Honeymoon hangover – introductory rate loans

Let’s understand one thing, even onnormal home loans lenders don’t make much if anything out of your home loan in the first year or two.  These loans are intended to attract you in the hope that you will stay with the lender and there are some very good deals available and they can be particularly attractive to borrowers with large loans on single properties as a saving of even 0.25% can be substantial.  For first time borrowers looking for loans around $300,000 a 0.25% rate reduction can save you $750 in the first year – the question is how much will you be saving if you stay for 2 or 3 years.

Introductory rate or honeymoon loans are loans that offer a ‘special’ low rate for an introductory period and then the rate escalates to a higher ongoing rate. Before the government’s ban on early exit fees these loans were a real trap, giving  an attractive rate for 6 or 12 months then locking you in on a uncompetitive rate for 3 to 5 years with big penalties if you tried to get out early.

In the new regulated market hangovers have improved however the competitiveness of the introductory offer is probably not as keen.

Things to be aware of:

  • you may not be allowed to make additional or lump sum payments
  • you may not have access to offset account or redraw during the introductory period
  • any special or package discounts may not be fully honoured at the end of the honeymoon
  • you may have to pay additional fees to switch to a better product after honeymoon is over.

In years past in my role as a mortgage broker I used to get regular calls from what I called ‘honeymoon junkies’ people who just went from one honeymoon to the next.  However there just aren’t that many good ones and the lenders quickly realise what they are dealing with and start looking for reasons to reject the applications.

In todays finance world of automated credit scoring you need to be careful about going in for a short term.  The magic number is around 6 credit inquiries over the last 2 years and these include credit cards, car loans, mortgage insurance and home loans.  One home loan application with mortgage insurance will probably generate 2 inquiries however if there is any re-work done on the loan eg: valuation is short so higher LVR required – this can result in another round of credit inquiries.  So if you hope to refinance in 12 months time to a better deal you better not apply for any store cards etc.

Residential construction home loan

A good client of mine recently asked if they could have a line of credit in order to bulldoze their existing house and build a new one – they wanted to manage the build themselves.  The answer was no – and virtually all lenders I am aware of under almost all circumstances will say no to that proposal.   It’s not that they want to make more money out of a construction loan – it is simply that they want to control how and when it is disbursed.

So the primary difference between a construction loan and a normal home loan is that the lender controls the outlay of funds rather than a single lump sum payment into an account.  When you think about it, with the number of builders and developers who go broke every year it is understandable that the lenders require this. The process is called ‘progress payments’ ie: the  builder puts in an invoice claim for payment when he achieves specific milestones in the construction work.  The lender will probably send someone out to have a quick (or thorough) check to ensure that everything is as it seems and the pay the builder.

Unlike a standard term loan which is fully drawn at settlement your construction loan starts with a zero balance and then gradually increases as the progress payments are made.  This means that you are only paying interest on the balance at any given time rather than on the full loan amount.  In addition most construction loans are ‘interest only’ during the construction phase and this means you don’t start paying any of the principal off until the construction is over.

As a result of the extra administration and inspections most construction loans come with a higher interest rate (often the full standard variable) and /or additional fees such as site inspection fees for progress payments.  Keep in mind that the higher interest is charged only on the current balance and only for the duration of the build – so you are not committing to 30 years of high interest rates.

Having said that there are some lenders who offer fully discounted interest rates on construction with minimal fees and even the option to fix the interest rate… well worth asking us for advice on these.

Another thing to be aware of is that if you are buying vacant land, you will be required to commit to commence (or complete) construction within 12 months.  This is due to APRA regulations to avoid lending to speculative land buyers – after all they are really commercial borrowers not residential.

Finally it is important that you understand how the lender values the property for the construction loan. It would be nice if they  could forecast the value based on current comparable properties – however remember they are taking the risk and so the property is not comparable until it is fully completed.  Therefore they will use the purchase price or valuers estimate of the unimproved value of the land – plus the construction costs and this it.  It is important that you take this into account when calculating your contribution as you have to have enough left over after your deposit to complete the items that were not included in the construction contract – although many lenders will make small adjustments, do not take it for granted – speak to your mortgage broker.

Bridging Finance Home Loans

You may have considered renovating and decided against and so now you want to purchase another home. The question is do you really want to have to rent a place so that you have somewhere to live after you sell and before you purchase your new home? Think it through carefully as renting means entering into the often chaotic and cut throat rental market with agents, bonds and references. In addition it means that you will be up for the cost and inconvenience of two packups and removalists.

