Separating The Cheap From The Very Cheap
The Age
Sunday April 28, 1996
AN EXCLUSIVE survey for Money has shown that some home loans that appear among the five cheapest in newspaper surveys or advertisements could be ranked as lowly as 16th cheapest if your circumstances change and you decide to repay or refinance the loan in two years.
The study of 42 home loans shows that cheapest introductory rates do not always make the rates the least expensive, and that you must tailor your home loan to your circumstances.
A table summarising these rankings can be found on page C11.
`Tailoring' a loan is particularly important for people who are keen to continue shopping for the cheapest rates; and for those who might be forced to sell.
The main reasons for the changes in rankings are the up- front fees which the banks charge for home loans.
The impact of the initial fees are reduced the longer you have the loan. Conversely, people need to understand that the sweetheart rates offered by the banks normally only have a short-term effect. The cheaper on-going or variable rate is more important if you hold your loan for longer.
Also bear in mind that the table on C11 was created on today's interest rates, so only give an indication of your true costs under today's interest rate environment. If the interest rates change, so too might the position of your lender and the real costs of the loan.
Perhaps the most dramatic changes in people's fortunes came from the larger banks. The National, for example, is ranked number six if you obtain your finance for two years. However, its standing falls to 40 if you hold the loan for the full term of 25 years.
The irony of the National's home-loan plan is that clients are required to increase their repayments each year - and therefore their home loans are paid off earlier.
Watch also for the special two-year fixed loans on offer from some organisations. While the cheaper rates of around 8.69 to 8.9 per cent sound attractive, some banks will lock you into their variable interest rates for a further three years. If you attempt to break this contract you may be subject to a penalty which is commonly the equivalent of a month's interest.
Other big blow-outs in our survey included the Newcastle Permanent Building Society, which went from number one ranking over two and three years to number 20 over seven years and number 25 over 25 years.
Most newspaper surveys, and bank publicity, use the average annual percentage rate (AAPR), which measures the true interest cost of the loan (including establishment and ongoing fees) over seven years. Seven years is used because this is the average time that a person holds a home loan.
Watch, too, the bank's conditions. With many two year and three-year fixed loans, there is an obligation on the borrower to remain with that bank for up to five years. While this might result in a lower interest cost it comes at the loss of flexibility, which will be handy if interest rates do fall.
As is noted in the table on C12, the penalty costs for customers breaking these contracts with their banks can differ, but a common cost is around one month's interest - which works out to around 0.9 per cent of the value of your loan.
With newer styles of loans becoming available, people might be likely to switch home loans more frequently than before, in order to to take advantage of interest rate movements.
As a result, the AAPRs based on seven years migth be highly inapproapriate for your needs.
Conversely, with more banks now offering portability for their loans ( i.e. when you sell, you transfer your new home into your existing mortgage to save stamp duty) there could be some people who will hold their loan for longer periods.
If you do, note the real cost of interest and repayments on $100,000 loans over 25 years.
© 1996 The Age