Buying a property to live in, whether it is a house or apartment, is often the largest purchase people will encounter in their lives. Buying a property should therefore be undertaken with a thorough understanding of what is involved and how it may impact your long-term finances. These include buying versus renting, understanding the terminology common in the real estate industry, how much you can afford, and decisions that can affect how long it will take to pay off the mortgage. The following sections outline some of the more important things to consider when buying and paying for a property. The focus of this article is on buying a property to live in rather than for investment purposes.
Decide whether to buy or rent
There are other options to consider than buying a property. Renting can sometimes be a better option depending on your current financial situation and goals. Below are some things to consider when deciding which of these two options suits you best.
Buying a property
Reasons when it may be better to buy a property rather than renting include:
- You are committed to staying in the same area for at least 5 years, and preferably 10 years to realise capital appreciation.
- You understand the upfront costs associated with buying a property, including having saved enough money to pay the deposit or downpayment, which is usually between 5% and 20% of the cost of the house. Legal fees, building inspection fees and taxes are additional costs that must be added to the total cost of the house. These extra fees are often added to the loan.
- You understand and can afford the ongoing costs of owning a property apart from regular mortgage payments, including insurance, maintenance and utility costs.
These reasons require you to have a secure job with a stable income to avoid problems of not being able to pay for the loan, regular utility costs, taxes and any maintenance that is needed in addition to your regular living expenses.
Renting a property
Reasons when it may be better to rent a property to live in rather than buying include:
- You are less certain about your future. For example, you may need to move or travel frequently for your job or you could be planning to move overseas or to a different location in your country within the next few years.
- You have significant debt that needs to be paid off first. You would be better off renting while paying off the debt before saving to buy a property to live in.
- You don’t have sufficient funds to pay for the deposit/downpayment or the upfront costs.
Ultimately the decision to buy or rent a property comes down to your personal financial situation. One is not necessarily better than the other. If you dream of owning a home in the future but cannot afford one now, you could rent while saving for a deposit.
Terminology
Before going into more detail about buying a property, it is worth understanding some of the terminology associated with the purchase and the loan that you will need to service over the next two to three decades. Refer to this table when reading the sections below.
| Term | Meaning |
|---|---|
| Lender | The lender is the party providing funds to pay for the property. Lenders are most often banks. Mortgage brokers can be consulted by borrowers to help find suitable lenders and organise the loan contract. |
| Borrower | The borrower is the party (e.g. a person or people) borrowing money from the lender. The borrower pays the loan back to the lender over a given period of time with interest. |
| Interest and interest rate | Interest is the proportion of extra money you need to pay back to the lender in addition to the original loan amount over the life of the loan. The interest rate is a fraction of the outstanding loan amount and is usually specified as a percentage per year. For example, an interest rate of 3.7% per year on a loan of $350,000 would require an interest payment of nearly $13,000 for the year. |
| Deposit | A deposit, also called a downpayment, is the amount of money paid by the borrower to the lender before the lender releases the money to pay for the property. A deposit is typically between 10% and 20% of the home value but can be as low as 5% for some lenders. The recommended deposit is 20% of the home value plus the additional costs associated with the purchase. A deposit of 20% indicates to the lender that you can save effectively and are therefore more financially reliable. |
| Lenders mortgage insurance | The lenders mortgage insurance (LMI) protects the lender in cases where you can’t make a loan repayment. Deposits less than 20% usually incur an LMI fee due to the potentially higher risk. This fee can be paid before the lender releases the money to pay for the property or it can be added to the loan. |
| Principal | The amount owing on a loan is the principal. If you take out a home loan worth $450,000 the initial principal is $450,000. After paying off $50,000 on the loan, the principal will have reduced to $400,000. |
| Repayment amount | The repayment amount is the amount of money you will need to pay back to the lender each month or fortnight. The minimum repayment amount will vary based on the loan type (interest only or principal plus interest) and the interest rate. Include this amount as an expense in your budget to ensure it can be paid each month. It is worth setting up this payment automatically soon after you get paid to avoid overspending on other things. Most lenders will accept more than the minimum repayment amount, which has some advantages for the borrower. |
