Borrowers need to make sure they’re not wearing rose-coloured glasses when they go shopping for a mortgage this house-hunting season.
It’s spring and a young man’s (or woman’s) thoughts turn towards … property. And what charms it may hold this year. Official interest rates are in suspended animation, the banks are competing for your business and property prices are subdued.
There are green shoots everywhere if you’re a buyer. The Reserve Bank of Australia hasn’t touched the official cash rate since November last year and escalating concern about the world economy means a rate cut isn’t out of the question. “Our baseline scenario is still one of rates on hold this year but we feel that the door for a rate cut is opening wider,” St George Bank economists said in a recent note.
Heck, the banks are pruning home-loan rates anyway. With Australians saving $10 out of every $100 – a turnaround from spending more than they earn – they are awash with deposit funds they need to lend out to turn a profit.
That’s why fixed-rate loans are so cheap – as much as five official rate cuts cheaper than the average standard variable rate among the big four banks, says the managing director of mortgage provider Australian Mortgage Options (AMO), Robert Projeski.
It looks like a buyers’ market out there. The days are long gone when you had to race from auction to auction to nail a purchase before prices soared higher. Researcher Australian Property Monitors is predicting just 5 per cent growth in values over the next year. Prices in some areas may fall.
But there are weeds in this garden, too. Remember, if the RBA cuts rates it will only be because the news is bad enough to warrant giving the economy a leg-up.
The last thing you want is a new mortgage in one hand and a redundancy notice in the other. There’s no guarantee the banks will march lock-step with any RBA rate cuts. They may hesitate to cut their rates further if they deem it unprofitable to do so. They certainly acted independently by pushing rates higher than the RBA’s rises in recent years.
Plus, buying into a falling property market can be dangerous if you pay too much for the wrong property in the wrong place. The worst-case scenario is that sliding values mean you end up owing more than your home is worth.
Ask the Americans who have walked away from their homes in the past few years (an option there because banks get the keys and nothing else under their non-recourse loans; in Australia, the banks can keep chasing you for the money).
And with interest rates low, it would be easy to be seduced by the big sums a lender’s calculator says you can borrow. But if a loan feels too big to be true, it probably is. With those caveats in mind, here’s a spring checklist for a healthy home loan, whether you’re a first-home buyer or looking to upgrade to a house with a bigger garden.
“First things first, make sure you know where you’re at financially,” Mortgage Choice spokeswoman Kristy Sheppard says. ”Create a detailed budget so you truly understand your cash flow, can see where savings could be made [and the money directed to your deposit], and to work out how much you really can afford in repayments.
“Then go online and play with home loan calculators to get a decent idea of how much you should and can borrow, and therefore what deposit you’ll need.”
Remember, too, that you’ll need the equivalent of about 5 per cent of a property’s purchase price just to cover transaction costs such as stamp duty, lender’s mortgage insurance, conveyancing and pest and building inspections. On a $600,000 property, that’s $30,000 upfront you’ll need to build into your budget.
WEED YOUR FINANCES
While you’re at it, have a financial clean-up to make yourself the most attractive customer possible to a lender, Sheppard says.
“Checking your credit history is vital,” she says.
“Lenders closely scrutinise a potential borrower’s credit history … Yours should be squeaky-clean.”
Generally, a default is listed on your credit file after three months of missed payments and what you consider a simple default on, say, a phone bill, could hinder your home-loan approval.
Lenders will also look at your employment history, your income, savings and assets, as well as your expenses, credit and store cards (the credit limits, not just what you’ve used) and any other loans.
So, pay your bills on time and try to stay in the same job for now – or be able to explain any gaps.
FERTILISE YOUR DEPOSIT
The days of 100 per cent home loans are gone, so you’ll need at least a 5 per cent deposit – preferably much more.
With Sydney and Melbourne median house prices about $600,000, that’s a deposit of at least $30,000.
Some lenders are still insisting on a 10 per cent deposit, which would be $60,000, and if you want to avoid paying for lenders’ mortgage insurance (which covers the lender, not you) you’ll need $120,000 for a 20 per cent deposit.
HSBC’s head of mortgages, Alice Del Vecchio, says some lenders are lowering their hurdles but “from our perspective, we remain quite rigorous in terms of how robust we want customers to be … we want to make sure they’re not stretching themselves even before they start.”
While the talk is of rate cuts now, no one knows what the future holds over the life of a loan, she says. Besides, accumulating a good deposit demonstrates an ability to put money aside regularly – and it’s good practice for what lies ahead.
When doing your sums, bear in mind that money can seemingly evaporate when you’re settling into a new home.
Mortgage Choice’s annual survey of first-home buyers this year found that one in five had taken on “significant” extra debt within the first two years of securing a home loan.
Nearly half of those people said the sum was more than $20,000 and 5 per cent had borrowed another $100,000.
The money was for cars, renovations, clearing credit card debt, furniture and appliances, in that order.
Del Vecchio says she’d rather people factored in such costs and took out a bigger home loan upfront than run up expensive credit card debt later and get into strife.
“If you do need to buy things, there are better ways to do it, so have that conversation,” she says.
