How to Play the Mortgage Game and Win!
by Mark Causer
It will not come as a surprise to any of you, especially the first home buyer, that Australia has one of the most expensive property markets in the world. Capital city house prices have more than quadrupled and household debt has tripled since 1990.
The recent annual Demographia survey of house prices across seven English speaking nations places Australia up front, with the exception of land starved Hong Kong, Australia remains the highest cost housing market in the Anglo world. Out of the 325 metropolitan markets around the world, Sydney was the 3rd most expensive and Melbourne the 5th with other major cities not much better. In the US, many bustling metropolises like Atlanta, Dallas and Houston have house prices much less than one third of those seen in Melbourne and Sydney.
As a result of Australia’s very expensive property market, homeowners really notice any slight increases when interest rates are raised. In fact, such is the expense and percentage of the family annual salary that mortgage repayments devour, talk of interest rate drops and RBA’s 2.30pm announcement takes on unprecedented importance – many investment houses will run a ‘book’ on which way rates will move!
Following on from this in more recent times, is the general public feeling of utter helplessness when our major banks fail to pass on any rate cuts. While we have some relief now with low interest rates relative to days gone by (think 1990s when rates where high double digits), most projections show that interest rates will rise again and many people may start to feel stress from their mortgage, if the GFC is not already placing a strain on their monthly budget.
This article is designed to provide some helpful tips on how to beat rate rises and avoid mortgage stress.
1. Review your budget and plan for higher rates
While interest rates are low now, they will inevitably rise again – remember your mortgage is generally a very long term proposition. It is important that you know what interest rates may become, so you will be able to budget for the higher rates before they occur. If you do not budget, you may find that you have a loan that you are not able to afford AND worse still, the value of your underlying asset (your house) has not moved or may have even dropped in value!
2. Borrow Less
The Australian Dream – own your own home in a nice street. One of the simplest ways to reduce the amount of interest you will pay is to borrow less. If you are able to borrow less you will save interest over the course of the loan. Easier said than done, but maybe starting off small and building up may be a more conservative approach, larger deposit, smaller purchase price!
3. Take on a simple or basic home loan
Basic home loans are loans that come with few features. While this is the case, they will also come with lower interest rates. It may be an opportune time to review your existing mortgage, as you may have several features that you don’t require and this is causing you unnecessary fees and charges.
4. Read the fine print around introductory interest rates
Introductory interest rates are reduced interest rates that are offered to people for the first part of a loan, generally the first twelve months as a ‘hook’ to get you in the door. While you will save money during the initial part (generally the first twelve months) you may revert to a more expensive ongoing loan after the honeymoon period has finished. The better option may have been to fix or secure a less attractive rate upfront and disregard the cheaper first year ‘special’.
5. Make Extra repayments
Many mortgagees make monthly loan repayments. Moving to fortnightly or even weekly repayments will help reduce your interest costs. Most home loans calculate the interest daily. Therefore, the more often you put money onto the loan account, the less money will be owing on the loan for interest to be calculated. Additionally ANY additional repayments you can make will help (you should ensure that this feature i.e. to make additional repayments is included in your loan contract). By making additional repayments throughout the loan, you will not only reduce the value of your loan but you will pay less in interest over the course of the loan. Remember, loans can run for up to 30 years, small periodical additional repayments can make a material difference over time.
For example, if you have a $250,000 loan with a 6.45% interest rate and a 25 year loan term, your monthly repayments will be around $1,680. Over your loan term you will have paid $254,062. However, if you paid just $100 extra every month, you will have repaid your loan three years and one month earlier and paid $216,850 in interest - this is a saving in excess of $37,000. This is a significant saving derived from only an extra $100 each month (or $25 per week) and you may even be able to find more and set your automatic monthly repayment higher.
6. Pay any loan fees & charges upfront
When you start your home loan you will generally have to pay several upfront fees. You should consider paying these fees with your own money upfront and not from borrowed money. This will reduce the amount on your loan and therefore the interest that you are charged over the loan term. Include these fees in your calculations when you are saving towards the initial deposit.
7. Lock in a low interest rate
Fixed rate loans today are very low – they could go lower, but then again they may not. You can save money if you lock the rates in at the right time, the right time is not today or tomorrow or next week, it is when your budget can handle the fixed repayments that you must make. It can be a very dangerous game to try to pick the interest rate market
8. Consolidate Debts
Interest rates are low, BUT they could well rise if conditions in Europe improve. You should consider consolidating all your debts into one debt. Instead of paying the 15% – 20% rates that apply to credit cards, you should consider putting this type of debt onto your home loan to save money.
9. Offset / Redraw facility
If you have a offset / redraw facility you should take advantage of it. The best way to use a redraw facility is to deposit you wage into the loan account and use your credit card over the month. Therefore, while the money is on the account you will have less interest charged to the account.
When you make those additional repayments to your loan they are not gone forever, instead additional repayment features will often come with the companion feature of redraw so you can withdraw those additional repayment amounts if you need them, or if you have been using your loan account as a savings account for extra funds, while saving on interest charges. Of course, if you redraw the amounts you have made in additional repayments, your loan amount will go back up and so too will your repayments. You will also need to be aware of redraw terms, conditions and costs such as:
- Redraw facility fees
- Fee per redraw
- Minimum / maximum redraw amounts
To help you choose a home loan with a redraw facility, you need to think about how you plan to use your loan account. There is no point searching for a loan with these features if you’re not going to use them. There is usually some sort of charge, compared to a basic loan without any extra features – this charge is in the interest rate.
Even if you don’t think you can spare much of your wage for additional repayments, making the effort can reap genuine savings. Rather than aiming to deposit your extra funds into a savings account, keeping them in your home loan will save you more interest than you would have earned. A high interest savings account will pay around 5% interest but if you are paying 7% interest on your home loan, you are actually losing 2% in interest. Plus, the interest earned from your savings is being taxed, however, you are not taxed on interest you save.
If you have a long term goal i.e. a car or a holiday, instead of ‘investing’ into a savings account, invest this money into your home loan, and redraw the funds when you reach your goal. You will have offset interest while you work towards the goal!
There are a lot of features you can add to your home loan and having a fully customisable loan product can be a great way to tailor a loan to your needs. However, you need to make sure you are actually going to use and benefit from these features because otherwise they are simply costing you money.
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