Taking out a mortgage can be an intimidating and confusing process – and the banks don’t exactly go out of their way to make it simpler.
With all the strange processes and baffling jargon, it can be easy to make a wrong move and wind up with a sub-par home loan.
Unfortunately, this could cost you tens of thousands of dollars over the life of your loan.
So pay close attention as we walk you through five common home loan traps.
Trap #1: Staying loyal to your bank
One of the most common mistakes borrowers make is to rely on their local bank branch for independent mortgage advice. But they’re not independent – they’ll only recommend their own home loans, even if they know there are better options out there. Bank staff are incentivised to sign up new customers, not to educate them about rival products.
Don’t make the mistake of showing loyalty to your bank, because it won’t be repaid. If you get cajoled into a more expensive mortgage, it could cost you tens of thousands of dollars over the life of your loan.
Solution: Weigh up a wide variety of options by doing an online comparison search or visiting a mortgage broker.
Trap #2: Ignoring challenger lenders
Another common mistake is to refuse to look outside the big four banks – even though the Australian mortgage market contains more than 100 lenders offering several thousand home loan products.
The big four often charge higher interest rates than challenger lenders. For example, a recent online comparison search for a $400,000 owner-occupier home loan found that challenger lenders had 29 of the 30 lowest rates.
One reason people give for sticking with the big four is a fear that smaller lenders are unsafe. But don’t forget that the risk is taken by the party giving the money (the lender), not the one receiving it (the borrower).
Solution: Keep an open mind about smaller banks, credit unions, building societies and non-bank lenders.
Trap #3: Fixating on interest rates
While interest rates are important, they’re not the only thing that matter. Choosing the cheapest mortgage could actually cost you money if it doesn’t have the features you need to best manage the loan.
For example, if the loan didn’t have an offset or redraw facility, you wouldn’t be able to reduce the amount of money against which you were charged interest. Or if the loan prohibited extra repayments, you would lose the chance to pay off the loan ahead of schedule.
You also need to pay attention to fees, because a cheaper loan with higher fees could cost you more over the life of your mortgage than a dearer loan with lower fees.
Solution: Treat features and fees as seriously as interest rates.
Trap #4: Overlooking the comparison rate
One easy-to-make mistake is to focus on the advertised rate rather than the comparison rate.
The advertised rate is often an artificially low figure, because it doesn’t include fees. The comparison rate is a better guide to how much you’ll pay because it does include fees.
Sometimes, the difference between the two rates can be miniscule or non-existent. For example, at the time of writing, Reduce Home Loans had a variable rate product whose advertised rate and comparison rate was 3.44 per cent. However, NAB had a two-year fixed loan with an advertised rate of 3.69 per cent and a comparison rate of 4.86 per cent.
Solution: Read the fine print.
Trap #5: Stretching out the mortgage
Choosing a 40-year loan term over the standard 30 years might seem smart, because it reduces your monthly repayments. However, it could cost you a massive amount of money over the life of your loan.
Imagine if you borrowed $400,000 at 4 per cent. The monthly repayments would be $1,672 for a 40-year term and $1,910 for a 30-year term. But the total repayments would be $802,442 over 40 years compared to $687,478 over 30 years – a difference of $115,000.
Solution: Choose a 30-year loan if possible. If a 40-year loan is all you can afford, refinance to a shorter loan term as soon as your financial circumstances improve.