Home - A Loan

Sydney Morning Herald

Saturday September 18, 1999

By Vita Palestrant

There are fancy loans that all but pay off your house without any effort on your part. But are they for you?

IF finding the right home is a gladiator sport, then choosing a home loan comes a close second. With more than 3,000 mortgage options on the market it can be a giddy affair for first-home buyers. That's why it's important to leave yourself plenty of time before signing on the dotted line.

Despite all the hoopla surrounding the different types of home loans, they basically fall into two camps and are priced accordingly. It's worth keeping that in mind when you are shopping around if you are to avoid getting led astray by clever marketing.

Home loans can be boiled down to basic and fully featured loans. The fully featured variety has lots of bells and whistles, some useful, others less so, that promise to save you money. As there is no such thing as a free lunch, you can count on paying more for this option.

There is typically a 0.5 up to 1 per cent difference between a standard variable loan and the basic variety (see tables). Once you apply this difference to a large sum of money over a 25-year period we are talking about serious money.

Fully featured loans are attractive because they are highly flexible. Some behave like all-in-one transaction accounts: you can put your income into it and use it to pay the bills. This minimises your interest costs and lets you repay the loan sooner. Or that's the theory.

Gregan McMahon, managing editor of Your Mortgage Magazine, warns that first-home buyers are normally on a very tight budget, which means the more expensive fully featured loans are generally inappropriate for them, especially if they are planning a family down the track.

"I hear horror stories where borrowers who haven't got much left over after making their mortgage repayment are being sold all-in-one type accounts which are up to 1 per cent higher. They get sucked into the marketing hype."

But unless you leave more money in the account than you spend it's of no use to you. Rather than saving money, it will add to the cost, he warns.

"The largest factor that influences a home loan is the interest rate. If you don't have a high disposable income you want to look for the lowest, cheapest rate. The cheaper the rate, the cheaper the repayments. Either it allows you to borrow more or you can pay it off faster. You want a cheap loan with the ability to repay extra and take it back if you need it."

Bill Rankin, lending director of mortgage brokers Smartline Home Loans, agrees that mortgage-minimisation-style products are not best suited to first-home buyers. Unfortunately they are persuaded by graphs that show you can pay back the loan in an "astoundingly quick time".

"It's so easy to paint a wonderful picture of fancy features that mix mortgage needs with wealth creation. But simple things are usually best. Always be wary of paying an interest rate higher than is necessary," he says.

Like McMahon, he suggests you go for a basic loan and build up substantial equity in the property first, and then get fancy later on. "The only thing to watch out for is, there might be a penalty if you pay it out in the first three to four years. But if you've planned to stay, then the cheaper interest rate normally outweighs the other problems," he says.

When non-traditional lenders first entered the home-loan scene, basic products were fairly rigid. You couldn't make extra repayments, split the loan into part fixed and part variable or take the loan with you to your next property (called home-loan portability).

However, the major banks took fright at the inroads the non-traditional lenders were making and introduced basic products themselves. The net affect of all this competition is that basic loans these days offer considerably more flexibility than they used to, which means you clear that mountain of debt rapidly. But you have to know what to look for.

As the tables show, there is an advertised rate and something called the AAPR. This is the average annualised percentage rate, or in more simple terms, the comparison rate. It is the more important of the two because it reflects the true cost of the loan.

It takes into account all your upfront costs such as establishment fees, ongoing fees, and annual fees. It is especially helpful when comparing loans with introductory rates.

Unfortunately, most consumers get fixated on the advertised rate when shopping around, forgetting that fees and charges can add thousands of dollars to the cost of the loan.

Kate Beddoe, senior finance policy officer, at the Australian Consumers' Association, says the AAPR can be as high as 1 per cent above the advertised rate and, for that reason, the association would like the release of the figure mandatory so consumers can see what they are really paying.

"Unfortunately, when we talk about high fees and charges most people think of their transaction account. The reality is that 20 per cent of the money banks made from fees and charges last year came from home loans," she says.

In the absence of a mandatory AAPR, consumers should press their financial institution for it when shopping around or check comparisons tables like these.

Cassandra Williams, manager of research services at interest research company Cannex, says another drawcard for first-home buyers is a loan with an introductory rate. But check it against a basic product first, she says. For instance, the Commonwealth Bank offers an introductory rate of 5.29 which then reverts to 6.55 (its standard product). The introductory rate makes it look very cheap. But its AAPR is 6.54 versus an AAPR of 6.19 for the basic loan.

Where interest rates are heading is another issue for borrowers. Williams suggests either of two strategies. Either make as many extra payments as you can to create a buffer to protect you against any rise in rates or think of fixing part of the loan.

While some basic loans will let you split the loan, others will not. Williams recommends you check on whether splitting entails extra costs, two establishments fees and two on-going monthly fees.

Gregan McMahon is another who advocates splitting your loan if you are worried about an interest rate rise. It will give you enough flexibility to accelerate your repayments.

"If you fix at least some part of the loan you are at least protected if rates go up. If your income increases, or you have money coming in, or your spouse goes back into the workforce, you have the variable part you can use to repay the loan faster."

Finally, the features you are most likely to need on a basic loan are redraw, splitting, top up (if you want to renovate) and portability. Leave the fancy stuff - the equity loans and all-in-one-loans - for later when you are financially well established.

"There is no such thing as a loan forever. The average home loan lasts seven years. Get something that suits you now," advises McMahon.

© 1999 Sydney Morning Herald

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