“You’ve got to be realistic. Go in thinking about the repayments that will have to be made after the honeymoon period has expired” Warren O’Rourke, Mortgage Choice
“If you can make more than your basic repayment always do it. If interest rates drop, leave your repayments where they were. Build yourself up a bit of a buffer” John Rolfe, BankWest
“You should be able to see from the comparison rate what you’ll be paying for the term of the loan – not just the introductory period” Anne Thanudchang, ProPex
Think of the word honeymoon and you might conjure up romantic images of candle-lit dinners or sipping cocktails in an exotic location. Now think of honeymoon rate home loans and equally appealing images should come to mind. Offering respite from the harsh reality of high interest rates for a set period of time right when you need it most – at the start of your loan term – these loans are an enticing proposition for certain borrowers, particularly first homebuyers.
The thing is, we all know that a honeymoon has to come to an end. So what happens when your honeymoon rate period finishes? What should you be aware of to ensure the perfect match that you (hopefully) have with your home loan doesn’t turn into an ugly and expensive divorce?
Getting to know you
As the name implies, introductory rate loans offer a lower interest rate, usually for a period of six or 12 months. The average reduction is 0.5–1.0% off the standard variable rate (SVR), but this can vary between financial institutions. At the end of the introductory or honeymoon period the interest rate reverts to the institution’s SVR.
Most lenders will offer a choice of fixed or discounted variable rates over the term of the introductory period (capped rates may also be available). The variable introductory rate is tied to the SVR; for example, the discounted rate may be 1.0% lower than the SVR. However, if the SVR shifts from 7.25% to 7.50%, the discounted rate will also increase from 6.25% to 6.50%. On the fixed introductory rate front, borrowers can be looking at a rate between 6.29% and 6.57% for one year – compared with 6.95–7.60% for a standard one-year fixed rate.
“We offer a 12-month fixed and a 12-month discounted variable where we provide a discount on whatever the current variable rate is at the time,” says John Rolfe, head of mortgages at BankWest. “Generally if you’re in a position where you think interest rates are going up you’d look at the fixed option. If you think they will reduce in the next 12 months you may be better off going with the discount variable.”
Loan features will vary from lender to lender. While some will limit the features, such as the ability to make extra repayments during the introductory period, in most cases your introductory rate loan will have the same features as the loan it will revert to at the end of the introductory period. “We treat it as if it’s a variable rate loan – whatever the product it’s going to roll to at the end,” says Rolfe. “If it’s going to roll over to one of our Gold Home Loan rates for example, we would treat it exactly the same.”
Match made in heaven?
Introductory rate loans were introduced into Australia in the early 1990s, and banks used them as a lure for new customers. Today, while their popularity has waned, they are still a popular choice for borrowers entering the market. “When people start out there are so many fees they have to pay – stamp duty, legals, mortgage insurance,” says Anne Thanudchang, director of ProPex. “A lower interest rate for the first year can help out just a little bit.”
There are countless reasons why a low rate intro loan might be useful. “It’s a good entry option for some people,” Rolfe says. “You might have a situation with a husband and wife where at present they’re restricted in terms of income but in 12 months time they’ll be in a better position, so it may be better for them to take an intro rate.”
The appeal for first homebuyers is undeniable. “They can be great for first homebuyers or those who want some spare cash during the first year because they’re renovating or starting a family,” says Steve Blinkhorn, head of home loans at St. George Bank. “The proposition there is that while you get used to having a mortgage your repayments for the first 12 months are a bit lower.”
The money saved in that first year can be put to good use, like furnishing the home, renovations or, as Thanudchang says: “If you’re on an intro rate of 5.99% you could put any money saved into a higher interest bearing bond which earns 7%, or into shares which could earn up to 13%.”
However, the goal of many homebuyers is to pay off their loan as soon as possible, so any opportunity to make extra repayments should be grabbed with open arms. You can take a big bite out of your mortgage by making repayments based on the rate the loan will revert to.
“Many borrowers would be better off commencing their association with their mortgage from day one with the higher repayments,” says Warren O’Rourke, national manager, corporate affairs at Mortgage Choice. “If they make the higher repayments from day one then obviously they’re contributing to a reduction in interest and also a reduction in terms – which all makes sense.”
Rolfe agrees with this approach. “The same sorts of rules apply for any housing loan. If you can make more than your basic repayment always do it. If interest rates drop, leave your repayments where they were. Build yourself up a bit of a buffer.”