SPRAY FOR PESTS
Having determined how much you need to borrow, it’s time to stress test your planned home loan to eradicate any bugs.
One rule of thumb is that you should consider whether you’d be able to meet your repayments if interest rates were 2 percentage points higher.
Del Vecchio says lenders will run this sort of calculation when they’re considering your application anyway, and HSBC errs on the side of caution with a higher buffer than most.
Sheppard suggests “practising” your repayments now so there are no financial surprises once your home loan is a reality. If your repayments will exceed your rent, start saving the difference to get the feel for the amount that will come out once you move.
PRUNE YOUR SHORTLIST
Naturally, Mortgage Choice suggests using a broker to help you wade through the hundreds of loan options out there, on the basis they can sniff out good deals in what’s a competitive market and take the administrative burden off your shoulders.
That’s fair enough but do be aware that brokers don’t sift through every loan in the market. Each broker network has a “lender panel” – a list of the particular loan providers with which they work.
Sheppard suggests you check your broker has at least 20 lenders on its panel.
Also, not all lenders offer their products through brokers. HSBC, for example, prefers to sell its loans directly.
Del Vecchio of HSBC says that, even if you do use a broker, you should do a bit of research yourself so you’re confident you’re getting the best deal.
Shopping around for the right loan can make a big difference. Money asked researcher RateCity to run the numbers on the cheapest and the most expensive variable-rate loans on its database.
We used a loan of $300,000 over 30 years and the official comparison rate (or AAPR), which factors in fees.
RateCity found a borrower could save $53,700 over the life of that loan by switching from the most expensive rate (7.92 per cent at the time) to the lowest-rate loan (7.05 per cent).
Once you’ve chosen your lender, get your loan pre-approved so you’re certain of your finances and because pre-approval can be a great negotiating tool – it shows you’re a serious buyer ready to act.
TEND YOUR GARDEN
Once you’ve purchased and those repayments become a reality, stay on top and build a buffer by making higher-than-required repayments and putting any windfalls on to your mortgage.
Mortgage Choice’s recent Saving and Spending Insights survey found 35 per cent of respondents make extra repayments and 39 per cent use a savings account that offsets mortgage interest. Most people factored in an interest rate buffer – mostly around three percentage points, though eight per cent of respondents had a buffer of five percentage points or more.
And nearly half said they’d use a rate cut to eat into their mortgage further, by maintaining repayments even though less would be required. Brokering a loan
Behnam Borna, an engineer, wanted to make sure he knew precisely what would be involved when he and his wife bought their first house, so he spent six months learning the process. But even then he was in for a few surprises.
Borna and his wife, Sara Sattarzadeh, became the owners of a three-bedroom townhouse in Donvale, Victoria, last Friday, which they bought with a 10 per cent deposit and a variable-rate loan from Bankwest, plus the help of broker Monica van Riet from Mortgage Choice, Stonnington, Port Melbourne.
“When I went to the broker I thought it would be a straightforward process because of my job and income,” Borna says. “I wasn’t aware of the detailed criteria each bank would have.
“The broker was able to break down the number of banks which would be able to provide funds to me based on what I had in the bank.”
He also didn’t realise he’d be up for lender’s mortgage insurance or that the first-home owner’s grant had fallen back from $21,000 to $7000.
“And I had no idea how big the stamp duty would be – $38,000 – that was a bit of a shock,” he says.
“In the end I was very happy I engaged a broker in advance,” Borna says. “If I hadn’t, I might not have failed in finding a loan but the process definitely would have been delayed.” Bridge the gap between your old and new houses
If you are looking to upgrade from one property to another, should you sell before you buy?
Selling your home and finding another to buy rarely coincide precisely, spokeswoman for Mortgage Choice, Kristy Sheppard, says.
One option is to ask for an extended settlement on the property you’re buying to give you time to sell your home, she says.
But that’s not always possible, which is where bridging finance comes in – a loan of typically six to 12 months covering both the old and new debt.
A search of Mortgage Choice’s database shows about 1 per cent of the loans its brokers arranged in the first four months of this year involved bridging finance. The proportion has since dropped to about 0.5 per cent – perhaps a sign of caution as house-price growth slows.
Head of mortgages at HSBC, Alice Del Vecchio, says there’s no right or wrong answer to whether you should go down this path. Buy first or sell first, she’s seen both work well, she says.
”You do need to have an honest conversation with your bank,” she says. They will give you the best- and the worst-case scenarios and you have to make sure you’re comfortable with the latter. Ask yourself how long you could support a bridging loan if you don’t sell as quickly as expected.
Sheppard says you may have to be more ”realistic” on price for your first property, either to secure bridging finance or to sell more quickly.
She also advises shopping around for bridging finance, as loan features, conditions and structures vary. Some lenders may want regular repayments, while others may add the bridging loan interest to the loan balance for the next home and not require payment until the first home sells. Key points
- Create a budget, building in costs such as stamp duty.
- Clean up your credit profile.
- Accumulate as big a deposit as you can.
- Stress test your proposed loan.
- Shop around and negotiate.