With so many loans offering countless add-ons, it’s difficult to know what features – if any – to go for. Your Mortgage looks at the most popular features currently available.
W hen looking at home loans the lure of extra features can be strong. Features such as offset accounts and redraw facilities can also cloud comparisons of different loans. To find the loan that will actually save you money in the long term, you’ll need to consider what each add-on means and what you’ll pay for it.
If you want additional features, generally you will pay the price through a higher interest rate, so it makes sense to hunt around for the lowest rate loan that has the features you require. In all likelihood, paying 0.5% more for a loan with features that will in theory save you money will actually end up costing you more in the long run.
The first step is to understand the features on offer and make an informed choice as to which ones you need.
1. Redraw facility
Making extra payments on your loan is a great way to reduce the term of your loan and thus reduce interest. Paying an extra couple of hundred dollars each month could knock five or six years off a 25-year mortgage and save you thousands over the term of your loan. But what happens if you find that by making extra repayments you’ve left yourself short of money? A personal loan can further complicate matters, and the credit card route is not the way to go. A redraw facility may be the answer. This allows you to withdraw your extra payments should you ever need to.
A redraw facility is useful because if you’re paying anything over the minimum repayment you’re building up redraw. It’s essentially a safety net because many borrowers – especially first homebuyers – often don’t have much money left after they’ve purchased.
Any extra repayments you make above and beyond the minimum are available for you to redraw in one hit to pay for a bigger purchase – a car, for example.
A redraw facility can be a valuable feature because it allows you to make additional repayments (reducing the total interest you pay on the loan) with the knowledge that you can access the money at a later date, should you need to.
|What is it? A loan feature that allows you to make additional payments and then access those funds when required.|
|Best suited to: First homebuyers|
How much does it cost?
Redraw facilities also come at a cost and a number of basic variable home loans don’t even have them. Factors that need to be considered include:
- cost of activating the redraw facility
- number of free redraws per year
- fee per redraw
- maximum number of redraws per year
- minimum redraw amount
- maximum redraw amount
Before you even access a redraw facility, some lenders charge you for simply activating it. Fortunately, you only need to pay this fee once, and that’s only if and when you decide to use the facility. You may want to use this as an ‘emergency fund’ where you put any spare money you have. While there may be a fee involved in accessing these funds, they are better occupied reducing the size of your outstanding balance than sitting in a transaction account or in your back pocket.
The number of free redraws per year is the number of times each year you can withdraw additional home loan repayments you have made at no charge.
Once a borrower has used the quota of free redraws they are charged a set fee for each additional redraw made. For example, if you are permitted four free redraws per year and the fee per redraw is $50, you will be charged $50 when you make your fifth redraw and $50 for each additional redraw during the year.
Redraw fees usually vary from $15 to $50 with a number of lenders not charging for redraws at all. The maximum number of redraws per year ranges from only two to an unlimited number.
The minimum redraw amount is the smallest amount a borrower can withdraw at a single time. This feature is important in determining the true flexibility of a loan. Many lenders offer no minimum redraw, while others offer minimums as high as $4,000. This type of reduced flexibility is the distinguishing point between all-in-one accounts and loans with a redraw facility.
The maximum redraw amount is typically the total amount of additional repayments that have been made, although some lenders reduce this amount by an amount equal to one month’s payment.
Ultimately, redraw facilities are not designed for frequent use and the restrictions mentioned earlier illustrate the complications involved in trying to use a redraw facility in this way. Redraw facilities are designed to allow you to make additional payments when possible, knowing that access to these additional funds is available, should it be required.
So, for example, if your loan balance is $120,000, in a regular home loan account interest would be calculated on a daily basis and charged to the account each month on that full amount. If you have a 100% offset account, where you place all your earnings, and the balance of your savings is, for example, $10,000, that money acts to reduce the balance on your home loan. Rather than earn interest on the $10,000 at the current term deposit rate (which is always lower than the interest charged on your home loan), the money in the 100% offset account effectively reduces the balance of your loan, so you only pay interest on $110,000 at, say 5%.
|100% offset account|
|What is it? A separate savings account run in conjunction with your home loan. You receive no interest income from accumulated savings; instead this amount is offset against the loan balance.|
|Best suited to: All borrowers|
Partial offset loans
The poorer cousin of the 100% offset account is the partial offset account. When you put cash into a partial offset account, you only offset at the interest rate applicable on that account, which by definition is less than the interest rate on your loan.
Using the same example as above, if you have a home loan balance of $120,000 and have $10,000 deposited in a partial offset account, that money still acts to reduce the balance on your home loan.
