Don't Cut Corners On Your Mortgage
Sun Herald
Sunday July 6, 2003
The Reserve Bank kept interest rates where they were last week but you should try to reduce your home loan payments anyway. Business editor David Potts shows how.
NEVER mind the Reserve Bank, you should learn to love your mortgage. Not that you have much choice really, but your home loan should be the centrepiece of your finances. Hard as it is to believe, your mortgage could even be your escape route from the shackles of, er, your mortgage.
That's because if you make theright call on interest rates now, it'llhelp you to become rich all right, better off later.
And you'd be surprised how much mortgages have changed since you took yours out, or even last looked around. Needless to say, the banks aren't going to ring you up and tell you all the extra things you can do with your mortgage, or how to cut the interest rate.
Interest rates
The Reserve Bank had been tipped to cut interest rates last week because that's what the US did the week before. The US, you might remember, cut because the global economy, which is basically itself, looks crook.
There would also have been the bonus of hauling in what could yet prove to be a runaway dollar, although considering our ever-worsening balance of payments, you wouldn't think that was a pressing issue.
Anyway it didn't cut, but there's always next month.
Not that it really matters anymore whether it does or it doesn't.
The most you could expect rates to fall would be 0.5 per cent by Christmas. More likely is they won't do anything. And the chances of rates rising next year are better than of them falling.
Touch wood, but the US economy is looking better all the time. Don't be surprised if its recent 0.25 per cent rate cut turns out to be the turning point.
So if it ever comes, a cut by the Reserve Bank isn't going to be earth- shattering, and certainly no more than you could give yourself with some judicious shopping around for lenders, or even by fixing your mortgage.
Fixing
Lenders report next to no interest, so to speak, in fixed-rate loans despite the fact that some are more than 1 per cent below the standard variable rate.
This is all the more strange since the most anybody thinks rates will drop is 0.5 per cent, and here's a chance to give yourself that and double again.
All right, you'd be kicking yourself if you fixed next week, and next month the Reserve Bank cut rates.
But get a life. Besides, how would you feel if rates started creeping up next year, hmm?
``This is the right time to lock in," said Peter James, managing director of non-bank lender RESI Mortgage Corporation.
Mind you, he's an exception among lenders by saying that. But then if everybody was shouting from the rooftops that it's time to fix, do you think you'd be getting a good deal? Not likely one of the reasons fixed rates are so attractive at the moment is because nobody wants them.
In fact, the perverse thing about fixed-term interest rates is that they are at their most attractive when everybody thinks rates are going to drop.
It's a seductive argument who in their right mind wants to fix when rates are dropping anyway?
The trick is to get in first. And guess what in the week before the Reserve Bank was supposed to cut, the lowest fixed rates crept up slightly. You see, the penny had already dropped for the people who count in setting where fixed rates will be the professional money market. There they don't wait around for you to get the best mortgage deal.
Andrew Willink of the independent Cannex (which supplies Investor's mortgage rates table) said this is the first time in four years when it was attractive to fix since we are in one of those rare periods when the fixed rates are well below the variable rate.
``The best time to fix is when the market expects rates to drop," Willink said. ``It always overshoots."
Even so, he warns against fixing your entire mortgage because then you can't make extra repayments or pay the loan off without hefty penalties.
You can also be creative in the part you fix. Lenders will let you fix for periods from one to 10 years. Different periods, as a rule, have different rates. When you fix, you should also bear in mind what's going to happen when that part of the mortgage matures. If rates are lower then, well and good. But what if they're higher?
A smorgasbord of fixed maturities should at least average out the interest rate you're paying over time.
Willink warns the average interest rate cycle is about three years, so fixing any term beyond that is taking an unnecessarily big punt.
That would kind of rule out Westpac's 10-year rate of 6.99 per cent (or comparison rate 7.01 per cent), especially as by going much shorter you can give yourself an instant rate cut.
By the way, if you're thinking of changing lenders so you can take advantage of cheaper variable rates they start as low as 5.39 per cent, more than 1 per cent below the standard bank rate James has a rough rule of thumb.
If you're paying the standard rate of 6.57 per cent or more, it'll pay you to switch loans, if not lenders.
But if you're already paying less than this, then the penalties and hassles probably aren't worth it.
``I normally suggest people not fix, but locking rates in at below the basic variable rates right now is exceptionally good value," Nicholas Gruen, managing director of mortgage brokers Peach Home Loans, said.
``I expect standard variable rates could well be above 7 per cent within 18 months."
Comparison rate
You might have noticed that lenders tell you what the comparison or true rate is as well as the advertised interest rate on a loan.
The true rate, calculated by Cannex, is no mystery to Investor readers since we've been using it for years. It takes into account fees and charges plus the impact once any honeymoon or introductory rate runs out.
In fact, it was the prevalence of honeymoon rates that the banks were pushing which bordered on misleading advertising that prompted the true rate calculation.
So naturally Investor readers looked past honeymoon rates because they are nothing more than a con to suck you into a lender.
Not everybody has been so astute, it seems, and the state governments have made use of the comparison rate compulsory in advertising.
This is despite the fact that New Zealand has dropped the idea because it was confusing borrowers and it is causing all sorts of problems in the UK, most of which we're about to experience.
Don't get me wrong the comparison rate was a great idea. Ten years ago.