Many people hope to sell quickly and manage a payout one at the same time as they take out the new loan ie:a simultaneous settlement – in my experience it works about 1 out of every 10 times.   It sounds much easier than it is in reality and if you get it wrong the consequences can be terribly frustrating and potentially very expensive.

Just imagine the phone call from your agent saying that your buyer’s loan was cancelled at the last moment causing your sale to fall through and now everything is in flux.  The result at best would be an expensive short term loan and very possibly you would be pressured to heavily discount the sale of your existing home in order to get a quick sale – we are talking serious money!  

So when clients come to us with this possible scenario we always recommend that just in case we use a lender who will offer a good bridging option ie: a bridging loan, it doesn’t need to be expensive and it can relieve so much stress.

The bridging period is the period between the settlement on the purchase and the settlement on the sale of the existing home.   Things to consider;

  • you probably have a loan on your existing home and until that property is sold ( and sold means money in the bank ) the existing loan has to be taken into account when calculating your borrowing capacity which means,
  • unless you have sufficient income you may struggle to meet the repayments on the two home loans that may exist during the period between the settlements,
  • even if you think you can scrape by it is potentially unlikely lenders will agree as they have to use padded figures for expenses and selling costs when making their calculations.  They cannot simply ignore the fact that you will have two home loans albeit maybe only for a a few weeks or months.

As a result you may need to plan for a bridging loan – and like so many home loan products there is no single answer but some are much better than others.  Bridging finance is not available from all lenders.  Then there are lenders who offer pseudo-bridging where they calculate your ability to repay based on the total borrowing (peak debt) and usually charge the full standard variable ( your discount will not apply) which is typically almost 1% over the better rates that you can find.

Then there are the genuine bridging loans from only a few lenders.  These lenders will calculate your ability repay based on the final loan amount ( end debt) rather than the short term peak debt.  If you have sufficient equity in the existing home they will also allow you the option of only making the end debt loan repayments while capitalising the interest on the bridging amount into the loan.  This means that if you can’t afford to make repayments on the peak debt you don’t have to and that can take away a great deal of stress during what is already a stressful period.

Then there are a very – very few lenders who offer you these genuine bridging loans at their normal loan rate – some even allow fixed rate loans.

You have usually 6 to 12 months in order to sell the existing property.  This means that you can take your time and hold out longer in order to get the price that you want and that alone can save you thousands of dollars.  Many people have heard terrible things about bridging finance but speak to us if you want to hear the good news – 02 9037 4084

Variable rate home loan – an explanation on how these mortgages work

As their name implies interest on a variable rate home loan varies!  Life used to be simple with these when lenders all followed the Reserve Bank (RBA) Cash Rate movements ie: when the RBA increased the Cash Rate by 0.25% every lender used to do likewise with their variable rates.  In those days we had a ‘standard variable’ interest rate that was pretty well uniform across all lenders. However today that is no longer the case as lender now pass on all or part or even none of the rate changes and this means that what is a competitive offer today may not be competitive only one month later.

Many people are attracted to ‘discounts’ offered and some actually base their decision on the size of the discount without realising that there is no ‘standard variable’ any more. So a 1% discount from one lender may result in the same ‘actual rate” as a 0.50% discount from another lender – don’t get lured by stated discounts – look at the bottom line interest rate.

Variable interest rate home loans come in a number of guises – the differences can be subtle but may also be critical to your needs.

To Good to True – Basic Variable Home Loan

These are often loans sold with a very low interest rate however you have to be very careful and ensure that you read the fine print. It is not unusual for these loans to have a fixed term eg:30 years and that term cannot be reduced by making additional or lump sum payments.  They also may be restricted to repayments monthly in arrears only and this can add considerably to the actual cost of the loan. If you don’t believe me give me a call with some figures and I will show you the comparisons.   These loans are becoming less common as they verge on breaching the consumer credit act.

Introductory Home Loans (Honeymoon deals)

These are a popular marketing tool for many lenders offering what appears to be a very attractive rate for 6 months, 12 months or even 3 years.  However after the honeymoon there is often a hangover and that usually comes with a higher rate.

Another thing to be aware of when taking a honeymoon option is that lenders who are offering special bonus package discounts (see below) very rarely pass these on at the end of the honeymoon period – so make sure that you get a pricing offer in writing.

