Why you should conduct a home loan health check
A home loan is the biggest financial commitment that most people will ever make.
It’s not only a big commitment, it’s a long commitment – generally 25 to 30 years.
That’s why a home loan should never be a set-and-forget product – something you take out and then forget about for the next two or three decades. Instead, it should be something you review on a regular basis to ensure you’re getting the best rate, the best fees and the best features. Welcome to the concept of a ‘home loan health check’.
One reason you should conduct regular home loan health checks is because a seemingly small difference in interest rates can make a big difference over the life of a loan.
For example, imagine you’ve got 20 years left on your mortgage and you manage to refinance from a home loan with an interest rate of 4.50 per cent to one at 4.00 per cent. The table below shows how much you’d save based on whether your outstanding debt was $300,000, $500,000 or $700,000.
|Total repayments at 4.50 per cent||$455,508||$759,179||$1,062,851|
|Total repayments at 4.00 per cent||$436,306||$727,176||$1,018,047|
This is clear evidence of the importance of regular home loan health checks.
Some people don’t refinance because they don’t realise there are credible lower-rate options in the market. Other people, though, do realise, but never seem to get around to refinancing because they keep telling themselves, “There’s no rush, I’m only paying a few dollars extra per month.” However, as the above table shows, a small reduction in monthly repayments can add up to a big reduction in total repayments over the life of the loan.
Of course, the cheapest loan isn’t necessarily the best loan, but interest rate is always an important factor when assessing the pros and cons of a particular product.
The wonderful thing about RateCity’s home loan health check is that it not only gives you an idea of how your interest rate compares to the rest of the market, it also suggests several alternative mortgages for you to consider.
Conducting a home loan health check shouldn’t mean just comparing interest rates. It’s also important to look at fees.
Many home loans come with ongoing fees, which can include monthly fees, annual fees and offset account fees. Borrowers can also be slugged for redrawing funds or making additional repayments. Lenders also like to get you on the way out, often charging you a discharge fee when you finally close the loan.
Fees are a bit like interest rates in that paying a bit more in the short term can add to a paying a lot more over the life of a loan.
Imagine, again, that you’ve got 20 years left on your mortgage and you switch to a home loan with lower fees. Here are the sort of savings you might make:
- $100 per year = $2,000 over 20 years
- $200 per year = $4,000 over 20 years
- $300 per year = $6,000 over 20 years
- $400 per year = $8,000 over 20 years
- $500 per year = $10,000 over 20 years
Still not convinced about the benefits of a home loan health check?
If you’ve done a home loan health check and decided you do, indeed, want to switch home loans, you’ll have to do what’s known as ‘refinancing’.
Here’s how refinancing works. Imagine you have a mortgage with Lender X, with an interest rate of 4.50 per cent, outstanding debt of $300,000 and a remaining loan term of 20 years. After using a comparison tool to compare more than 100 lenders, you decide you like the look of Lender Y, which is offering a comparable product to Lender Y but for only 4.00 per cent. If you ultimately decide to refinance, Lender Y would repay your debt to Lender X – so you would owe nothing to your old lender and $300,000 to your new lender.
However, there are several refinancing traps you should bear in mind before signing on the dotted line.
First, you should confirm that when you did your home loan comparison, you considered the ‘comparison rate’, not just the ‘advertised rate’. The advertised rate is often an artificially low guide to how much you’ll pay, because it doesn’t include fees and charges; the comparison rate, though, does factor in these costs. With some loans, there will be no gap or a miniscule gape between the advertised and comparison rates; with others, though, the gap can exceed one percentage point. This is a key point to bear in mind during your home loan health check.
Second, if you do refinance, you will have to pay a range of fees to both lenders. Your old lender will probably slug you with a discharge fee; and if you close a fixed-rate loan, you will probably have to pay a break fee as well. Your new lender will probably charge you any combination of the standard set-up fees – establishment fee, valuation fee and settlement costs. All these fees could easily add up to more than $1,000.
