Borrowing

Selecting a mortgage is a big decision. You’re likely to have the loan for many years and if you pick the wrong one it can cost you. A competitive interest rate is important but that’s not all: if you’re not careful you might find yourself locked into an inflexible product that doesn’t suit you.

It would be frustrating to be diligently paying as much off the mortgage as you could and then find you couldn’t redraw the extra money in an emergency. On the other hand, you might be paying too much in interest or fees if your loan has fancy features that you don’t use because you’re only able to pay the minimum amount each month.

Finance first

To make sure you get it right, you should start thinking about finance as soon as you decide to start looking for a property. This is true whether you’re an investor, a first-home buyer or looking to upgrade your existing home.

Before you even begin to look around you should work out how much you can afford to borrow. Although the lender you choose will examine your finances and determine whether they think you can repay them, it’s wise to do a self-assessment as well. Use budgeting and mortgage repayment calculators on websites such as ratecity.com.au or infochoice.com.au to help you do the sums.

The head of consumer advocacy at Resi Mortgage Corporation, Lisa Montgomery, says it’s prudent to assume interest rates are at least 2 per cent higher than today’s rates in any calculations you do. That will help you avoid a debt you can’t afford when rates go up.

Work out what deposit you will need, too. In mid-2008, before the global financial crisis, 653 mortgages out of about 2000 monitored by home loan comparison website RateCity were available with no deposit. Now there are none.

Only 62 home loans on RateCity’s list will finance up to 97 per cent of the value of the property. This is down from 89 loans in December 2009 and 355 in 2008.

Mortgage providers will usually make you take out lenders’ mortgage insurance if you don’t have at least 20 per cent of the property’s value as a deposit. Lenders’ mortgage insurance protects the lender against loss in case you default on the loan.

It’s important to note that it does not protect you as the borrower, so there’s no value for you in having it. It simply adds an extra cost to your purchase, which is best avoided if possible.

When you’re working out your budget, remember you’ll also have to pay fees to a solicitor or conveyancer and a mortgage registration charge.

You might have to pay stamp duty to the state government, although some people will qualify for discounts and exemptions so check with the state revenue office what rules apply to you.

Pick the features

The next vital step when hunting for a mortgage is to think about what you want out of the loan. Ask friends and family for their opinions but remember that you need to make the final choice yourself.

“It is very much an individual decision,” Montgomery says. “Sometimes the loan that your friend or your family member has might not be the one that’s going to suit your needs.”

Start by familiarising yourself with the kinds of loans available, the features they offer and the conditions that apply.

Are you just after the lowest possible rate or do you want other features that will give you more flexibility? Will you qualify for a standard mortgage or will you need to apply for a low doc loan because you’re self-employed, for example?

The faster you can pay off your mortgage the less it will cost you in interest, so there’s a definite advantage in repaying the loan early.

Some options, such as the ability to make additional and lump sum repayments, can save you thousands of dollars in interest over the life of the loan.

Paying $200 a month more than the minimum repayments on a $300,000 home loan with a 30-year term charging 5.8 per cent interest saves $86,512 in interest and lets you clear the debt six years and eight months sooner.

Offset accounts are also useful for reducing the interest you pay over the loan’s term. An offset account is basically a bank account linked to a mortgage. The money in the account is at call but instead of accruing interest like a savings account, all or part of the balance is offset against the amount outstanding on the loan when interest is calculated. Check what percentage of the money is offset. Ideally, 100 per cent would be.

If you have a $280,000 mortgage and $10,000 in a 100 per cent offset account the lender only charges interest on $270,000 of the loan. This would save you $42,596 in interest and two years and one month off the loan’s term, according to ANZ’s 100 per cent mortgage offset calculator. The result is the same as if you had paid that amount off the mortgage but you can easily access the money.

A redraw facility allows you to access extra repayments you have made on the loan. Lenders may offer redraw services free of charge or they may charge up to $75 for the transaction. All redraws are subject to approval and there are some cases where lenders won’t normally let you make a withdrawal, such as if you’ve been made redundant.

Some lenders will permit you to take a holiday from your repayments for between about two and 12 months. This can free up cash flow for that time, which is useful if you need the money for other things – travelling or having a baby, for example. The lender will revise your repayments upwards after the holiday to make sure you can clear the debt in the original time frame. Make sure you plan ahead so you can be confident that you’ll be able to cover the increased repayments. Like redraw facilities, it’s uncommon for a repayment holiday to be offered to people who have lost their jobs.

The right price

When you’ve decided on the type of loan and features you want, it’s time to shop around on price.

There’s a good reason why the interest rate is the feature of a mortgage that attracts the most attention. Over 25 years, a $250,000 mortgage charging 6.7 per cent a year will cost $265,818 in interest – you end up paying more than twice what you borrowed.

A loan the same size with the same term but charging 5.7 per cent will cost $46,252 less over the term.

There are hundreds of lenders and thousands of mortgage products out there, and their rates vary dramatically.

Look beyond the interest rate when comparing on costs, says Choice spokesman Christopher Zinn. Other charges such as application fees, valuation fee and transaction costs can mount up. Like interest rates, these also vary.

Watch out for honeymoon deals and enticements such as deferred establishment fees. Lenders use these incentives to dissuade you from switching. It may be appealing not to have to pay fees upfront but they may leave you out of pocket if you try to switch to a different product should your situation change or preferable products become available.

“A mortgage isn’t like a marriage, where you tie the knot and live happily ever after,” Zinn says. “With a mortgage, you should be prepared to move, having only to pay reasonable costs associated with that move.”

Lenders also use loan packages to lock you in. These often come with discounted interest rates and low or no-fee transaction accounts and credit cards, which may be attractive.

“We’ve found people have been reluctant to switch to better deals because their card or transaction account is with the same bank,” Zinn says.

While it might be convenient to sign over all of your banking to the mortgage provider – and the features offered can be useful – Zinn says be careful that these package deals don’t restrict your flexibility and leave you worse off in the long run.

Cut a deal

Once you’ve chosen a loan that meets your needs, don’t be afraid to negotiate on price.

Lenders won’t advertise the fact that they will negotiate one-on-one, but RateCity chief executive Damian Smith says there are plenty of cases where people can get quite different rates from the same institution through different channels.

“Clearly some customers matter more than other customers to banks. There are some people that banks really want as a customer and there are some people who they might not want as much.” The better your savings record, the easier it will be to get a low rate, he says.

If you are going to negotiate, be prepared. You need to have the information when you walk in the door.

“There’s no point in haggling with your bank manager if you don’t know what the alternatives are,” Smith says. “They’ll know what the alternatives are and if you want to out-negotiate them you have to walk in the door with full knowledge of ‘here’s what I can get next door’.”

Up until a few years ago there was a real trade-off between interest rates and price, but Smith says this is no longer the case.

Flexible loans are now offering some competitive rates.

Smith says improvements in technology are allowing lenders to offer these desirable features at a lower cost.

Competition in the mortgage market is also starting to pick up again, although major banks are still writing about 90 per cent of new home loans. More competition should mean better deals for consumers.