Basic Variable Home Loan

These are loans that usually come with few frills however very often offer fantastic value – especially for first home buyers and average mum & dad home borrowers.  They will typically be Principal & Interest ( P&I)  ie: they do not offer an Interest Only (IO) option – they don’t offer an offset account however usually they will allow additional and lump sum repayments with redraw although this will probably have a fee of around $25 – but not always.  They will typically have an application fee – those that don’t will almost certainly have a valuation and legal charge which usually works out the same anyway.  It is also not unusual to have a low monthly administration of around $5.   For this type of product Heritage Bank are currently very competitive.

Packaged Home Loans ( Pro Packs)

These loans are often called Pro Packs because the were originally only offer to people in professions with minimum salary requirements.  I have heard lenders refer to these as “Ego Packs” as they almost always come with Platinum Credit Cards and ‘private bankers’ who supposedly look after only a very small group of ‘special’ customers.  The most common complaint that hear from clients about their ‘private bankers’ is that they change personnel every 3 weeks 🙁

To qualify for significant discounts ie: you end up with a rate nearly as low as a good basic variable (see above) you have to borrow in excess of $250,000 although you have to go to $750,000 or more in order to get serious discounts ie: greater than 1% .

The problem is for people with a single property and one loan say $250,000 then the annual fee which is commonly $395 represents the equivalent of 16 basis points loading on your interest rate and that probably is not good value – even with a Platinum Credit Card.

However for borrowers who have very large loan and/or property portfolios then a package loan can offer very good value because as their name implies you can package all of the property loan accounts under the same annual fee.  These borrowers may take advantage of discounted lines of credit for share trading and/or personal use and keep one loan account per property for ideal tax recording. The better packages also waive all application and valuation fees thus saving quite a lot if you have multiple properties.  The very good package also waive all other fees such as fixing, switching, loan top ups etc.  At the moment I lean towards Suncorp’s package as it is not restricted to any number of accounts, it is competitively priced at $300 pa and competitive rates.  Westpac’s Premier Advantage is always a nicely featured product while CBA are hamstrung with their tedious MISA offset account, NAB charge monthly fees per account, St George and ANZ are limited to only 5 accounts under the package.

There are some semi-package loans that can be very competitive for mid-level borrowers such as AMP, ING, Heritage and Members Equity.

Fixed Rate Home Loans can be a gamble if you let them

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Teachers Mutual Bank  have moved the goal posts with a fantastic fixed rate home loan on 3 years fixed rate at only 4.49% –  you should be thinking very carefully about taking advantage of at least some of the great rates on offer at the moment.

As a mortgage broker I see a great deal of confusion on the subject of fixed rate home loans.  These loans are very different to other loans and they even have their own terminology – my advice is GET ADVICE and who better than a professional mortgage broker 😉

Do not enter into a fixed rate loan just because you think the interest rate is good and you will come out ahead of the banks – that is a big gamble and history suggests that you will probably lose.

PROS

  • if interest rates start to increase you can relax in the knowledge that your rates are locked in

CONS ( do not apply to all lenders )

  • if interest rates start to decrease you will fret over the fact that you are locked in,
  • if you want to exit the loan, for any reason and if rates have fallen you can be up for very significant break costs and I mean potentially tens of thousands of dollars,
  • in order to secure the rate that you are quoted you will normally have to pay a rate lock fee – typically 0.15% of the loan amount.  Otherwise your get the fixed rate that applies on the day that your loan settles,
  • with most lenders your ability to make extra or lump sum repayments are severely restricted and you cannot’ normally redraw these extra payments during the fixed rate period,
  • very, very  few lenders offer a 100% offset account which links to the fixed rate loan.

This doesn’t mean you shouldn’t consider a fixed rate home loan – you should simply ensure that you understand the limitations.  We do have lenders who offer flexible fixed rate loans with repayments or offset accounts but that is by no means typical.  Contact me to discuss your individual needs.

A quick note on comparison rates – because fixed rates normally revert to standard rates ( without discount) at the end of the fixed rate period you would choose to either fix again, switch to a discounted variable or simply refinance.  Comparison rates can’t take this into account and so they are basically irrelevant for fixed rate loans ( and most others) – see article on ‘comparison rate confusion‘.

I just wrote a current note on rates at //www.peachhomeloans.com.au/mortgage-news/2012/09/a-quick-note-on-fixed-interest-rates/ you might find interesting.