A third trap to be aware of is the potential danger of refinancing in a falling market. Imagine that when you bought the property it cost you $500,000 and you borrowed $400,000. That would have given you a loan-to-value ratio (LVR) of 80 per cent and allowed you to avoid paying lenders’ mortgage insurance (which generally is only payable if you have an LVR above 80 per cent). Now imagine that, two years later, you’ve decided to refinance, having reduced your debt to $385,000 – but having also seen the value of your property fall to $475,000. When Lender Y revalues your property as part of the refinancing process, it will discover that your LVR is now 81 per cent and charge you lenders’ mortgage insurance, which could be about $2,500.
Finally, you should make sure that your new loan term matches your old. The default loan term for many mortgages is 30 years, so if you’re not careful, you could accidentally shift from a mortgage that has 20 years left to run with Lender X into a mortgage that has 30 years with Lender Y. If you’re wondering why that matters, check out these calculations:
- The total repayments for a $300,000 mortgage over 20 years at 4.50 per cent is $455,103
- The total repayments for a $300,000 mortgage over 30 years at 4.00 per cent is $515,267
You could save tens of thousands
Conducting regular home loan health checks is a no-brainer. After all, they’re quick, easy and free.
Also, there’s no obligation to refinance if it turns out that you already have an outstanding home loan.
Of course, a home loan health check might also reveal that there are alternative mortgages out there that could save you literally tens of thousands of dollars over the life of your loan.
Different loan options
The right mortgage rates can make an enormous difference to your unique financial situation. But what are the differences between the variable, fixed, split and comparison rates that are available from different lenders?
By putting the details of a variety of home loan offers all in one place, RateCity can help you forecast the effects that mortgage rates can have on your budget. You’ll also have the option to narrow down your shortlist of lenders to only those offering the rates and features that will ideally suit your lifestyle.
Variable mortgage rates
Many of the home loans available in Australia have variable interest rates, which rise and fall over the lifetime of the loan. These rates are typically based upon Australia’s official cash rate, which is set by the Reserve Bank of Australia – when the RBA meets and brings the cash rate up or down, the nation’s lenders often raise or lower their mortgage rates accordingly.
By choosing a variable mortgage rate, your monthly repayments may be reduced if interest rates are cut, saving you some money and providing you with some financial flexibility. But if interest rates go up, you may find yourself having to pay more for your mortgage than you initially bargained for, which could put you at risk of mortgage stress.
Quick guide to mortgage stress
Households are said to be suffering from mortgage stress when 30 per cent or more of their pre-tax household income is being swallowed by mortgage repayments.
The reason life becomes stressful at that point is because once households have paid for their mortgage, day-to-day essentials and various fixed costs, they will have little if any money left.
That’s why it’s so important to factor in interest rate rises before taking out a mortgage.
Go to a home loan calculator and punch in some numbers. Could you pay the mortgage if interest rates rose by 1 or 2 or 3 percentage points? If the answer is no, you need to think long and hard before taking out a home loan, because a change in the interest rate environment could place you in mortgage stress.
Fixed mortgage rates
Another option to consider is fixing the interest rate on your home loan for several years, keeping your finances insulated from the effects of rate rises. A fixed rate mortgage can also help to keep your household budgeting nice and simple, as your repayments remain the same from month to month for the duration of the fixed term.
However, a fixed mortgage means that if interest rates fall, you won’t enjoy the benefit of savings on your monthly repayments, as you’ll still be locked into your fixed rate. Breaking from the predetermined repayment plan can often prove quite expensive, so you may not enjoy as much financial flexibility from a fixed rate home loan.
Split Mortgage Rates
Some lenders allow you enjoy the best of both worlds between variable and fixed mortgage rates with the help of a split rate home loan.
In a split rate mortgage, a fixed rate of interest is charged on a percentage of your loan, and a variable rate of interest is charged on the remainder. The fixed percentage helps to keep your mortgage repayments relatively stable if rates rise, while the variable percentage allows you to enjoy some benefits and savings if rates fall.
The Comparison Rate isn’t another interest rate option like variable, fixed or split rates. Instead, it’s a figure used for estimating the approximate total cost of different mortgage options.
