The Key To Your Front Door
Sydney Morning Herald
Thursday March 25, 1993
HOME buyers have been offered some attractive mortgage deals in the past year or so, thanks to vigorous bidding by the banks for market share. The most notable offers have been the special deals offering highly competitive interest rates which have been capped or fixed for up to a year.
A fixed rate is precisely that - it doesn't move for the set period. In contrast, a capped rate can't go up during the set period but will fall if the standard home loan rate falls below the capped rate. For example, a home loan may be capped at 9 per cent for one year at a time when the rate on standard home loans is 10 per cent. If rates rise to, say, 11 per cent this will not affect the borrower with the capped rate loan until the capped period has expired. In contrast, should the rate on standard loans fall to 8 per cent the capped rate loans will fall to the same rate.
Capped rate home loans, as well as most of the special fixed rate offers available from the major banks, revert to standard variable rate home loans at the end of the capped or fixed period. These standard home loans are repaid gradually over 15 to 25 years in equal instalments. During this time the interest rate charged varies in line with overall rate movements. This uncertainty means some people are opting to use a home loan which charges a fixed rate for a relatively long period (usually three to five years). The main attraction of a fixed rate mortgage is that the borrower knows exactly how much he or she will have to pay each month or each fortnight for the next, say, five years.
Such certainty is important for people who want to borrow the maximum they can comfortably afford to finance each month. Such people don't have any financial leeway to enable them to meet higher repayments should rates rise.
The hope is that by the time the fixed term ends the family income will be higher and it will be able to cope if rates have risen. In most cases borrowers can refinance at another fixed rate at no cost or switch to a standard variable rate loan.
Unfortunately, while fixed rate mortgages have a lot to offer they do have an important drawback. This derives from the fact you are stuck with the fixed rate even if other interest rates fall. This aspect has been highlighted in recent years mainly because quite a few borrowers took out fixed rate home loans in early 1990 at rates of around 15 per cent. Shortly afterwards rates started to fall with those on standard home loans now down at 10 per cent or lower.
Borrowers in this sort of situation have to put up with continuing to pay 15 per cent or instead pay an early repayment penalty which allows them to refinance the loan at a lower rate, possibly with another lender. In many cases the penalty is so high as to remove any gain from refinancing.
Another, more unusual home loan option is what is sometimes known as a flexible mortgage. These are offered by most banks and usually require the borrower to pay only interest. As with a normal home loan the mortgage is secured against the value of your home. The main difference is that flexible mortgages allow you to use as much or as little of the approved amount as you like. As well, you can pay back and withdraw any amount you like, at any time. Such loans can operate as a home loan and a flexible source of funds to finance investments, a business or consumer purchases.
© 1993 Sydney Morning Herald