The problem is going to be that some of the sneakiest fees have been left out of the calculation. For example, fees charged for a redraw or an early repayment penalty aren't included in the calculation.
Likewise there are a whole raft of not yet invented fees that lenders will come up with that will also get around the calculation. One early suggestion is a contract fee. Still, it has to be said the banks were the biggest opponents of the comparison rate, so there's got to be something to be said for it.
Speaking of banks, if you earn more than $50,000 or you're a good customer which, perhaps strangely, means you have lots of debts you should qualify for a professional package which will knock up to 0.5 per cent off the standard variable rate.
Or the bank might offer you other concessions such as waiving account-keeping fees a benefit which won't show up in the comparison rate.
Incidentally, there's a boom in churning or borrowers refinancing, which mortgage broker Mortgage Choice said could be costing them up to $8500. Let's hope the comparison rate will show when it's just not worth switching.
Certainly it will give you a good idea of who is the cheapest lender. But bear in mind that home loans have become so competitive that you can get all sorts of you-beaut features for nothing.
So it may pay you to go for a loan which is 0.5 per cent higher than another one simply because it has things like direct salary crediting, fortnightly or weekly repayments, a redraw facility and an offset account which is like a savings account attached to your mortgage. Anything in an offset account comes straight off your mortgage, saving you interest.
Redraws, by the way, are the opposite. They are a drawdown of any extra repayments you've made so at the end of the day you are just borrowing it back, albeit at a much cheaper interest rate than a credit card or personal loan.
For borrowers who have any savings I know it sounds like a contradiction an offset account can be a pot of gold. So if you've got a bit of money stashed away in, say, a term deposit for emergencies, then using an offset account will give you a bigger return since mortgage rates are higher than deposit rates and will be tax free.
So impressed was Your Mortgage magazine with offset accounts, it bumped four-in-a-row winner RESI from the mortgage of the year rostrum in favour of the Toowoomba-based Heritage Building Society.
Yet RESI's 5.85 per cent variable rate is markedly cheaper than the banks' 6.57 per cent and has every feature except an offset account. The comparison rate for RESI is 5.88 per cent. Heritage comes in at 6.22 per cent, so that values an offset account at almost 0.5 per cent.
Cannex's Willink, always a reliable arbiter on these and other imponderables, agrees that offset accounts are the bee's knees.
``The greatest value in a mortgage is being able to make extra payments," he said. ``For example, being able to set the monthly repayment at a higher rate is worth five years off the loan."
Against that, the other benefits, including paying fortnightly instead of monthly are ``minute" from the point of view of cutting your loan.
Willink's calculations at the top of the page show you can slash more than 1 per cent off the true cost of your mortgage just by splitting your monthly payment into four weekly ones instead. That's because you're making 52 weeks worth of payments instead of 48 (that's 12 times 4 weeks, in case you're wondering).
Home equity
Mind you, if you've got debts all over the place the offset account isn't going to help you much. But you can still save a small fortune by reducing the interest rate on the debts you have.
That's where home equity and all-in-one accounts can be a boon.
These let you borrow against the unused equity you've got in a home, which you'll almost certainly have if you've owned a property in Sydney for longer than a year.
Often a credit card is thrown in, which means you can take your mortgage shopping with you.
Any decent home loan these days comes with a credit card and an automatic sweep that adds any outstanding balance on to your mortgage.
They should, however, come with a wealth warning. Piling consumer debt onto your mortgage is eventually going to make you worse off because you're swapping, say, a five-year $2000 debt at 15 per cent for a 25-year debt at 6 per cent. After about 12 years, the 6 per cent debt will be costing you more than the credit card if you'd paid it off after the five years.
But there's a way around this that can be very rewarding. If you can't pay the monthly debt off as it is due, at least pay the extra borrowing on your mortgage at the same rate of repayment you would have done on some other credit card or personal loan. Or at the bare minimum, at least make the monthly interest payment.
That way the debt won't build up.
Getting your salary paid into your mortgage rather than a savings or cheque account can work like an offset account, too. While your pay is sitting there it's saving you interest until you draw it down. Some lenders will even give you a separate line of credit account which is like an overdraft you could use for other things, such as investing in shares or other properties.
Frankly, if you've got a mortgage, there's no need to run a separate fee-infested bank account.
And the funny thing is that the more you use it, the more you could save.
HOW TO CUT YOUR RATE
* Use the comparison rate to make sure the pluses of a seemingly cheap rate aren't being gobbled up by fees.
* Fix some of your mortgage at a rate below 6 per cent.
* Use your mortgage for salary crediting and transactions.
* Check whether you're eligible for a professional package the banks will discount your rate by 0.25 to 0.5 per cent.
* Use an offset account for any surplus savings. On a $100,000 6.5 per cent home loan, Cannex calculates that $2500 held in an offset account will cut your effective interest rate by 0.25 per cent a year.
* And a lump sum repayment of $5000 in year 10 of the same loan would chop 0.4 per cent off a year. Or, say, $15,000 would slice 0.6 per cent off.
* The best way to slash your annual interest cost is by dividing your monthly repayment into four equal repayments. On a $100,000 6.5 per cent loan, the monthly repayment is $675. Divided into four weekly instalments, it's $168.75, even though you're obligated to pay only $155 weekly. The saving over 25 years is $18,686, which would slash 1.02 per cent a year off your interest. The 6.5 per cent rate becomes only 5.5 per cent.
© 2003 Sun Herald
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