Trouble on the horizon
As always, there are things to look out for. Chief among these will be the revert rate. This is the rate that the loan returns to after the introductory period finishes. You’ll need to make sure that this rate is not so high that it wipes out any savings made during the introductory period, and keep in mind that this is likely to be the rate you’ll be stuck with for years to come.
“A lot of people are naturally driven by price,” says O’Rourke. “When they look at what they’re paying in rent compared with what they’re paying in mortgage repayments, the difference can come as a bit of a shock. But that can be a short-lived thing so you’ve got to be realistic. Go in thinking about the repayments that will have to be made after the honeymoon period has expired.”
The criticism of these loans is that they encourage bad spending habits, as borrowers get fooled into thinking the honeymoon will last forever. “People get used to making a repayment, particularly first homebuyers,” says Rolfe. “You’re getting a great rate in your first year and you might be making a repayment of somewhere around $1,200 a month and then all of a sudden it jumps up to $1,400 and you’ve got to find that extra $200. As human beings we’re brilliant at spending what we’ve got but we’re not really good at reining back when we should.”
There are also a number of fees to be wary of – primarily in the form of exit fees and switch fees. Sometimes breaking a loan term early is unavoidable: for example, if you receive an overseas work posting shortly after moving in to your new home. It’s therefore important to know what you’ll be charged.
Generally, if you decide to pay out or refinance any loan within the first three years you will be charged an exit fee. This will vary between lending institutions – some will charge a flat rate and others a percentage of the loan amount at the time of the discharge. “Some institutions in the first year will charge you a 4% exit fee. In the second year it will be 3%, the third year 3%, the fourth year 2% and then nothing after that,” says Thanudchang. “But on a $500,000 loan – the average price of a property in Sydney – 4% of that is $20,000. That’s a fair chunk of money – are you prepared to pay that?”
A switch fee may come into play if you choose to roll over into a fixed rate rather than a standard variable rate after the honeymoon period, simply because the variable option is the one the lender would expect you to take. Again, the switch fee will be either a set fee or a percentage of the loan balance.
But don’t despair, you may be able to use this to your advantage. As the lender would have worked hard to get you onto their books, you may be able to negotiate a better deal to stay onboard. “In 12 months’ time you may be in a better position financially, so it may be possible to then go back to the bank and negotiate whether you can transfer to another product that may be more suitable for your needs,” says Rolfe.
Comparison rates can provide a useful (if not all-inclusive) overview of the cost of a loan. “The true cost of a loan should be transparent,” Thanudchang says. “You should be able to see from the comparison rate what you’ll be paying for the term of the loan – not just the introductory period.”
There’s been debate over the true value of comparison rates, and indeed countries such as New Zealand have removed them altogether. “There are a number of schools of thought on whether or not comparison rates work,” says Rolfe. “Several countries have removed them on the reasoning that they added no value and actually confused people. I actually think they’re fine, as long as they measure everything.”
Blinkhorn echoes this sentiment. “Comparison rates are helpful but they don’t include every fee,” he says. “They’ll only include fees that are ascertainable at the time the contract was struck between the lender and the borrower. What they won’t include are things like early termination fees, switch fees, etc. We also encourage customers to have a close look at their contract.”
As with any loan, thoroughly check all documentation, and be aware of all the rules and regulations. “We do have it written into the loan contract that we have to tell people what their interest payments will be after that introductory period ends,” Rolfe notes. “But mortgages are a necessary evil – no one goes out to buy a mortgage for fun. They’re something that’s required to purchase a home, but perhaps people don’t pay as much attention to the documentation as they should.”
Plenty of fish in the sea
With so many competitive loan products out there, do introductory rate loans still hold a place in the market? or are consumers better off pursuing other options? “The basic loan is going to be a better option for the customer who wants a lower ongoing rate but fewer features,” says Blinkhorn. “Generally what’s not available on basic loans is interest offset, but the trade-off for that is a lower ongoing rate.”
Both Thanudchang and Rolfe favour straight-in variable loans as a viable alternative as they provide more flexibility, and, if you are prepared to shop around you can get them at a competitive rate. “They used to be the basic or no frills loan but over time things have been added to them, even free redraw,” Rolfe says.
Clearly introductory rate loans are here to stay, even if they are less popular now than they were 10 years ago. Importantly, they provide a helping hand to first homebuyers so they will always be a valid option. To make the most of them, however, it’s a matter of determining what the revert rate is, the fees and charges for early termination, and being disciplined enough to use any savings wisely.