Fixed and variable rates might be the greatest differentiation between mortgage types, but there are a whole host of specialised products designed for different circumstances. While first-time buyers might not need all of these – it’s difficult to see why they might require a reverse mortgage, for example – it’s worth knowing the details for when you come across them during your research.
After all, the number of different types of mortgages available, when combined with the ‘industry speak’ used to describe them, can confuse even the most astute home loan rookie. So, without further ado, here’s Your Mortgage’s guide to some of the most common specialist products.
INTRODUCTORY RATE / HONEYMOON LOANS
This is a product aimed squarely at first homebuyers, and one which you’re likely to come across a lot. Also known as honeymoon loans, due to the ‘honeymoon period’ during which you pay a discounted interest rate, these loans usually offer a very cheap rate for an initial period of time – cleverly designed to catch a home loan hunter’s eye. However, this low rate only lasts for a limited period – usually 12 months, though some lenders offer the discount for as little as six months, or for up to three or four years.
The introductory rate can take one of two forms, the first being a ‘fixed discount’ and the second being a ‘discounted fixed’ rate.
The fixed discount is a rate that will be variable, but fixed at a certain level or margin below the standard variable rate. This means that for the introductory period, the discounted rate will move with the market. If the standard variable rate rises by, say 0.50%, so will the discounted rate, and if the standard variable rate drops by 0.50% the discounted rate will also drop.
The discounted fixed rate, on the other hand, is a rate fixed for the introductory period of the loan, and won’t move with the market.
What’s the deal?
Honeymoon loans are generally only offered to new borrowers, meaning that someone who already has a loan with the lender is usually not eligible. While these loans are popular, there are a number of things to consider. Most of these loans will ‘roll over’ (revert) to the standard variable rate after the introductory period. This means that any benefit you may have had by way of a cheap rate may be negated by the fact that you might now be paying what is generally the most expensive rate in the lender’s variable suite.
Some lenders may also ‘cap’ or limit the amount of extra money you can pay off the loan during the introductory period, which, in turn, may limit the benefit of having the introductory period.
If you take out an introductory rate loan you may want to consider making repayments at the roll over rate (if the loan product allows it) rather than at the introductory rate. This will get you into the habit of making repayments at the higher amount, so you won’t have to change your lifestyle significantly when your introductory period is finished. It also allows you to build up equity in your property a lot faster.
The sting in the tail
Another important point to keep in mind when considering cheap loans with introductory periods is that the lender is generally not going to let you get out of the loan at the end of the introductory period without charging a significant penalty. The lender has got you in the door, after all, and they want to keep you on their books.
Borrowers trying to exit a loan at the end of the introductory period, or shortly after it, can be charged a fixed amount, for example $1,000. Some lenders charge a percentage of the original loan amount if the loan is exited within the first two years – 2.5% of the original loan amount, for instance.
Borrowers planning to take advantage of the honeymoon rate then get out of the loan should look into the possibility of doing this before they enter the loan. Getting out after the introductory period is unlikely to be a painless process.
Don’t be dazzled
Borrowers should be careful not to be dazzled by glitzy honeymoon offers. While some of them can have their uses in particular circumstances, it is important to remember the honeymoon rate is usually just 12 months and the loan can last anything up to 30 years.
A conservative strategy to avoid getting caught in a honeymoon loan trap is to look for a loan which lasts for the term you plan to borrow for. For example, if you plan to repay the loan over 20 years, look for a loan of this duration. After you have chosen one, see if an introductory offer is available. If there is, consider the honeymoon period a bonus.
Using comparison rates can also prevent getting lured into a bad deal. However, it is important to realise that a lot of information relating to the loan is not captured in the comparison rate.
The comparison rate does not incorporate a loan’s features which has a direct impact on the effective rate of interest paid.
In the end, the key to successfully selecting a good cheap loan boils down to understanding what you want in a loan and properly researching the market before making a decision. You can find a listing of introductory and standard loans in the home loan tables at the back of this magazine or on the Your Mortgage website, www.yourmortgage.com.au, which is updated daily.
This, as the name suggests, is a type of loan you might come across if you’re starting from scratch with your home.
When building a new home, you will not need the entire amount of the loan drawndown all at once. If you did this, you would be making interest repayments on the entire amount right from the start and not just on the amount needed at the time. Construction of a dwelling is generally divided into five stages. These are as follows:
- Purchase of the land
- The pad (floor – also known as ‘bearers and joists’ for wooden floors)
- Roof (usually including frames)
- Lock up
With a construction loan, you can break up the drawdown of the loan amount into five progressive draws, which parallel the construction phases. As one phase of the construction is complete, you are able to draw down the next portion of the loan.