| Term | The term of a home loan is the duration of the loan, agreed upon by the lender and the borrower. Shorter loan terms (e.g. 20 years) require higher repayment amounts but reduce the total interest paid over the life of the loan. Conversely, longer loan terms (e.g. 25 or 30 years) require lower repayment amounts but result in a higher total interest paid over the life of the loan. |
| Repayment frequency | The repayment frequency is how often the repayment amount is paid to the lender. The repayment frequency is most often monthly (on the same date of every month) or fortnightly (every 14 days). This frequency commonly coincides with the borrower’s pay cycle to simplify budgeting. Note that paying fortnightly can result in paying off the loan sooner, as there are a little over two fortnights per month. Check the interactive calculator below for examples. |
Work out how much you can afford
There are a few different rules of thumb that you can use to help determine the amount of money that you can comfortably pay for a property to live in. These include:
The 28/36 Rule
The 28/36 rule recommends:
- spending not more than 28% of your gross income on your mortgage payments, including principal and interest payments on the loan, mortgage insurance (if applicable), land rates, property insurance, body corporate fees etc.
- spending not more than 36% of your gross income on the above mortgage payments plus all other debts that you owe, including car loans, personal loans, student loans etc. This means no more than 8% of your gross income should be from these loan debts. If it is, then less than 28% of your gross income will be available for the mortgage payments. In this case, you would either need to purchase a cheaper property or pay off those debts until the 28/36 balance can be met.
The advantage of the 28/36 rule is it will allow you to purchase the second most expensive house out of the three rules of thumb. The disadvantage is that it requires the largest amount of income to be paid towards the loan payments compared with the other two rules of thumb. This means there will be less money left over for other financial goals.
The 30% Solution
The 30% solution recommends not spending more than 30% of your gross income on mortgage payments. This covers the same mortgage expenses as the 28 part of the 28/36 rule above.
This rule allows you to buy the most expensive house out of the three rules of thumb. However, it does not take into account other liabilities including loans and credit card debt. This rule of thumb is not recommended if your loan repayments on other liabilities are significant.
If your other debts are relatively low and under control or if you don’t have any debts, then this rule of thumb can be a suitable option. It also recommends non-housing costs to be not more than 20% of your take-home pay, which is the amount of income you receive after taxes.
The 25% Method
The 25% method recommends spending not more than 25% of your take-home pay on your housing costs. This method was coined by Dave Ramsey, best-selling author of The Total Money Makeover: Classic Edition: A Proven Plan for Financial Fitness Link*. This is the most conservative out of the three rules of thumb and the least risky. This allows you to allocate your remaining money to other financial goals. The disadvantage is it can limit what you can afford, and you may need to purchase a smaller property or a property in a less expensive neighborhood.
The rules of thumb above should not be followed without careful consideration of your personal financial situation. One rule may be suitable for one person but not for another. It is also important to take into account other costs associated with buying a house, which are covered below.
Once you have decided which of the above methods suits you, and how much you can afford to pay in loan repayments each month, you can use the following calculator to find out how much you could borrow.
How much can I borrow?
Use the loan amount calculator to determine the amount of money you could borrow. Enter the amount of money you can afford each month based on the recommendations above, the interest rate from your preferred bank, and how long you expect to pay the loan. A typical term is 30 years, but can be lower. Generally, the older you are the shorter the term will need to be. You don’t want to be paying off a home loan after you retire unless you have a steady and sufficient stream of income!
Note: This calculator assumes a fixed interest rate for the term of the loan. Usually, interest rates on home loans will vary. However, it is useful to check how the different parameters will affect how much you can borrow.
What if I want to get a larger loan?
If you really want a larger loan to purchase your dream house that is bigger or in a more expensive location, the following ideas may help:
- Save more for the deposit. If you don’t need to buy straight away, you can save for an extra year or two to increase the amount you can borrow.