However, the deposit account may only be earning interest of, say 2%. In other words, you will be paying 5% interest on $110,000 and 3% on the $10,000. Why only 3%? This is the loan rate of 5% less the offset rate of 2%.
To best use an offset account, it needs to become the main financial product that you use. Having separate cheque and savings accounts only reduces the effectiveness of the product, so if you require facilities such as a cheque book, ensure that these are available with the loan product that you choose.
Using a credit card with interest-free days is one of the most effective ways to take advantage of offset accounts.
With a large number of lenders offering credit cards with up to 55 days interest free, you effectively gain 25 interest-free days from the date on your credit card statement. Regardless of when in the statement cycle you make a purchase, you are still able to take advantage of the interest-free days. Purchase on the day before you receive your statement and you will get approximately 26 days interest free, and purchase the day after the statement is sent and you will receive the maximum interest-free days.
The strategy is to make as many purchases on your credit card as possible and pay off the total balance before the end of the interest-free period. This leaves as much money as possible in your home loan account for as long as possible. The balance of the loan account is kept lower until the payment is made and the resulting interest charged on the loan is reduced. In effect, you are keeping the size of the loan down by transferring your expenses to your credit card and then using the features of the card to delay payment for as long as possible.
With the credit card, if you spend the bank’s money, it allows you to keep your monthly income in the offset account that much longer and all you have to do is pay the credit card off the day before the interest is due.
Offset accounts only work when your account has substantial funds in it; otherwise, the savings will be minimal. Essentially, it’s worthless if you don’t have money in it.
As an example, if you have borrowed $100,000 at 6.5% for a 25-year loan, you would be making monthly payments of approximately $675. To earn just one extra monthly payment of $675 each year from your offset account you would need to deposit $10,384 into the account and leave it untouched for a full year. Even if you earn the interest at the same rate as you are charged interest on your home loan – ie 100% offset – this is still tough to achieve.
WITHOUT OFFSET ACCOUNT
Loan size: $300,000
Term: 30 years
Interest rate: 7% pa
Savings account balance: $10,000
Interest rate: 5% pa
Interest rate paid: $300,000 x 7% = $21,000
Interest gained on savings: $10,000 x 5% = $350 (before tax)
Net interest cost: $21,000 – $350 = $20,650 per year
Interest on your savings account is also subject to a government tax depending on your income bracket, so the net interest savings are even lower.
USING OFFSET ACCOUNT
Loan size: $300,000
Term: 30 years
Interest rate: 7% pa
Offset account balance (100% offset): $10,000
Total interest saved: $62,661.69
Loan term cut by three years: Payable in 27 years instead of 30 years
Additional savings: Original $10,000 in offset account
By simply keeping $10,000 in the offset account you are able to reduce your interest payment by $62,661.69 and cut the loan term by three years. The interest gained through the offset account is also tax-free because it’s linked to the mortgage account. The added bonus is that you still have the original $10,000 you kept in the offset account.
A portable loan means you can keep the loan when you sell your home or investment property and purchase another. Doing this is sometimes referred to as security substitution. A portable loan with a low portability fee is going to be more valuable to someone who expects to move home frequently.
There are usually a number of restrictions on portability concerning the values of the new and old property and the settlement dates on the two properties. You need to ask your lender or broker what these may be. To keep your loan when you sell your old property and purchase a new one, you generally have to pay a portability or security substitution fee. This can be anything up to $500, occasionally more. However, some lenders may waive these fees so it’s worth checking before you settle on a mortgage.
Portability is often touted as a handy feature to have. This allows you to keep the same home loan when you buy a new property and sell the old one. However, with various fees and charges (mortgage registration fee, valuation charges, fee for transferring the loan to the new property), a portable loan may end up being just as expensive as refinancing. In reality, this feature is only useful when there is simultaneous settlement – which doesn’t happen that often – and when the new loan amount is the same as the old amount.
4. Additional repayments
The ability to make additional repayments can lead to substantial savings in the total amount of interest you pay over the term of the loan.
For example, if you pay even just an extra $50 per month on your $300,000 loan taken over 30 years, you will save $23,291 in interest and slash two years off your loan term.
5. All-in-one accounts
An all-in-one loan is effectively the combination of all your savings and cheque accounts into one loan account. All-in-one loans allow you to have all your earnings placed directly into your loan account.
Amounts above the minimum repayment can then be accessed from the loan account just like a day-to-day transaction account.
This means that the money which would normally be sitting in your daily transaction account earning precious little (if any) interest can be saving you money on your home loan instead.