This means that interest is only being calculated on that amount which has been physically drawn down, and you are only making repayments on the portion you have used. When construction is complete, you can nominate which product or loan type your loan reverts to.
Most lenders will normally lend only around 60-65% of the land value for purchase, and this is usually done as a land loan. Recently, however, some lenders are lending up to 90-95% of the land value, so it is a good idea to check with your lender how much they will lend.
When you decide to build and apply for a construction loan, the lenders will need to see, at minimum, councilapproved plans and a fixed-price building contract, before they will unconditionally approve a construction loan.
If you have borrowed to purchase land and are looking to obtain a construction loan, the value at which most lenders will estimate the completed package will be based on the value of the land, plus the cost of the building materials for the dwelling. For example, if your land has been purchased for $150,000, and the cost to build was estimated at $80,000, the lender would put the total value of the house and land at $230,000. An identical ‘completed’ house on an identical piece of land next door to you may be worth $300,000.
If you need to borrow more funds for improvements such as landscaping, you may be able to get your property revalued by your lender once the building is complete.
After each phase is finished, a valuer will normally go out to inspect it to make sure that the phase is complete according to the requirements set out in the fixedprice building contract. Once the valuer is satisfied, they will contact the lender and authorise the next payment.
If you are concerned that you may need to pay contractors before the set phases are done, you may want to consider obtaining a very small line of credit as part of the loan. That way, you will be able to pay any urgent bills from the line of credit before the appropriate phase is complete, and then pay your line of credit balance to zero from the construction loan, once the relevant phase is complete and the money has been drawn down.
To ease the financial burden during the construction phase, construction loans are usually interest-only. The interest rate may be slightly higher than that charged on normal residential loans, but should be less than that of a line of credit/equity rate.
Construction loan application checklist
Most construction finance applications are assessed according to the standard process and many of the same documents are required, along with a fully completed ‘build pack’ (or ‘Bank Pack’) which includes:
- Signed fixed-price building contract between borrower and a licensed builder Tender
- Stamped, council-approved building plans
- Copy of builder’s insurance policy Must-have features
- Interest-only repayments during construction and a switch to principle and interest repayments thereafter
- The ability to make extra repayments
- Flexibility – including redraw during the construction period. Will you able to switch to a more flexible product upon completion of construction? Some lenders offer a 100% offset account linked to the home loan, which is a handy feature as it allows you to save on interest by parking any cash to this account
Saves interest Because interest is calculated on the outstanding balance, not the maximum loan amount which has been agreed to, you are paying less interest on the loan. For example, if the lender has agreed to lend you $200,000 but you have only drawn down $100,000 to pay for the land and $25,000 as an initial payment to the builder at this point, you are only charged interest on $125,000, not $200,000.
During construction, loan repayments are interest-only, payable only on the amount of the loan that has been drawndown, which means lower repayments.
Peace of mind
The fact that payment is delivered to the builder in stages means that cash is not paid out until the builder’s work can be inspected and approved by the borrower.
“A benefit of a construction loan is that a valuer will inspect each stage of your construction on behalf of the lender before they approve each progressive payment,” says Martin Castilla, finance broker for Smartline and guest lecturer at The Property School. “This means the lender is ‘double-checking’ the builder’s work and what they are invoicing for. It can provide some peace of mind for the new owner.”
The borrower can borrow against the value of the property as if it were completed, as opposed to borrowing only against the value of the land or the current property.
This saves the borrower time and money in terms of going back for more cash in case the fund runs out during construction.
Another product type you’ll find heavily marketed is the ‘professional package’.
Most of the major lenders will offer special packages for borrowers taking up $250,000 or higher, although some form of discounts are available on mortgages from $100,000. Originally designed for higher income earners or borrowers in a specific profession, products and services were bundled up as a special package and the term 'professional package’ was born (since shortened to pro-pack).
Of course, time has moved on, and just about anyone who can afford it can now access these products, although the term pro-pack stuck. Generally speaking, a pro-pack includes:
- Interest rate discounts on variable rate home loans
- Up to four credit cards with no annual fee
- Free or discounted offset and savings accounts
- Discount on insurances including building, income protection and landlord protection insurances. Some even offer discounted car insurance
- Fee waivers or reductions on valuations, top-ups and switches
The central component is a home loan, which will need to be over a certain amount to qualify, that figure is usually relatively low at around $100,000 for some lenders. The banks will allow you to slot their existing fixed or variable loan products into the pro-pack and give a discount on the prevailing standard variable rate. The discounts range on variable loans are anywhere between 0.1% and 1% depending on the size of the loan – the bigger the loan, the greater the discount.