- If you are a first home buyer, look for bonus schemes. Ask your preferred lender if there are any benefits that are available for first home buyers. This can help reduce the amount of the loan and the deposit required.
- Share the loan with a trusted friend or relative who lives with you to reduce expenses. They could help with loan repayments, utilities, food and other expense that you agree to. This can be challenging for some, so it is worth seeking legal advice before entering into these types of arrangements.
How much should I save for a deposit?
A home loan deposit is typically between 10% and 20% of the loan value but can be as low as 5% or even lower for some lenders. The recommended deposit is 20% of the loan value plus the additional costs associated with the purchase. A deposit of 20% indicates to the lender that you can save effectively and are therefore more financially reliable. A good credit score is also important in the United States, which indicates to lenders that you can pay off debt consistently and on time.
What if I am a first home buyer?
Saving a 20% deposit for a first home buyer may be more difficult. If home prices increase at a faster rate than you are able to save, which was the case in many countries since 2020 and continuing in 2023, reaching that elusive 20% may seem impossible. In this case, it is acceptable to ask your preferred lender for a 10% or 5% deposit. The worst they can say is no, but if successful, you can get into the market sooner. As a bonus, while house prices are increasing the equity in the home will also increase. But remember, you will likely need to pay lenders mortgage insurance (LMI) if the deposit is less than 20%.
If you are not a first home buyer, it is strongly recommended to save at least 20% of the deposit. Why? Because you should have built up sufficient equity in your first home to help pay for the deposit.
Become interested in interest rates
The interest rate of a loan can significantly impact the total amount of your hard-earned cash that you end up paying over the lifetime of the loan. The reason for this is due to the length of time it takes to pay off, with even small differences in the interest rate resulting in big differences in the total interest paid. Lenders offer two main types of interest payments: fixed interest and variable interest rates. Some offer a mix of the two.
Fixed interest rate
Fixed interest rate loans require the borrower to pay a fixed amount of interest on the loan each month or fortnight. It corresponds to the interest rate defined by the lender over a specified period of time such as 3 years or 5 years. After that time has expired, the lender can adjust the interest rate up or down based on the prevailing lending market conditions.
Variable interest rate
Variable interest rate loans require the borrower to pay interest at the current interest rate, defined by the lender, each month or fortnight. The interest rate is adjusted up or down based on the prevailing lending market conditions and is closely tied with the cash rate of the country. In Australia, the cash rate is assessed and sometimes adjusted, on a monthly basis. Lenders usually adjust their variable interest rates soon after the cash rate is adjusted.
Which is better – fixed or variable?
There are pros and cons associated with fixed and variable interest rate loans. The main differences are covered in the following table.
| Interest Type | Pros | Cons |
|---|---|---|
| Fixed rate | 1. Easier to budget – you have a fixed amount to pay each time 2. Fees are often lower due to no additional overhead 3. Better choice in times when interest rates are low | 1. You will pay more interest if the variable rate is lower than the fixed rate 2. You may need to pay a fee to switch to a variable rate loan |
| Variable rate | 1. You can save more when Interest rates moving in a downward direction 2. Switching to a fixed-rate loan usually doesn’t incur additional fees | 1. You will pay more interest if the fixed rate is lower than the variable rate 2. Fees can be higher for extra options available on the loan |
What about both fixed and variable rate loans?
Some lenders offer a combination of fixed and variable rate loans. This effectively smooths out the variability of variable rate-only loans and can be useful to borrowers at times when interest rates are volatile or when there is uncertainty in the lending market.
Home loan account options
A number of home loan options can be used for different purposes. Some examples are explained below. Check with your lender to find out if they offer these options and whether any of the options are suitable for your financial situation.
