First home buyers beware of intro-rate loans

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May 12, 2011

Home buyers are being urged to consider introductory-rate home loans with caution, following an increase in uptake of the often surprisingly expensive honeymoon-period home loans.

The growth in introductory-rate mortgages follows a string of recent advertising campaigns from the banks, which market these types of loans to a public that may be unaware of the real costs involved.

Damian Smith, chief executive of financial comparison site RateCity, says introductory-rate home loans can cause long-term financial strain for a very short-term reprieve.

“Many lenders offer an introductory home loan deal with a discounted interest rate for a short period of time,” he says.

RateCity monitors 70 introductory home loans, most of which offer a discount for the first 12 months.

“While a discounted interest rate might be tempting when entering the property market for the first time, once the honeymoon is over the interest rate always reverts to a much higher rate than what you could find from another home loan,” Smith says.

First home buyers feel the biggest sting
First home buyers are the most vulnerable to sudden increases in interest rates at the end of a honeymoon period and the real concern is that this group will suffer financial strain if they choose an introductory-rate loan, more than other borrowers.

That’s because they are new to the real estate market and are often young and earning less so their proportion of income to repayments is higher.

“Once the honeymoon period ends and you have to pay hundreds of dollars more each month, the extra costs for one year of reprieve probably won’t be worth it,” Smith says.

The real costs of intro-rate mortgages
On average, introductory-rate home loans cost borrowers in excess of $16,000 more than ordinary variable mortgages, according to RateCity date (when comparing variable intro-rate mortgages with a 12-month honeymoon period and for a $300,000 loan).

That’s because the average advertised rate for introductory home loans of $300,000 available through RateCity is 6.8 percent, while the average revert rate is 7.58 percent. By comparison, the average interest rate for all variable rate loans is 7.27 percent.

The financial cost in the first year is around $1000 less for borrowers in their honeymoon period than those with the average variable rate loan. But for the years following, honeymooners pay $60 per month more or $16,000 over the 25-year loan.

“Introductory-rate home loans only suit those that are planning to pay off their mortgage during the honeymoon period or shortly after and borrowers who plan to switch to a better deal directly following the honeymoon period,” Smith says.

So before you sign up for an introductory-rate home loan you’d be wise to consider the ongoing costs of this type of loan. Because by opting for a low-rate mortgage from the beginning instead, you too could potentially save tens of thousands of dollars.

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