The price of the property and the interest rate on the home loan are probably the two cost factors potential homebuyers consider the most. But these factors affect the total cost of buying a home in different ways. Let’s take a look at the effects of each one.
The Impact Of The Price Of The Property
Property Price And Initial Costs
Be aware that the advertised price of a property is not the total cost of purchase. Initial costs may include stamp duty, fees for buyer’s agents, conveyancers, property valuations and more. Some of these expenses, such as the stamp duty, are based on the value of the property and, in general, the bigger the price tag of the property, the higher the upfront costs. They usually total about 5% of the advertised property price. Use our property purchase cost calculator to determine the home’s total cost to buy.
Property Price And Your Deposit
The largest upfront expense when buying a home is the deposit. In general, the larger the price tag for your property, the larger the deposit you will have to provide to buy the home. Lenders typically require a borrower to pay a deposit of 20% of the price of the home to qualify for a loan without paying Lenders Mortgage Insurance (LMI). This means that for a $500,000 home, the homebuyer would have to pay a deposit of $100,000. There are lenders that will accept 10%, 5% or even no deposit without charging for LMI but that increases the amount the homebuyer needs to borrow and usually raises the interest rate as well.
Property Price And Loan Amount
The property price determines how much you will have to borrow. Depending on the requirements of the lender, most homebuyers will borrow between 80% and 100% of the property value. For a $500,000 home, that means $400,000-$500,000.
The Impact Of Interest Rates
The interest rate on a home loan determines the cost of borrowing the money – the higher the interest rate, the more expensive the money. It also helps determine how much banks are willing to lend a homebuyer and how much it will cost to buy a home over the full term of the loan.
Interest Rates And Borrowing Power
When assessing a borrower for a home loan, a lender calculates the maximum amount it will lend a borrower. Interest rates are the main variable in this calculation, as repayments are either interest-only or a mix of interest plus a portion of the principal, and they increase the higher the rate. If the projected monthly repayment is higher than what the bank thinks a homebuyer can pay, the bank will determine that the loan amount is too much for the homebuyer to borrow.
The lender generally makes this assessment using an interest rate higher than the current rate. The Australian Prudential Regulation Authority recommends using a minimum of three percentage points higher than the current rate for serviceability assessments; for example, if a homeowner is being assessed for a home loan that carries a 4.25% annual interest rate, banks will typically determine borrowing power based on how much the homebuyer would be able to pay if interest rates went up to 7.25%. During a serviceability assessment, banks apply this ‘buffer rate’ to an applicant’s existing debt as well.
From May through December 2022, the RBA increased the cash rate by 300 basis points – three full percentage points – which most lenders will eventually pass through to borrowers in full. This reduced most borrowers’ maximum possible loan size by 20%.
Interest Rates And Monthly Repayments
The size of repayments is determined by the interest rate and the amount of the loan balance on which the borrower is paying interest.
Use our Mortgage Repayment Calculator to know what your monthly repayments would be based on different loan amounts and interest rates.
Case 1 – If the price of the home were still $400,000, your deposit still 20%, and the interest rate dropped to 2.21%, then your monthly repayment would be $1,217. The monthly repayment decreased by $350 with the lower interest rate.
Case 2 – Alternatively, suppose you waited for months to buy, and the price of the home rose to $450,000, and you paid a deposit of $90,000, while the interest rate dropped to 2.21%. The balance on the loan would be $360,000, and your monthly repayment would now be $1,369.
The house price increased from $400,000 to $450,000, but the monthly repayment decreased compared with when you had a much higher interest rate.
Note: Benefits such as offset accounts can reduce the amount of interest you pay on your home loan each month. Also, if you had to get a home loan at a higher interest rate because you did not have much for a deposit, you can often refinance to a lower rate after a few years.
Which Is More Important, Price Or Interest Rate?
Which factor is most important when purchasing a home depends on the homebuyer. A lower price tag will mean lower upfront expenses, while a substantially lower interest rate can reduce your monthly repayments. Both factors help determine the total cost over the term of the loan.
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As your mortgage broker, Home Loan Experts can help you assess your situation and find the right lender. Whether you’re looking for a competitive rate or a home with the highest value you can afford, we’re here to help.
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