Buying Property For Dummies Page 19

  Your savings history: Most lenders want proof that you have been able to save 3 to 5 per cent of the expected purchase price of your new home. This amount needs to be supported by a genuine savings record showing that you have saved over the past three to six months, rather than money you have been given or have managed to scratch together in a month or so.

  Savings can be in the form of

  • A savings account into which you have made regular deposits.

  • A term deposit you have held for at least six months.

  • Land or an investment property.

  • Managed funds or a share portfolio.

  • Voluntary superannuation contributions that are above and beyond the compulsory contributions your employer makes on your behalf.

  Avoiding mortgage insurance

  You may only need to show proof of being able to save 5 per cent of the expected purchase price of your new home to get a loan, but unless you can come up with 20 per cent of the purchase price, you have to cough up a few thousand more dollars to cover the cost of mortgage insurance. Mortgage insurance protects your lender from the risk of your defaulting on your loan. The insurance premium is added to your loan establishment costs when your home loan is more than 80 per cent of the expected purchase price of your new home. If you can manage to pull together 20 per cent or more, you can save yourself a lot of money.

  While lenders want proof that you can save around 5 per cent of the property value yourself, they’re not quite so fussy about how you get hold of funds beyond that. To save yourself the cost of mortgage insurance, you may want to ask family to lend you enough money to take your total funds over the 20 per cent mark. Even if you have to pay it back quickly, you’re going to save yourself several thousand dollars in mortgage insurance.

  Unfortunately, lenders don’t take into account rental payments as proof that you have the capacity to pay off a home loan — even if you have paid your rent on time for years and years. That approach by the lenders means that even if you pay, say, $2,000 rent a month, you need to save another $2,000 a month for six to nine months or so in order to save 3 to 5 per cent of the purchase price of your $450,000 home.

  Providing documents to your lender

  When you put in your application for a home loan, the lender is likely to ask you to supply some or all of the following documents:

  Proof of income, including

  • Two or three recent pay slips.

  • Two years of tax returns.

  • Proof of any other income, such as rental income or Centrelink payments.

  Proof of ongoing employment via a letter from your employer showing

  • The date you commenced employment.

  • The basis on which you’re employed — part-time, full-time or casual.

  • Your average weekly or monthly income.

  Proof that you have saved 3 to 5 per cent of the expected purchase price of your new home over a three- to six-month period. This proof may be in the form of bank statements or shareholding certificates and must be in the name of at least one of the borrowers.

  Proof if you have received a gift of money from family or a friend to help you buy your new home. You may need the person making the gift to sign a statutory declaration that states that the gift is non-repayable.

  Choosing the Home Loan That Suits You and Your Hip Pocket

  Learning about the many types of home-loan options, so that you choose the one that suits your lifestyle and growing needs, is important if you’re to be a long-term happy home owner.

  To fix or not to fix

  One of the first decisions you need to make when choosing a home loan is whether to get a fixed-rate loan (the interest you pay is fixed at a certain rate for a certain period) or a variable loan (the interest you pay varies according to the rate in the marketplace).

  Fixing the rate on your home loan means that you know exactly how much your repayments are going to be every month for as long as you’ve fixed the rate for. Even if interest rates go up generally, you can count on making the same repayments. Conversely, if interest rates go down you’re stuck with paying more than everyone else on variable rate loans for as long as you’ve fixed the loan. Property investors often like fixed-rate loans so they can budget exactly for their borrowing costs against their rental income.

  How the RBA rules your mortgage life

  Home loan interest rates, sometimes called mortgage rates, are related to the cash rate that is set by the Reserve Bank of Australia (RBA). The cash rate is the interest rate that banks pay or charge to borrow funds from or lend funds to other banks. Mortgage lenders then add a margin — ordinarily around 1.5 per cent — to this rate in order to make a profit.

  One of the main roles of the RBA is to ensure that inflation doesn’t get out of hand. Setting the cash rate is one important way the RBA aims to control inflation. When the economy is sluggish and people aren’t spending, the RBA lowers cash rates to encourage people to borrow more, and thus spend more. Higher spending leads to higher demand and can push up prices for products and services. If prices run too high, this leads to inflation, and as soon as inflation gets too high people can no longer afford to spend. When the economy is running too hot, the RBA raises cash rates to try to contain the boom by slowing borrowing and thus spending.

