your interest payments. A loan with a redraw facility allows you to withdraw any additional payments you might have made.

Some lenders offer loans with lower interest rates such as honeymoon rates loans, or basic variable home loans. Honeymoon rates and discount loans offer lower interest rates for a set period of time (usually 6-12 months) and then changes to a standard variable interest rate. While a basic variable home loan often has a slightly lower interest rate, it may be missing many other great features that other loans offer, such as a redraw facility.

If you have equity in your existing home you might consider taking out a reverse mortgage or equity home loan (also know as Line of Credit loans). These enable you to gain access to cash that would otherwise be unavailable. The interest rates associated with these loans are often higher, but in the case of the reverse mortgage, the interest payments do not need to be paid until the property is sold or the owners cease to live there.

Fees: Many lenders will charge a range of fees for setting up and guaranteeing your mortgage. These are usually added to the sum of money borrowed. Also, in most countries you will also have what's called a “closing fee”, which is an amount paid to close the home loan application. This is often between 2 to 3% of the cost of your home and may cover the cost of appraisals, credit reports, title search and insurance, and other costs assessed at settlement. On top of that, lenders will often have an on-going account keeping fee for your mortgage.

Brokers usually demand an additional fee or the purchase of a life policy for which they receive a commission.

Income multiples: Mortgages can be available for up to three and a half times your income. However ratios differ between lenders and are influenced by the number of incomes being considered. For example, if you're a couple buying your home, you can apply for a mortgage that takes both your incomes into account (so you can use up to 3 times your income, plus 1 times your partner's income). Or, you can combine both your incomes and borrow 2 times your combined income. It really depends what is the best option for you, and what method will give you the larger mortgage.

However, there are now lenders that will give you up to 5 times your salary, or even as much as 8 times your income amount. While this may seem helpful in getting you onto the property ladder, it also offers an easy route into debt, so you should only really take a mortgage out that you can realistically afford.

In some countries, some lenders will allow you to take out a joint mortgage with parents or a close family member, as a way to increase your borrowing power. They use their income as the main income to assess the amount you can borrow. Joint ownership creates joint responsibility however, so this option needs to be considered carefully.

Loan Amount: The actual amount of money you can borrow for a home purchase will be determined by lending institutions on an individual basis and is influenced by a number of factors, including income, assets, debts and ability to make repayments. Many institutions have formulas in place to calculate an individual's 'borrowing power' - and the value and location of the home will also be a factor. Loans may be available for 70% (or less, depending on the size of the deposit you have) to 110% (to cover legal fees, insurance and other associated costs) of the value of the property.

A lot depends on the country you're in as well. There's a very popular mortgage in North America, for example, called “zero down”, where as the name suggests, you can take out the equivalent of a 100% mortgage, with no deposit required. You will still have to pay the closing fees, but saving a minimum 5% of the cost of your home is a big help when you're first starting out.

Repayment Period: Although 25 years is a common repayment period, longer and shorter periods can be negotiated. The benefit of choosing a shorter period is that you will pay far less interest.

Lenders now offer mortgages for 25, 30, 35 and 40 years, with payments obviously being lower the longer the payment period is. Although taking a mortgage out for 40 years will mean more interest being paid, this is only if you take the full 40 years to pay. If you don't have much money to start with, a 40-year mortgage is ideal, as the payments are lower and you can then change to a different mortgage when you can afford to. Therefore, it's definitely worth looking into.

Research your needs: Questions to ask yourself

Now it's time to determine what your requirements are in home finance. For example, will you use the home finance only for buying an investment home?

You can start this process by considering the following questions - as well as any others you think of yourself - and recording your answers.

Have I arranged finance before?
	If you have arranged finance, work out what you did or didn't like about the finance. You may be looking for one exactly like it, hoping to upgrade, or even trying to avoid any particular features that you found inconvenient.

What do I want to use the mortgage for?
	The mortgage might be for a straightforward house purchase or you could be building a house and need to finance the various stages of the build. You might be an investor looking for a quick turn-round with minimum tax implications. There are many different mortgages available, so make sure that you have the one that's the most beneficial to you.

It may be that you're looking to be a landlord and are simply going to rent the property out, so perhaps an interest only mortgage would be best, allowing you to put the rent towards the cost of the mortgage as well, and pay it off quicker.

Or you may be struggling to get credit for a mortgage, in which case a rent-to-own option would be better, since this allows you to move in and buy the house that you're renting. If you're unsure, always take the time to look into what different mortgage terms mean.

How much money can I put towards the deposit?
	Mortgages are available for as much as 110% of the value of the house, however injecting more money at this stage with a higher deposit will give a better choice of mortgages and more competitive rates to select from. The normal minimum deposit is 5%, so always tailor the home you're looking for around that amount.

What would be an ideal repayment period?
	You might have 25 years of steady income ahead of you or perhaps you may take early retirement, reducing your income substantially.

There is no “ideal repayment period”, since nobody knows what's going to happen tomorrow. However, if you take into account what you can realistically afford each month and stick to that amount, this will allow you to work out how much of a mortgage to go for. Also, make sure you take out payment protection insurance on your mortgage, so that if you fall ill or lose your job, your insurance company will make your payments.

What are my personal circumstances?
	You might be in employment or are self-employed. Think about what monthly repayments you can manage and if you have a poor credit rating. Mortgage lenders have different types of mortgage to suit everyone. If you are self-employed, it may be difficult to get a “standard” mortgage, so a specialist lender that deals solely with self-employed homebuyers would be better suited to your needs.

What is my house-buying strategy?
	Some mortgages have hefty early redemption clauses, so it is worth considering how soon you may be moving on from this house. Many people go with a 5-year plan on their first home, for example, so if you fall into this category, make sure your mortgage lender won't punish you financially for selling up and moving on.

Understanding your needs is the key to a successful purchase and you can revisit your list of needs at any time during the buying process.

Once you complete this Research step, having informed yourself about the essentials of home finance and identified your needs, you are ready to move on to the next step: Evaluation.

Video Links

Buyz123.com Research Links:

Brokers

Why use a mortgage broker?

Is a mortgage broker for you?

Mortgage brokers - pros and cons

Deposits

Deposit dilemma - how much is enough

Down payments

General

Mortgage essentials - what you should know

Where should I get my mortgage from?

Mortgage Types

Mortgage types