For example, if a client is borrowing more than $250,000 with a specific lender, they may be eligible to get a discount of 0.50% off the standard variable rate for the life of the loan.
If however, they were to borrow under $250,000 with that same lender, they may only be eligible for a 0.20% discount off the standard variable rate for the life of the loan. While propacks are available regardless of your loan amount, discounts are often not worth the money for loan amounts below $250,000, due to the high monthly or annual fee you will be required to pay.
Banks tend to offer a wider selection of financial products than non-bank lenders, so the package is designed to attract as much of the customer’s business as possible. Expect higher rates on term deposits, depending on the amount deposited and length of time deposited for. There may also be discounts on financial advice and margin loans, which are used to invest in shares and managed funds. You could also be eligible for discounts on life insurance, income protection, home insurance and insurance you have on investment properties.
One or two lenders have been known to pay the mortgage insurance premium on a loan, instead of reducing the rate, as part of a professional package. Some lenders are also waiving the annual fee in return for a slightly higher interest rate. The key thing to remember is that the structure of a pro-pack is different with each lender, the more business you have to do with them, the more likely it is to be flexible, so explore your options.
The professional package can generally only be packaged with the standard variable rate loan the lending institution offers. It will usually be the loan with all the bells and whistles, and by getting a discount off the rate, you should be getting a pretty good deal. The question you need to ask is: ‘Do I really need all the bells and whistles?’ The same lender might offer a more basic product that suits your needs and will be cheaper, by way of interest rates and fees, than the discounted variable rate loan under the professional package.
IS PROPACK FOR YOU?
It is dangerous to generalise, however, you can use the following criteria to determine whether a pro-pack might be the right option for your situation A pro-pack might not be the best deal for you if:
- You are borrowing less than $250,000
- You only have one security property
- You have no personal borrowings
- You don’t use a credit card
- You have no plans to make any
changes to your loan structure Nevertheless, even if you fit into the above category, it is always prudent to crunch the numbers, just to be sure. On the other hand, you might be suited to a pro-pack if:
- You are borrowing more than $250,000
- You are likely to make changes to your borrowing
- You use a credit card
- You require more than one split
- You want to add some fixed rates into the mix
Source: Mates Rates Mortgages
Another of our common specialist products is the low document or ‘lowdoc’ loan. These have been available in Australia for a number of years. Initially, they were only offered by non-bank lenders but as traditional banks began losing market share in this area they included them in their range of lending products. They fell out of favour somewhat during the GFC, but are returning to the market as confidence grows.
There are some major differences between mainstream and low-doc lenders. The main one is that low-doc lenders do not require traditional proof of income such as company financials or tax returns. Instead, borrowers generally complete a declaration that confirms they can afford the loan. This is known as self-certification. These loans are particularly attractive to self-employed or full-time investors who may have difficulty showing a high level of income, as a result of either writing off a number of expenses, reinvesting profits into a business, or being slow in lodging their tax returns.
“Low-doc loans are a flexible solution for self-employed people who have income and assets, but are unable to provide the required financial statements or tax returns at the time of application,” says Andrew Clouston, managing director of Club Financial Services. “However, borrowers should be aware that interest rates and fees are higher with low-doc home loans. Lenders mortgage insurance (LMI) fees often applies and they are usually capped at 80% of the valuation of the property.”
Indeed, one of the key components of a low-doc loan is the lenders mortgage insurance. LMI essentially protects the lender against any loss should the borrower default on the loan. While traditional loans typically require LMI if you are borrowing more than 80% of the property’s value, low-doc loans often require LMI if you are borrowing more than 70% – and in some cases 60%.
Borrowers wishing to obtain a low-doc loan will normally need to satisfy three main requirements:
- Self-certify their income
- Confirm their self-employment status (if appropriate) – usually with a registered ABN or accountant’s letter; and
- Have a clean credit history and good repayment record for existing or previous loans
Low-doc borrowers should be aware that as there are only two mortgage insurers in Australia, any income declared in an application with one lender might affect any future applications with another lender or mortgage insurer. If the declared income is substantially different on subsequent applications, the mortgage insurer may question the discrepancy.
