We set the record straight on some popular beliefs about mortgages and interest rates
1. There’s no such thing as a standard variable rate
Lenders will advertise a standard variable rate but that’s not what most home owners settle on.
Investors are paying slightly more in interest for their loans but if you are a new customer, are seeking a big loan, have a big deposit or are willing to sign up for a bunch of other financial products, then rate discounts will almost certainly apply.
RateCity data shows that owner-occupiers with at least a 20% deposit often enjoy rates lower than other mortgage holders.
Whatever you do, don’t settle on your lender’s advertised standard rate.
2. Mortgage offset is better than redraw
Both essentially do the same thing – reduce the interest that you pay on your home loan – but an offset account is a little more versatile. If you intend to rent out your home one day and buy elsewhere, then it’s important that any extra repayments are directed into an offset account rather than the home loan’s redraw facility.
This way while you’re still living in the home you would only pay interest on the balance of your loan less the cash in the offset account, minimising interest on what is a non-tax-deductible debt.
When you’re ready to buy your next property and rent out your home, you would simply take the money out of the offset account and your debt on the property you intend to now rent remains and you’ll maximise your tax breaks.
Redraw can also have some restrictive conditions, such as your lender being able to turn off the facility if your financial situation changes. Redraw fees and maximum and minimum redraws can also apply.
3. You’re better off refinancing if you’re not on a good deal
You can potentially save over $22,000 in interest by refinancing a $400,000 30-year loan to one that’s just 0.25% cheaper. So with this in mind you’d think the answer would be “yes” to refinancing. No! Well, at least not until you do a break even analysis first.
Exit fees may have been banned on all loans taken out from July 2011 but there can be other costs with refinancing. Add them up and then divide by your monthly repayment savings. This will give you the number of months you need to recoup the costs.
So if, for example, it costs you $1000 to move but you’d save $50 a month in repayments, your break even period is 20 months, meaning it will take you just under two years to recoup the cost of moving.
Can you be certain that your new lender will be just as competitive in two years as they are today. That’s the trouble with the saving examples given in favour of refinancing. They assume the interest savings will be there for the entire 30-year term.
4. If you lock in, you’ll get it wrong
TRUE (BUT ONLY SLIGHTLY!)
In the past 20 years had a borrower fixed for three years rather than gone with a variable interest rate, in 51% of cases they were worse off. That’s according to Canstar, the financial comparison site which crunched the numbers.
According to Canstar’s Mitchell Watson, getting it right or wrong can have a big impact. If, for example, a borrower had fixed for three years in May 2012, by the time it had matured they would have saved $2500 in interest on a $300,000 loan.
On the other side, if they had fixed in October 2012 they would have paid $2400 more in interest by choosing to fix for three years.
There are even greater examples going back to 1995 where choosing to fix, rather than opting for a variable rate, would have cost a borrower in excess of an extra $20,000 in interest over the fixed term. If you crave certainty, then at the very least you should think about splitting your loan into fixed and variable portions.
Most fixed-rate loans allow extra repayments of up to $30,000 during the fixed-rate period without penalty.
5. It’s risky to take out a loan with a non-bank
Non-banks abide by the same consumer credit rules and regulations as other lenders, so as a borrower you can be assured that you have similar rights and expectations of services.
As Melissa Urquhart, of State Custodians, rightly points out, at the end of the day the lender has lent you the funds, not the other way around.
“The risk really is with the lender, not the individual,” says Urquhart. “Without early exit fees you are free to refinance at any time.”
6. It’s hard to get a home loan if you’re self-employed
There are more hurdles to jump when proving your income when you are self-employed. According to mortgage broker Terry Hunt, of Smartline Personal Mortgage Advisers, most lenders will ask to see two years’ financials, tax returns and notices of assessment.
As Hunt points out, one of the benefits of being self-employed is that you may have more business deductions than you would as an employee, allowing you to reduce your tax. The downside is that a lender will use your net taxable income when calculating your borrowing capacity.
Lower income equals less borrowing power.
7. You’re better off with a packaged home loan
Hunt says that while packaged loans can provide lower interest rates and other features such as offset accounts or free credit cards, you need to be careful of the fees.
“If you have a smaller loan or don’t need all the bells and whistles, a basic loan product could cost you less overall.”
According to Canstar, the sweet spot – that’s when the annual fee is offset by the interest rate discount saving – kicks in on loans greater than $150,000.
8. Weekly repayments are better than fortnightly
FALSE: There is practically no difference. On a $500,000 loan at 4.5% over 30 years, the saving in interest would be $177 by paying weekly. Hunt says it’s just not significant.
What you should be concerned about is how your lender calculates your weekly or fortnightly repayments.
To make big savings you should make an extra repayment each year. For example, if your monthly repayment is $1000, your fortnightly repayment should be $500 and your weekly repayment $250. Some lenders take the monthly repayment figure, multiple it by 12 and then divide by 26 to give you your fortnightly repayment. This won’t give you that extra payment.
Don’t miss out on a great rate
By the time you find your dream investment property and settle, 90 days could have passed. More if there are document delays. In that time you could see three official rate changes meaning the rate you signed up for could be very different to the one you’re given. If you plan on locking in you could secure your fixed rate offer by accepting a rate lock guarantee.
Rate locks are generally only offered on fixed rate home loans. It usually protects you from rate hikes for up to 90 days. Because fees of up to $750 can apply it’s worth assessing where you think fixed rates are going. In a rising interest rate environment it’s probably money well spent. If rates go down most lenders would allow you to still benefit from the lower rates.