  All this tinkering with interest rates and the economy has a direct effect on you the home owner. When the RBA raises the cash rate, the banks follow suit and mortgage rates go up and, if you have a variable-rate loan, you get a rise in your monthly repayments. Drops in the cash rate are less instantly, but usually fairly quickly, passed on by the banks in the form of lower mortgage rates. Interest rates have been relatively low for the last five years. However, these low interest rates encouraged people to take on debts around double that of 1990. That scenario means that even when interest rates rise by a couple of percentage points or so, the effect is much more dramatic than when rates rose by 5 per cent or so during the 1980s.

  This intimate connection between inflation and interest rates may make you as the new home owner much more interested in the state of the economy than you have ever been before. The RBA determines interest rates with a quarterly review in February, May, August and November each year. For more information you can check out the RBA website at www.rba.gov.au.

  Most Australian home owners prefer to have a variable rate on their home loans — even though variable rates can move up or down without much warning. At one time, in 1989, the variable interest rate moved up to around 17 per cent and stayed there until March 1990, gradually dropping to 10 per cent by 1992. Since June 1996, rates have stayed below 10 per cent, averaging 7.2 per cent. But while they have been as low as 5.5 per cent, they’ve also been as high as 9.75 per cent. So you have to be prepared for anything. People are always speculating whether the Reserve Bank of Australia (RBA) is about to lift rates, and every now and then an economist comes out with a menacing prediction that interest rates are going to rise back up again to double figures.

  Although the figure varies over time, at any one time less than 5 per cent of Australians have fixed loans, compared to about 65 per cent of New Zealanders and 80 per cent of those in the United States. This reluctance to fix seems to be partly a cultural thing — perhaps Australians like to bet that rates are more likely to go down than up.

  Fixed-rate loans are also more restrictive than variable-rate loans. One of the biggest issues is that you can’t make extra repayments above a certain level on a fixed-rate loan. That may mean that if you want to pay your loan out early — say, if you get an inheritance or some other kind of windfall — you can’t do so without paying a penalty.

  Some fixed-rate loans don’t give you other features, like being able to redraw on the money you’ve paid in. Many aren’t portable — don’t let you transfer the loan across to another home if you move.

  Splitting the difference

  Every time the RBA decides to lift the interest rate, thousands of people
rush to fix their home loans. And for a number of periods over the past five years the interest rate on some fixed-rate loans has actually been lower than the variable rate. A scenario such as that means fixing at least some of your loan can make sense.

  Splitting your loan — where some of it is in a variable rate loan and some in a fixed-rate loan, lets you have a bet each way. You know exactly how much you need to repay each month on your fixed-rate loan for however long you fix it for. If the variable rate goes up, you also have the comfort of knowing that at least some of your loan is quarantined at a lower interest rate.

  By having some of your loan in a variable rate you can take advantage of the possibility that interest rates could go down. You’re also able to make extra repayments on the loan when you can. And you can benefit from features and facilities like being able to redraw on your loan.

  You can split your loan by taking out two separate mortgages on your home — either with the same lender or two different ones. You can split the loan in half, or in any proportion you like. Some lenders allow you to link one of the loans to a mortgage offset account, in which the interest earned on your savings account offsets the interest charged on your mortgage.

  Introductory illusions

  When you’re buying a new home, the prospect of paying a lower interest rate for the first year or so is very tempting. Many lenders offer so-called introductory or honeymoon rates that promise lower repayments for the short term — ordinarily a year, but sometimes for longer. These loans can either be variable rate loans that move up or down 1 or 2 per cent lower than the rates on standard home loans, or a lower rate fixed-rate loan.

  After the honeymoon period is over, introductory-style loans often revert to a higher-rate loan than a standard variable loan. In some cases, they can be as much as a percentage point higher. Over the life of your loan that difference can add up to a much higher interest bill than if you took the normal variable rate to begin with. Look at the comparison rate that all lenders must include in any home loan advertisement or schedule of interest rates to get a truer picture of the average interest rate over the life of the loan. The comparison rate takes into account the interest rate (including the interest rate the loan reverts to after the introductory period is over) as well as fees and charges relating to a loan, and reduces it all to a single percentage figure. (This figure is often in the fine print, so get out your magnifying glass.)

  No-frills variable

  If you want the absolute cheapest form of home loan, investigate a basic variable loan. This type of loan is really a variable home loan at a more attractive rate because you don’t pay for the extra bells and whistles you can get with a standard variable loan.