Credit-impaired potential borrowers should approach lenders who offer nonconforming low-doc products to see if they qualify. Most low-doc lenders will consider switching the borrower to a full-doc product at no cost, when the borrower can provide the traditional forms of income verification.
Low-doc and non-conforming loans
It is important to be aware of the distinction between low-doc and nonconforming loan products. While both waive the requirement to view and retain copies of the applicant’s tax returns and financial statements, low-doc loans are almost exclusively available to those with an unblemished credit history, are mortgage insured, and generally do not want to borrow more than 80% of the security’s value.
Non-conforming loans, meanwhile, are mortgages that do not conform to a lender’s typical loan underwriting criteria. This may include situations where the applicant has a poor credit history, or who may not have been employed long enough to show a history of earning an income. Nonconforming loans may exceed 80% of the security’s value and the interest rate is based on the severity of the credit history.
A low-doc loan is made to a borrower with a clean credit history. Therefore the most important factor for the lender to consider is the value of the asset being used as security.
Because the asset is vital to these loans, the location of the security is also imperative. Hence insurers and lenders alike may not lend in high-risk areas such as inner-city high-rises or large rural allotments.
OTHER COMMON LOAN TYPES
There are a number of other loan types that the first-time buyer may not come across, but are still useful to know about.
In many cases, vendors (sellers) putting their homes on the market will be selling with the intention to purchase another property, or buyers may be waiting for completion of the sale of an existing property prior to buying a new one.
If there is a mortgage on either of the existing properties, things can get a little tricky if the sale of the existing property will not take place until after settlement of the new one. To ease the strain and allow completion of purchase for the new property, ‘bridging finance’ may be arranged.
Bridging finance allows you to obtain finance to ‘bridge’ the gap between having to pay for a new property and receiving the proceeds from the sale of your existing one.
What will normally happen is that a lender will take security over both properties until the sale of the existing one is complete. Usually the bridging amount or ‘peak debt’ will not be allowed to be above 80% of the value of both properties.
Some lenders will allow you to capitalise the interest payments (add them onto the loan) for a period of time or until the 80% limit is reached, to ease the financial burden on the borrowers. The bridging loan is usually separate from the lender’s normal products, and may be slightly more expensive, however the borrowers nominate which product their loan defaults to after the bridging period is over.
When you sell your existing property you just pay the proceeds from the sale off the balance on the bridging loan, and revert to your nominated loan product.
Line of credit/equity line
A line of credit is similar to having a big chequebook, however with interest accruing on the balance. A line of credit, or equity line as they’re sometimes called, is an approved limit of borrowings that you can use a piece-at-a-time, or all at once.
Let’s say you have a line of credit of $200,000. This means that you can use up to a total of $200,000 all at once or perhaps invest $50,000 in the share market. If you did the latter, you would only pay interest on $50,000, as the remaining $150,000 would be untouched. If you were to use a further $70,000 for house renovations, for example, then you would be paying interest calculated on $120,000 ($50,000 for shares + $70,000 for investment), leaving $80,000 to use at a later date if required.
“A line of credit loan facility can be a great way to access the equity in your home and can be used for things like home renovations, investments or other personal purchases,” says Clouston. “It acts as a loan, but, unlike a loan, a line of credit doesn’t require you to pay interest on the credit you don’t use.”
The reverse mortgage loan was introduced to the market to cater for retirees wanting to take advantage of the equity they have in their home and use it to supplement their retirement income. Basically, retirees can use this type of loan to borrow money against the equity they have in their property, and have it paid to them in either a lump sum or in instalments, depending on the lending institution involved.
Generally all repayments, fees and charges will be added to the loan balance each month so that the borrower/s don’t have to make any payments whatsoever. The lender recoups the repayments and fees when the borrower/s pass away, the property is sold or the borrower/s no longer live in the property. Having said this, generally the borrower/s may make payments at any stage if they wish to reduce the loan balance.
There will normally be a minimum amount of around $10,000 and quite often a maximum allowed that will be expressed as a dollar figure, or as a percentage of the value of the property. To qualify, the borrowers will generally need to be over 65 years of age. Some lenders will wear the risk if the end debt amount is more than the property is worth, however this will vary from lender to lender.
These loans are obviously great for older people who may be doing it a little tough financially after retirement, or who may need a large amount of money in a relatively short time for a dream project such as a caravan trip to the Outback or a luxury cruise.
One thing to be wary of is the ‘all care, no responsibility’ method of repayment. Basically, the debt is left to the beneficiaries of the borrower/s to pay, which might come as a nasty surprise to beneficiaries expecting a ‘clean’ inheritance.