Offset accounts
Offset accounts are like standard savings accounts where you can deposit or withdraw money as needed. The benefit of an offset account is that it can reduce the interest paid on a linked home loan. The more money in the offset account, the greater the reduction in interest paid on the mortgage. For example, if you have a home loan worth $500,000 linked to an offset account containing $50,000, you would pay interest on $450,000 instead of the full $500,000. If the interest rate on the loan was 4.8% per year (0.4% per month), you would be paying $1,800 in interest for the month instead of $2,000. This is a $200 savings every month, or $2,400 every year.
Most banks offer offset accounts on variable rate loans, and some offer them on certain fixed rate loans. Check with your lender to see if you can take advantage of this option. The important thing to remember with offset accounts is the more money you have in them, the more you can save in interest payments.
Interest only and principal plus interest repayments
The repayment amount can be based on two main options: interest only or principal plus interest.
Interest-only loans are typically used for investment properties, where the borrower receives rent from the tenant and uses the rent to pay for only the interest portion of the loan. The loan amount remains constant, which means the amount of interest does not change over time (for a fixed rate loan), or it fluctuates with the variable rate. The interest-only repayment will only last for a fixed period, such as 5 years, after which the repayments will switch to principal plus interest. You will need to make sure you are prepared for the higher repayments when this switch occurs. Using a budget can help make sure there are no surprises by checking periodic transfers to your nominated account(s) and adjusting how much is transferred where necessary.
Principal plus interest loans are the most common and have a number of benefits over interest-only loans. Repayment amounts are calculated from the loan principal plus the interest on the principal. Because of the higher repayment amount, the principal reduces after each repayment is made. This results in a reduction in interest paid over the lifetime of the loan.
The pros and cons of both types of loan repayments are summarised below.
| Repayment Type | Pros | Cons |
|---|---|---|
| Interest only | 1. Reduced repayment amount can help borrowers get into the property market sooner 2. Useful for investment properties, where the rent can be used to help pay for the loan | 1. The principal does not reduce over time 2. More interest is paid over the life of the loan 3. When the interest-only period ends, the increased repayments need to be factored into the budget |
| Principle plus interest | 1. The principal reduces over time, allowing the loan to be paid sooner 2. Less interest is paid over the life of the loan 3. Interest rates can sometimes be lower than interest-only loans | 1. Higher repayments reduce the amount you can save or invest elsewhere 2. Higher repayments can mean it will take longer to get into the property market |
Redraw facility
A redraw facility allows the borrower to pay more than the minimum repayment amount to pay the loan off sooner. This also helps to reduce the total interest paid over the lifetime of the loan. The extra amount paid can be withdrawn if necessary, such as for an unexpected expense or emergency. This is similar in concept to having an emergency fund, but the extra money paid is deposited into the loan account in addition to the standard repayment amount.
Other costs to consider when buying a property
The information covered above takes into account the main costs associated with buying a property. Other costs that need to be taken into account, and budgeted for, are listed below. These costs can be paid for by the loan, which reduces the amount you can spend on the property, or through saved money.
- Building inspection fees. It is important to ensure the property is structurally sound, has been built to local regulations and will not become a major headache after the purchase. Building inspections can also include areas outside the house such as sheds, swimming pools, landscaping and other outdoor additions to the property. Building inspections generally cost a few hundred dollars.
- Pest inspection fees. Pest inspections usually involve termite checks, but also anything that can allow other insects and animals to enter the house or roof space. Often building and pest inspections are performed at the same time. Make sure you use a reputable and qualified inspector so that important issues aren’t missed. Pest inspections cost about the same as building inspections. Combined building and pest inspections can cost between $500 and $1,000, and sometimes more, depending on the size of the property and how many external additions are present.
- Legal and conveyancing fees. A significant amount of documentation is required with property purchases. It is therefore recommended to seek legal advice (from a lawyer, solicitor or conveyancer) to ensure this is done properly. Legal fees can start at around $1,000 and be as high as several thousand dollars depending on the complexity of the purchase. Whilst this cost may seem high, having legal support can avoid even higher costs after the purchase if the necessary documentation was not done correctly in the first place.