Most lenders charge fees as well as interest on the home loans they offer, which can make a significant impact on their total cost to borrowers. A mortgage with a low interest rate and high fees can sometimes turn out to be more expensive than a mortgage with a higher interest rate and lower fees.
To make the total cost of different mortgage offers more clear to borrowers, lenders are required to provide Comparison Rates for each of their home loans. A Comparison Rate combines the interest rate of a mortgage with its standard fees and charges, and expresses the total as a single percentage. This can make comparing the approximate total cost of different home loans side by side much simpler.
It’s important to remember that even a home loan’s Comparison Rate may not take its every cost into account – some loans have nonstandard costs associated with some of their optional features that aren’t included when calculating its Comparison Rate. Plus, some home loans come with features that can provide extra value to you, but also aren’t accounted for in the Comparison Rate.
It’s important to consider the impact your mortgage rates could have on your finances in relation to the length of your loan’s term. Most home loans start with a term of 25 or 30 years, though shorter and longer options are available.
Paying a home loan off over a longer period will involve making a greater number of repayments, each one for a smaller percentage of the loan’s principal. While these smaller repayments may be more affordable from month to month, you may ultimately end up paying more interest in total over the lifetime of the loan.
Conversely, a shorter home loan term means making a smaller number of repayments, each one for a larger percentage of the loan’s principal. While these repayments may be less affordable from month to month, the smaller number or interest payments may mean ultimately paying less interest in total over the lifetime of the loan.
What kind of borrower are you?
While different home loans may prove more appealing to different borrowers, your financial situation could also make an impact on the mortgage rates your lender offers.
Owner occupiers, whether they’re first home buyers or existing homeowners upgrading to a new property, are more likely to be offered lower interest rates on their mortgages, as lenders consider these borrowers to be relatively safe risks. While the flexibility of variable rates may appeal to these borrowers, first home buyers especially can often find the stability of fixed rate mortgages useful for managing their repayments while they build up their equity, especially if they’re on a discounted introductory rate. Of course, these borrowers should also remember that these “honeymoon” will eventually revert back to the lender’s standard rates, and budget accordingly.
Mortgages for investors are more likely to have higher interest rates, as lenders generally consider investment loans to be at higher risk of default.
When refinancing a home loan, your new interest rate will depend on a range of different factors, though generally the more equity you have in your current property, the safer the lender’s risk, and the lower the resulting interest rates.
Mortgage rates from banks and non-banks
When looking at the mortgage rates for home loans from banks, it’s important to also consider whether they can provide additional value, such as bundling access to savings and transaction accounts, credit cards, and other bonus features along with the home loan. However, loans from banks can often have fixed lending criteria, with less room for flexibility to suit different financial situations.
Some non-bank lenders offer competitive interest rates, as well as flexible lending terms to better suit different financial situations. However, these lenders may not be able to provide the features and services available from certain banks. For example, some lenders are online only, and operate with no branches, offices or shopfronts, which means there’s no option to sit down and go over your paperwork with your lender in person.
Offset accounts and redraw facilities
Even if you have a mortgage with a good rate, there may be options and special features available to make smarter use of your available finances, and maximise the benefits of a low interest rate.
An offset account is a savings or transaction bank account that’s linked to your home loan, so that any money paid into this account is included when calculating your interest, which can help to limit the size of your repayments. For example, if you have a home loan for $500,000, and you’ve paid off $200,000 so far, if you also have $15,000 in your transaction account, the lender will calculate your interest repayment as if you owed $285,000 rather than $300,000.
If you pay extra money onto your home loan, and get ahead of your repayment schedule, a redraw facility can allow you to withdraw these surplus funds from your loan (subject to the lender’s terms and conditions). This can allow you to pay more of your available savings onto your mortgage, and bring yourself closer to making an early exit from the loan, while remaining confident that you’ll be able to access these funds again in case of emergency.
Compare mortgage rates
While low interest rates are important qualities to look for when selecting a home loan, there’s plenty more to compare when looking at mortgage offers from different lenders.
RateCity puts information on a wide variety of home loans all in one place, so you can quickly and efficiently narrow down your shortlist of potential loans to only those that are the best fit for your financial situation.