The home loan from hell

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Exclusive investigation: Jackie Pearson reports on nightmare mortgages and how you can avoid ending up with the home loan from hell.

September 21, 2009

In March 2008, Alan and Esther found the home of their dreams. They needed a $300,000 home loan to pay for the property and were worried about finding a loan that would give them repayment certainty for the next few years.

At the time, the Reserve Bank had increased official interest rates 11 times in a row and it looked like variable mortgage rates were certain to hit double digits in the near future. Alan and Esther thought the best thing they could do was to lock in their loan at a fixed rate of 9 percent for five years.

Their decision seemed clever at the time but within six months it had turned into a nightmare. From September 2008 the official cash rate was slashed to the historic low of 3 percent and the average standard variable home loan rate had fallen from a high of 9 percent to around 6 percent.

Currently, the lowest advertised standard variable rates available are as low as 4.79 percent p.a. Alan and Esther still have well over three years before they come off their fixed rate and are paying up to $728 extra per month in interest.

The couple have also discovered that they would need to pay $35,000 in break costs to get out of their fixed rate loan early.

Always check break costs
At the time of taking out their loan, Alan and Esther was certain rates would continue to rise for at least the next couple of years – the economy was booming, inflation was on the rise and there was no way of knowing the Global Financial Crisis was around the corner.

They knew fixed home loans came with break costs but didn’t think they would need to refinance until at least the end of their five-year term. They are now stuck and frustrated by the savings they’re missing out on.

The Financial Ombudsman Service (FOS) has recently reported a large increase in the number of complaints about break fees, particularly about the lack of information about such costs provided at the time borrowers have taken out their loans.

Different lenders have their own ways of calculating break costs so check your mortgage agreement carefully and ask questions if you don’t understand the way break costs will be calculated if you want to get out of your fixed rate loan early.

The amount you’ll have to pay in break costs is determined by the number of years your fixed term has left to run, the current interest rates and the loan amount.

Because Alan and Esther wish to break their contract with three years left to run, the lender will charge them the remaining three years worth of 9 percent interest minus the current interest rate (benchmark five-year fixed rate is 7.72 percent p.a.), multiplied by the original loan amount. So the lower interest rates go, the higher your break costs.

For example, if your original fixed rate was 9 percent p.a. but rates have fallen to 5 percent p.a., with one year to go on a $300,000 loan your break costs would be around $12,000, with two years left the amount goes up to around $24,000, three years $36,000 and four years almost $50,000.

It pays to shop around
Esther and Alan are also lumped with a $10 monthly service fee and their total repayments over the 25 year life of the loan will be around $593,000.

If they decided to pay the break costs, shop around and refinance with a variable rate home loan of 5.2 percent p.a. for instance, the couple would reduce their monthly repayments from their current $2,517 to $1,789. The total cost of their 25-year loan would be reduced by more than $56,000. With the $35,000 break cost, Alan and Esther would still be $21,000 better off.

The risk with shifting to a variable rate is the uncertainty of the interest you will pay as it rises and falls to the lender’s discretion.

Beware of hellish loans with incredible fees and charges. It pays to shop around for the best rates and the most flexible, inexpensive terms and conditions before signing that dotted line.

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