Common Mistakes When Choosing the Right Mortgage
Choosing the right mortgage structure is more important than many people realize. Not only can choosing the right mortgage type, the correct structure, and the right payment options could all cut years off your home loan. They could also save you thousands of dollars in interest and money back into your pocket.
Therefore choosing the right advisor to guide you with this decision making process is fundamentally important.
Here are some common mistakes people make when it comes to choosing the right mortgage.
Too often the first mistake lots of people make is just applying for any old home loan to purchase the house they want without thinking about anything else. Let’s face it; you just want to buy that house.
Once you’ve acquired the house, your primary focus then shifts to moving in. By the time the dust has settled, it’s likely you’re not even thinking about the home loan anymore.
It could be 3 to 5 years when a fixed period is up for renewal or you have decided you want to redraw from some equity that you might eventually review your home loan.
The second most common mistake people make is staying loyal to the bank you’re currently with. If you choose to deal directly with a bank, you might have a good understanding of the loan products and interest rates they offer, but you won’t be aware of what else might be available from other lenders.
Obviously, banks only sell their own products. However, each bank differs in their time cycles in terms of their ability to offer funds. Essentially this means some banks are able to offer better rates and products than others at varying times throughout the year, depending on their source of funding.
Staying loyal to your current bank without comparing other options available could mean you won’t have access to the right loan type, most competitive interest rate, or service. Imagine if you applied for a home loan with your current bank and their ability to access funds was limited at that time. If your application was declined, would you still shop around for another lender, or would you just give up on getting a mortgage?
Your willingness to shop around and see what other lenders have to offer could be the difference between buying a home and not!
Once you have decided you want a home loan, it’s wise to decide on the right payment type to suit your needs. Many investors automatically request that their investment loans are set to interest only in an effort to maximize tax deductions. There are also plenty of owner occupied borrowers who want to make interest only payments on their home mortgage too.
However, since APRA’s changes in 2017 interest only loans are becoming more difficult to access. In many cases borrowers now need lower loan to value ratios and higher servicing in order to qualify for interest only loans.
As a result, more and more people are being switched to principal and interest payment options.
With an interest only payment option, you only pay interest charges that have accumulated on your outstanding loan balance each month. You don’t actually pay anything off the loan amount at all.
By comparison, a principal and interest repayment is broken into two components. The first component covers the interest charges due and the second portion pays down your loan balance a little.
Keep in mind that if you stay on interest only repayments for a few years and then decide you want to switch to principal and interest repayments, your monthly payment amounts could end up being a lot higher than you anticipated.
For example, let’s say you have a 30 year home loan and you’ve stayed on interest only payments for the past 10 years. Your mortgage balance would be exactly the same as it was when you first borrowed the money, as you’ve only being paying the interest costs all that time.
When you do decide to switch over to principal and interest payments to start paying down the loan, the repayments need to be calculated over the next 20 years – not 30 years. The result is that the principal component of each payment you make will need to be much larger in order to pay off your loan balance in the remaining time left on the loan term.
Another mistake a lot of home owners make when choosing a mortgage is not thinking about how their mortgage type could affect their long term goals. If your primary goal is to pay down your home loan as quickly as possible, choosing the right loan type and payment structure can be an important decision.
In order to make a real impact you have a few options available. You either need to make extra repayments to help reduce your mortgage balance a little faster, increase your payment frequency from monthly to weekly or fortnightly, or link an offset account to your home loan account to help reduce the amount of interest you pay each month.
Interestingly in the first 5 years of a home loan, the principal reduction can be negligible. If your goal is to try and pay down your home loan as quickly as possible, it’s important to be sure you buy in a price range you can easily afford so you’ll be able to make extra repayments without breaking your budget.
Before you decide on a type of home loan, take a bit of time to look at the loan features and work out whether you might need them over the next 30 years. As an example, you might want to think about whether you’ll need to access your home loan redraw facility. Some banks may charge a fee to redraw your own money from your home loan.
An offset account is different to a redraw facility. With a redraw facility, you can sometimes withdraw any extra repayments you’ve made that were sitting in your home loan account.
By comparison an offset account is just the same as a regular transaction account, with the addition of being linked directly to your mortgage. You can have your salary paid into it and arrange for direct debit payments to come out of it. You can also leave your savings in the account, which actively helps to reduce how much interest you pay on your home loan.
Far too many people shop around for the cheapest possible interest rate and don’t tend to look much further into what their loan type could mean in terms of achieving their goals. Before you make a decision about which home loan you apply for, take the time to discuss the options available with a good mortgage broker.