WHEN it comes to choosing a home loan, it pays to look at the overall cost of the loan over the full repayment term.
A mortgage with a very low rate in the early stages of the loan term could prove surprisingly costly over time.
The sort of loans I'm referring to are “introductory” or “honeymoon rate” loans, and according to financial comparison website RateCity, these mortgages should be approached with caution.
Introductory rate loans feature a very low rate for the first 12 months. Once this honeymoon period ends the interest rate can really jump, often leaving borrowers to deal with higher repayments and a more expensive long-term interest bill.
To illustrate, RateCity says that on a mortgage worth $300,000 a borrower using an introductory rate home loan could end up paying over $16,000 more in long-term interest than if they opted for a standard variable rate home loan.
There are around 70 of these loans currently available, and they often appeal to cash-strapped first home buyers. As home buyers tend to have a lower income, they can be especially hard pressed to keep up with the repayments once the low rate period ends.
That's why you should look at the cost of the loan over the whole term – information that your lender or broker should be able to provide.
For a more lasting rate discount, it may be worth looking at a “package” loan – also known as “ongoing discount” mortgages.
Packages combine a home loan, an everyday account and often a credit card, all held with the same lender. Most come with an annual package fee – usually a few hundred dollars, but in return you get fee waivers on the credit card and transaction account plus a rate discount that lasts for the life of the loan.
These rate discounts have ranged from about 0.6% to 0.8%, though the highest discounts have generally been reserved for borrowers with more substantial loans.
That's starting to change. The rate discounts on package loans have recently become more generous, in some cases around 0.9%. And research group Canstar Cannex says that some lenders are now offering their best rate discounts to borrowers with a smaller loan-to-value ratio (LVR), which refers to the proportion of your property's value funded by the mortgage.
The Commonwealth Bank and Queensland Teachers' Credit Union are among the lenders that now incorporate discounts based on your LVR rather than the size of the loan. It's an approach that definitely offers a good incentive to save a decent deposit.
There are hundreds of home loans to choose from. If you're unsure about what you're getting ask your lender or broker for a clear explanation.
Paul Clitheroe is a founding director of financial planning firm ipac, Chairman of the Australian Government Financial Literacy Board and chief commentator for Money Magazine.