  As the name suggests, what you get is a straight-out loan that you’re expected to pay back each month (or fortnight), with interest. You don’t have access to loan portability, or get an offset or a redraw facility (see the following section for an explanation of these features). What you do get is an interest rate that is often one-half of a per cent lower than the standard variable loan. Sometimes you don’t even have to pay a mortgage establishment fee (also called an application fee), which is the fee charged by the lending institution to cover its costs in processing your loan and preparing your mortgage.

  A basic variable loan is good if you’re more concerned with price than with the flexibility and features you can get with a more expensive standard variable loan.

  The downside of taking out a basic variable loan is that sometimes you can’t transfer the loan when you move home.

  Standard variable vanilla

  The so-called standard variable loan (the rate applied by the lender to its premium product) generally offers a number of optional features, which means you can tailor the loan to your needs. This loan type may offer these features:

  Extra repayments: Lets you pay extra funds into your loan account without any penalty. Can be on a regular basis or on occasion when you have spare cash to put into the loan. The best way of reducing loan interest.

  Loan portability: Allows you to transfer the loan when you move to a new property without having to break and re-establish the loan.

  Offset facility: A savings account linked to your mortgage, so that the interest earned on your savings offsets the interest charged on your mortgage. This feature may save interest on your loan.

  Redraw facility: Allows you to redraw any funds that you pay over and above your required monthly repayments.

  Salary credit facility: Allows you to pay all your salary into the loan and draw on it as you require.

  The more features that are on offer by a lender in a standard variable loan, the higher the interest rate and the higher the account-keeping fees are likely to be.

  Line of credit loans

  A line of credit loan is potentially an endless revolving loan that you can keep drawing on up to 80 per cent of the value of your home (the 80 per cent level is the point at which mortgage insurance kicks in, something you’re best off avoiding). The idea is that you pay all your salary and other income into the loan account, and you redraw on those funds to cover your living expenses. These loans are usually operated in conjunction with a credit card. You pay for everything on your card, and then each month you redraw on your line of credit to pay off the credit card. You may also have an associated transaction account that gives you access to cash.

  Theoretically, this process can reduce the total interest you pay because your pay sits in your account for a full month before you pay off the credit card. If you have a credit card that pays rewards, you can get the benefits from that as well.

  Lenders who advocate line of credit loans often show charts that demonstrate the financial benefits of using this system. However, critics of this type of loan point out that little difference exists between this system and making extra payments into your home loan. A financial danger to keep in mind, too, is that you can keep drawing to the limit on the loan and never actually pay the home loan off. Line of credit loans are, in fact, interest-only loans, and if you only ever make the minimum repayment, you may never pay off the principal.

  Features and facilities can add one-half of 1 per cent and sometimes more to the interest rate on a basic home loan. Make sure you’re able to use and take advantage of the features you pay for. Do some maths to work out whether you’re better off making extra repayments, for instance, rather than paying your salary into your loan and redrawing on it to pay for living expenses.

  Going professional

  A professional home loan package, at its basic level, gives you a discount on the interest rate on the loan — ordinarily around one-half of 1 per cent and often up to a percentage point off the standard variable rate. So-called professional packages were once reserved for people like doctors and lawyers asking for loans above around $250,000. These days few home loans come in at less than $250,000; and lenders care little about how you earn your income for you to qualify for a professional package — as long as your income is at least $50,000 for a single, and $80,000 for a couple. (Note: This amount varies between lenders.)

  Most professional packages also offer additional benefits, such as no mortgage establishment fee, no fees on offset transaction accounts or credit cards that are part of the ‘package’, as well as discounts on insurance and other banking products.

  The catch is that you pay an annual fee — often a few hundred dollars a year. But even accounting for that extra expense, you’re likely to save money. On a $405,000 loan, every one-half of 1 per cent reduction in the interest rate saves you around $150 a month. Add to that amount the savings on credit card and transaction fees, and you’re likely to be ahead around $2,000 a year, even with an annual fee of $300.

  Lenders may or may not offer you a professional package when you make inquiries about taking out a home loan. Ask if you qualify. Each lender has its own rules and eligibility criteria.

  Shopping Around for Your Lender

  Understanding how to get a good deal on
your mortgage loan from your lender is just as important as the type of home loan (refer to the previous section ‘Choosing the Home Loan That Suits You and Your Hip Pocket’) because, to you as a home owner, your mortgage repayments are typically your biggest monthly expense.

  With literally hundreds of mortgage lenders out there, how are you possibly going to work out which one is going to be right for you? Much of that process depends on whether you see a mortgage as a stand-alone part of your financial affairs or, as so many people now do, as the core product of them all.