IS THE BEST HOME LOAN THE ONE WITH THE LOWEST INTEREST RATE?
For anything that we buy, we’re programmed to seek out the best possible price. Every day we see advertisements promoting sales of discounted items on window shop fronts, catalogues, TV and mostly when shopping online. Even when we go to the bank for a home loan we carry that expectation with us because of the tendency to consider the ‘cheaper is best’ option. We are most concerned with the lowest interest rate that the lender can offer us, rather than how it impacts the bigger picture. Naturally we think finding the best mortgage is really easy; the lower the interest rate, the better the deal – right?
Not quite.
While interest rates are important, it’s not the only factor. It shouldn’t be ignored as a small difference in the rate can mean thousands of dollars over the life of the mortgage but it can work in both directions if you haven’t properly considered all the additional variables. Learning to scrutinize a mortgage lender’s fees is crucial in avoiding being duped into paying excessive charges for a mortgage.
Don’t confuse the best home loan with the cheapest interest rate. It’s not an ideal solution for everyone and there are often individual circumstances that would prevent you from wanting to acquire them.
For instance for the first home buyer, it might be easy to go with the lowest interest rate and not consider any other factors, but the smart investor needs to be more on the ball with different set of expectations.
The number of Gen Y’s who own multiple properties is now on par with Baby Boomers and here is another startling revelation – they are buying them at a younger age and more savvy when it comes to which lender product to use.
Sadly, not everyone understands the importance of structuring their loans correctly let alone choosing the right one and later compromising their future potential to invest. This is generally through suggestions from the bank, to lend with them. It’s important to remember that lending money out is different from borrowing money. The lender looks at mitigating risk with each and every corner with all borrowers, hence why an applicant’s situation is heavily scrutinised before a decision is made to lend funds. Lender guidelines are in place to make maximum money with the lowest possible risk.
We all wait patiently every month to see what the Reserve Board (nowadays your bank) will do with rates and the media goes into a frenzy with news about which banks have passed on what. But why?
Imagine this; you go and buy a new car. It doesn’t even cross your mind to negotiate the price of petrol to run the car. Sounds crazy to do so but petrol is the cost to run the car, isn’t it? As the interest rate is the cost to run your mortgage. If you want to purchase a property, you need money from the bank. You don’t need an interest rate. Why is there so much emphasis placed on the interest rate?
It’s important to seek assistance from a professional mortgage broker to help you dig deeper and really understand the true cost of any loan before committing. Brokers have access to mortgage information from a wide range of lenders, not just the big banks, although they can work with them as well.
If you notice with many low interest rate mortgages, the conditions set forth are typically the same:
• One property, 80% Loan to value ratio, dual & PAYG Income (We call it a straight forward deal)
• Higher fees to discharge or refinance your loan
• Cashout & valuation restrictions
If you decide to prepay the mortgage, and your agreement does allows this, the penalties involved may prevent you from doing so.
The term of the mortgage can also make a difference, for example – If you take a one-year term because it has a lower rate than a five-year term, you may save, but you may not if, in one year, rates have increased and you have to renew into a much higher rate.
Alternatively, you may choose a five-year fixed rate to have the security of knowing what the rate and payment will be – only to watch rates fall and not get the benefit you would have if you had chosen a shorter term or a variable.
Historically, variable rates tend to do better and when people don’t realise this, they just lock into a fixed rate. On the other hand, it’s not as simple as what might be the cheapest rate, because what may be the cheapest today might not turn out to be the cheapest later on. If taking a variable rate is going to save you $500 a year in interest costs but you’re going to wake up in a cold sweat whenever the rates go up, it’s probably not for you.
While the economy can change, there’s little worry about rates going up right now. Lending rates in Australia and in most of the developed world have been at historic low levels since the 2008 stock market crash.
It’s important to make sure you know how much money your property is registered for by the lender. In some cases, lenders put higher values on the property than what you paid for it. This leaves you room to borrow more money from the lender later, for example through a line of credit. But it’s also a form of golden handcuffs. You have to stick with the same bank because if you want to switch, you have to refinance and you may face penalties.
Self-employed people should really look beyond the interest rate. Self-employed people traditionally qualify for mortgage amounts based on net income. But if you’re self-employed, you usually have a lot of write-offs and your net income can be really low on paper.
There are all kinds of different products available for self-employed people, though. Certain lenders will qualify you based on your gross income, as you would if you were employed.
Although a lower interest rate translates to less interest paid, there are other factors to consider when committing to this type of mortgage, especially where the conditions can be very rigid. No one can predict what will happen in the next 5 years, but it is important to consider the road ahead before diving head first into a mortgage commitment with an enticing interest rate. Banks are not known to be generous and these low interest rates are offset by terms and conditions that can potentially set you back in the future. The most important thing to consider is the possible lifestyle changes you may potentially face and how your decision today may affect you later. If you decide that the conditions involved in the low interest rate mortgage are unlikely to affect you negatively throughout the term of the loan, then you are a good fit for this type of mortgage. However, if you can foresee the conditions to be a hindrance, then it may be worth your while to pay a higher interest rate in exchange for the flexibility in the conditions.
It’s like going to Costco and picking out a 80-inch television that looks great. You may love it for the price, but what if it doesn’t fit into your living room?
With a closer look, home mortgage applicants may decide to review other factors in combination with the interest rate to make a more informed decision when applying for a new loan.
It’s about time we realised that low interest rates are not a good thing. Before making your choice, discuss all options and understand the plus and minus of each!
Contact us for a FREE no obligation consultation or discuss strategies to correctly structure your loan on 03 8390 5855 or email mitesh@thinkandgrowfinance.com.au