Navigating The Home-loan Pool

The Age

Monday February 25, 2002

Annette Sampson

IF YOU think 3000-plus kinds of home loans swimming in the market must be marketing overkill, you are probably right. But many of these loans are tailored for different segments of the market, giving home buyers the chance to find a product that best suits their needs.

This means smart borrowers can choose a loan that will help them manage their finances better and own their home sooner. But how do you find the loan that fits?

Money Manager asked the research company Cannex, Tim Bolton of Mortgage Solutions Australia and Bill Rankin of Smartline Home Loans for some suggestions to suit six different kinds of home buyers.

Young and single - the cash-strapped first-home buyer

Don't be sold on lots of bells and whistles, says Andrew Willink, managing director of Cannex.

If you are a cash-strapped first-home buyer, the odds are that you won't have a lot of disposable income left after you make your loan repayments so you'll have little need for features such as redraw facilities or offset accounts.

Mr Willink suggests either a basic home loan with a low variable rate or a home loan with an introductory offer with the interest rate fixed for six months to two years.

"Introductory offers can help by keeping your monthly repayments down for as long as two years," he says. "But the rate the loan reverts to may be higher than the rate on alternative products, so you'll need to check the AAPR."

The AAPR, or "comparison rate" as it's also known, measures the annual costs of the loan over the first seven years and includes upfront and ongoing fees as well as the interest costs. If your lender doesn't disclose the AAPR, you can use the online calculator at www.cannex.com.au

Mr Willink says another feature to consider is one that allows you to structure your loan over 30 years instead of 20 or 25 to reduce your monthly repayments.

He says you should shop around for a lender that will provide you with a high loan-to-valuation ratio (LVR) if your deposit is small. Many lenders will lend up to 95 per cent of the value of your home but will insist on mortgage insurance if the LVR exceeds 75 to 80 per cent, says Mr Willink. And you should make sure you get a refund of your application fee if your loan is rejected.

If your income is fixed or unlikely to rise much in the next few years, you may want to look at a fixed rate home loan, says Smartline's Mr Rankin. This may also be an option if your finances are so tight you would not cope with a rate rise.

Young couples - the more affluent first-home buyer

Your main priority will probably be to pay off your loan quickly, says Mr Rankin. You'll have some extra disposable income and you'll want to reduce your loan if you can. A low interest rate is still a priority but the loan should allow extra repayments and maybe offer a redraw facility or offset account so that you can park your savings and reduce your home-loan interest bill.

That probably means looking at a standard variable loan, although Mr Rankin says you shouldn't rule out basic home loans.

"Some have extra features or some lenders will allow you to split your loan so that part of it is a basic home loan and part is a standard variable loan with those extra features," he says. "A couple of years ago basic home loans were just that. But a lot now have features like redraw, though they may be offered at a cost or there may be limits on how you can use them."

Mr Willink says these borrowers should also ask about banking packages. If you're eligible, they can reduce your banking costs as well as providing a discount on your home-loan rate, he says.

If you're considering a standard variable loan there's sense in taking one with an introductory interest rate to minimise the costs in the early days. If you take out a capped or discounted variable-rate introductory offer you can generally make extra repayments, even during the introductory period.

Mr Willink says the loan should be portable and allow for "top-ups" if you want to extend or upgrade.

Young family -upgrading to a bigger home

This is typically a time when your finances tighten up again. Your mortgage repayments may increase and you may have to get by on a single income.

If this is the case, says Mortgage Solutions' Mr Bolton, features such as an offset account will be less important as you'll have less opportunity to save. He says you may be able to get by with a loan that offers a limited redraw facility instead, if it gives you a lower interest rate.

Mr Willink says if your disposable income is lower, this will make you more vulnerable to interest rate changes so you should have the option of fixing part or all of your loan.

"People are more likely to split their loan because they still need some of the flexibility that comes with variable-rate loans," he says.

Again, loan portability, the capacity to make extra repayments and a redraw or offset facility can be useful. If you are both working now but plan on living off a single income later it makes sense to be able to make extra repayments now so that you have a buffer against possible interest rate rises later.

