Keep your eyes peeled as you repair loans and take repayment offers
Right now, banks are going crazy advertising insanely low interest rates on home loans. It comes as the ANZ boss said rates may have to rise sooner than expected to avoid escalating social problems.
And home loan expert Mark Bouris in a one-on-one interview with me on my Switzer TV Property program last night gave some timely warnings about fixed rate home loans, recommending borrowers to look into near not only the announced rates of their new loan but also the comparison rate!
It comes as ANZ CEO Shayne Elliott admits that the loan-to-income ratio, which tells you how we Australians can repay our loans, is very low. That means we could face interest rate hikes to some extent, but he says the pace of house price growth is starting to ‘raise eyebrows’ in places that matter (banks, bank reserve, APRA, etc.) for interest rates.
That said, RBA Gov. Phil Lowe is sticking to his story that rates won’t go up until at least 2023 and maybe 2024. And seasoned economists like Bill Evans of Westpac and Shane Oliver of ‘AMP Capital (which the media always cites) doesn’t disagree with Dr Phil.
As the australian Lachlan Moffet Gray pointed out today that “on Tuesday RBA Governor Philip Lowe reaffirmed his belief that inflation will not be high enough to justify a 0.1% rate hike until” 2024 at most early “”.
I think he thinks the real estate boom can be slowed down by APRA telling lenders to play tight with loans, like they did in 2016. It killed the spike in house prices and lowered the value. houses in 2017 and 2018. But this trick will not work. slow down the global boom which I think will take hold of the global economy.
The ANZ boss did not explain how he thought the social problems could arise from these increases in house prices, but they could easily arise because people are paying too much and borrowing too much to buy a house and then saw that Dr. Phil was wrong about the interest. rates, which increase earlier than expected.
Dr Phil could be wrong. If he is wrong, he will have to increase the rates. And for social or economic problems to occur for those in debt, there would have to be a number of rate increases for the problems to become serious. If borrowers or potential borrowers are worried that rates will go too high, they would be well advised to take a few lessons from Mark Bouris on what I call Home Loans 101.
My interview with Mark focused on these insanely low fixed rate home loans, these huge repayment offers from lenders (which he says don’t reach anywhere else in the world), and how borrowers should look at the rate. of comparison interest and not just the advertised price.
So here’s what Mark taught me:
1. Usually, a fixed rate home loan means that you cannot pay off your loan any faster if you have a windfall. Some lenders currently allow a limited amount of additional repayments on fixed rate loans, but most will not allow you to withdraw these funds.
2. If you want to get out of a fixed rate home loan, there will be a breakage fee. And if you plan to sell or renovate your home in the short or medium term, avoid a fixed rate.
3. A cocktail loan, where you fix only a portion of your loan and leave the balance at a variable rate, may be a better option because it means you can reduce the variable loan portion of the loan. Also, if the rates go up and you have a half-fixed and half-variable loan, then each rate hike will be halved.
4. The Comparison Rate gives you an overview of the long term cost of your loan, including after the expiration of the fixed rate period.
5. Comparison rates are calculations that take into account all verifiable costs of the loan, including verifiable costs (set-up, discharge, and ongoing) and the interest rate on the loan. The comparison rate looks at the variable rate a borrower commits to after the fixed term ends and the interest rates you will pay at the end of the fixed term. Mark says that 90% of borrowers simply opt for the variable rate loan their bank gives them after the fixed term expires and they often have very high rates.
6. With a variable rate loan, if the comparison rate is similar to the overall rate, then there is less cost to worry about and vice versa. On ANZ’s website, their variable rate Break Fee lump sum loan has a variable rate of 3.49%, while the comparison rate is 3.91%. The cause of the difference here is the annual fee of $ 395, which becomes a proportionately larger cost over time as the loan is paid off.
7. Honeymoons don’t last forever. This example using the Westpac Flexi First Intro offer, where the Headline variable rate is 2.29%, shows it. The comparison rate for this loan is 2.72%. This difference is not due to an annual flat rate, it is rather a function that the loan is strongly discounted the first two years and that the discount is reduced by 0.5% thereafter. The rate therefore returns to 2.79% in this example. That said, Mark says the interest rate structure on ANZ’s website is reasonably well disclosed.
8. Looking at the Comparison Rate and Fixed Rate Home Loans, Mark pointed out a CBA product, which is a 4 year fixed rate as part of their Wealth Package at a quoted rate of 1.99%, while the comparison rate is 3.66%. So having such a big difference would mean that you have to do a lot of investigation to find out where the difference is coming from. In this case, the differences are mainly due to:
- The variable rate to which the fixed rate automatically reverts after 4 years. In this case, it is 3.85%.
- Package fees also help, as they add up to $ 395 per year.
- And to a lesser extent, there are some minor installation and unloading costs.
In short, if there is a big difference between the overall rate and the compare rate, it should be an indicator to dig deeper into so that an individual can determine what is going to provide them with the best value in the long run.
9. Regarding the money back offers, I asked Mark how good they were.
He said they were “great for the economy when it needs spending because of the coronavirus, but what about the borrower over time?” “
10. “Coupled with fixed rate loans, these repayments have the potential to offer quite substantial short-term benefits, but at a long-term cost,” he said. The chart I have included below illustrates this point, with a life of loan costs varying up to $ 80,000 between a simple variable rate offer and the fixed rate security from the same bank.
10. A 2.69% variable loan with $ 4,000 cash back looks compelling compared to a 2.39% variable rate without cash back. However, this table, which illustrates the cumulative interest paid over different terms over the course of the loan, shows that it does not take long for the cash back benefit to erode.
Comparison of two P&I real estate loans of $ 500,000 set up over a period of 30 years
11. “As you can see, a consumer ready to refinance his mortgage every 2 years may take advantage of the cash back, ”says Mark. “However, the question remains to know what is in the best interest of the borrower, a refinancing every two years impacts his credit report and also poses another problem of redefining the loan conditions …”
12. He also argued that more often than not (unless borrowers have not been mature for years), when a refinancing takes place, the loan term is typically reset to 30 years. “It can give the illusion of saving on monthly repayments, but as we all know it can end up costing the borrower more in the long run,” he said.
At constant scope, cash back is an obvious advantage. However, the problem arises when the initial cash incentive encourages a customer to purchase a product that may not offer good long-term value.
The clear lessons are that you need to look at the comparison rate on any loan you take out and understand where it could take you in two, three, or four years. In fact, being on top of your loan and always looking for the best deals makes perfect sense.
Also, if you accept a repayment offer, you had better change your loan, but it could affect your credit rating down the road. And if you are a borrower who skipped the comparison rate and let the loan settle and forget, you could lose a lot of money over time.
One point Mark made that should keep your eyes peeled is that banks are not in the charitable business. These low fixed rates might be perfect for you if it means you pay less per month when you might have cash flow problems, but banks are withholding short term reduced profits on these loans so they can have you for a long time.
And they don’t do this because they enjoy spending time with you for social purposes. You are a potential profit center, so make sure they don’t make you too much money!
And as I always say: “Anything worth doing is worth doing for the money!” “
By the way, I asked Mark what his YBR best variable home loan rate was and he said it is at 2.39%, or 2.42% on a comparison rate basis. He also said that there are cheaper online loans. But for non-online loans, this should be a good number to keep in mind if you are looking for the best possible deal.