- Stamp duty (Australia, many European countries, Hong Kong, India, Ireland, the UK and others). Stamp duty is a tax that is paid by the purchaser to the government and is usually based on a percentage of the purchase price of the house. In Australia, different states and territories charge at different rates.
- Closing costs (US). Closing costs in the US include mortgage taxes similar to stamp duty, but also include legal fees, title insurance, bank fees and other government fees.
Stamp duty and closing costs are the largest additional costs associated with buying a property. They can range from 1% to 2% of the purchase price up to several per cent. A simple internet search will provide details of these costs in your country.
Home loan calculator
To estimate the total cost of a home loan, we have put together a home loan calculator below.
Note: This calculator assumes a fixed interest rate for the term of the loan. Usually, interest rates on home loans will vary. However, it is useful to check how the different parameters will affect the total amount you could pay, including interest and fees, over the life of the loan.
Surplus cash: pay extra on the mortgage or invest it?
When paying off a mortgage, the choice of paying down the mortgage with extra money – either with a lump sum or with extra payments, or investing the spare cash – depends on a couple of factors. These include:
- Mortgage interest rate. If interest rates are low, it would be worth considering investing spare cash and lump sums into a diversified index fund in the stock market, which could earn more interest than the gain from paying extra each month to satisfy the low-interest mortgage. You could effectively increase the lump sum and extra repayment amounts over 10 to 20 years and use it later to pay off the mortgage. Conversely, if interest rates are higher than the expected return from the stock market, you’d be better off paying down the mortgage sooner to reduce the total amount of interest paid.
- How long before the term is reached. If the term of the loan is approaching within the next 5 to 10 years, investing a lump sum in the stock market might be riskier due to short term volatility. In that case, you might be better off paying down the mortgage with a lump sum.
As with other areas of finance, there’s not always a 100% right or wrong decision. If you are uncomfortable with choosing one strategy over the other, you could implement both strategies: invest some spare cash in the stock market to grow it over 10, 15 or 20 years to eventually use to pay down the mortgage as a lump sum. In addition, you could also pay down the mortgage with any lump sum payments you receive, such as a bonus or tax return. These strategies are explained in more detail here.
Tips to getting a good deal on your home loan
- Aim for lower interest rate loans.
- Understand the hidden fees associated with the loan. Comparison rates are a good way of comparing different lenders and loan types.
- If you are a first home buyer, check with your lender whether there are any grants or bonuses available. This can reduce the loan amount and the deposit needed for a loan.
- Choose a shorter term if you can afford it to lower the total interest paid over the life of the loan. However, keep in mind potential losses from not investing some of your cash.
- Select fixed interest, variable interest, or a mix of both loan types based on current market conditions.
- Consider whether you need any special options with the loan, which could cost more over its lifetime.
- Seek advice from a qualified financial adviser to help you get the most out of your home loan based on your personal financial situation.
More resources on buying and paying for a property
The following books provide more detailed information on the topics covered in this article. Feel free to browse through this list and support the site by making a purchase at one of our affiliate partners. Please read our affiliate links disclosure for more information. Note: The links below will open in a new browser tab or window.
NOTE: If you do not plan to make a purchase but you have learnt something useful that has improved your finances, please consider a small donation. It will help to keep this site active and current. Thank you!
Remember to choose your preferred format (paperback, hard cover, digital etc.) before making a purchase!
- Buying A House – The First Time Homebuyer’s Guide by Michael T Perry Sr. Link*
- AUSSIE MARKET MATE: A Step-by-Guide to Buying Your First Home in Australia by Michael Thompson Link*
- The 90 Day House: Buy a House in 90 Days with No Money Down – Owning Your Dream Home is Easier Than You Think! by Kenzie A. Bond Link*
- The Wealthy Renter: How to Choose Housing That Will Make You Rich by Alex Avery Link*
- How to Buy Your First Home (And How to Sell it Too) by Phil Spencer Link*
(*) This site contains affiliate links to products. We may receive a commission for purchases made through these links at no extra cost to you. Please read our affiliate links disclosure for more information.