Mr Willink says another important loan feature for young families is an option to top up or extend the loan to pay for renovations or extensions.

Empty nesters - comfortable borrowing to change homes

Older borrowers with high levels of equity in their homes are a key target for home-equity lenders.

As many of these people have surplus income, the idea is that they can borrow more and use the extra money to build wealth elsewhere, such as by buying shares or managed funds.

"They want access to their funds to do extra things with their money," says

Mr Willink.

Home equity loans are much like overdrafts. You get an approved credit limit, secured against the value of your home, and can repay and redraw it at will.

Most also allow you to deposit income such as a salary into the loan and have a linked credit card for daily spending that is "paid off" each month from the loan.

Home equity funds used to be much more expensive than standard home loans but now you should be able to get one for a similar interest rate, says Mr Rankin.

As most of these loans are structured as revolving lines of credit, you need to be sure they suit you before you sign up.

Mr Willink says he is concerned that the lender reviews the loan each year and can ask for their money back at any time.

"If you know you might have difficult times coming up you would be better to have a term relationship with the lender through a standard variable loan," he says.

"You also have to consider that your partner could run off with 80 per cent of the equity in your home simply by taking the linked credit card."

Mr Rankin says this approach requires discipline as there is no requirement to pay off the loan.

If this doesn't appeal, a better option may be a standard variable loan with an accessible redraw facility or an offset account, he says.

Tax is also a consideration as you can claim a tax deduction for interest on investment loans but not for interest on your home loan. If the loan is intended to cover the two, you'll need to consider how you will keep your investment and private borrowings separate.

Investors - have cash, will borrow

If you still have non-tax-deductible debt owing on your home loan, there's no point in using your savings to pay off the interest on your tax-deductible investment loan, says Mr Bolton.

"You're better off taking out an interest-only loan for your investment and using your savings to pay off your non-deductible debt," he says.

Some investors who do own their own homes like to pay off the principal as well, he says, "but there's no real right or wrong".

Mr Willink suggests investors look at fixing their interest rate to help with budgeting. They should look for a loan that allows the interest to be paid annually in advance (usually offered in May and June each year), which provides them with a discount on the interest rate and an immediate tax deduction.

If you prefer a variable rate, he says, it's better to look for a basic loan with a low interest rate as you don't need the additional features available on standard home loans.

"You want a clean loan account that allows you to calculate the interest in a simple manner for tax," he says. "The only feature you may want is loan portability and you can get that with a basic product."

"You usually don't want them because there's no reason to pay the loan off quickly," he says. "But what may be useful is an offset account where your savings can reduce your interest bill but the money is kept totally separate to your investment loan. You can then spend that money in any way you want without running into tax problems."

Mr Bolton says investors should also look at how much of the rental income from the property the lender will allow as potential income in assessing your loan application. While some will allow as much as 80 per cent or more of the rent to be counted, others are less generous.

"There can be differences of $100,000 between lenders in how much you can borrow," he says.

"The lender's ability to accommodate you over the years is important."

Mr Bolton says he "has no idea" why home equity loans are often sold to property investors as few people have so much equity in their home that they can afford to go out and buy investment properties without adding the new properties to the loan as security.

Irregular earners - self-employed and casual workers

People on irregular incomes can find it difficult to borrow but Mr Willink says this often depends on their ability to negotiate and to present themselves as a good lending risk.

If you have a problem it may be worth hiring a mortgage broker to present your case. They will know which lenders to approach. As a last resort, you could try a lender who offers non-conforming or low-documentation loans. These are usually more expensive than normal home loans, but are available to people who fall outside the mainstream lenders' criteria.

"They are good loans for people who can't find a lender and who are prepared to pay a premium," says Mr Bolton.

Mr Rankin says mainstream lenders are getting better at dealing with casual and self-employed workers as more people opt out of traditional employment.

"There's also a wide range of low-documentation products which are offered by more traditional lenders," he says. "We have 22 lenders on our panel and eight of them offer this style of product."

If you use a non-conforming lender, says Cannex, you'll need to do your homework as interest rates can vary depending on things such as the risks involved and the LVR.

© 2002 The Age

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