Effective ways to manage home loans better by Alok Das

(Disclaimer: This article is intended to deliver some general pieces of information only. Your situation may not necessarily relate to what is contained in it. Before making a decision regarding your home loan, it is recommended that you seek professional advice.)

Background

Having one’s own home is the most common Australian dream. This dream, in most cases, is achieved through a home loan. In addition, when people want to purchase investment homes that is also achieved through a home loan, often referred to as ‘Investment loan’ or ‘Investment home loan’. In this article I have discussed some ways that you can use to manage a home loan better. By the words ‘manage a home loan better’ I am referring to a few techniques you can use to:

1. decide where to start from
2. decide on the loan amount
3. save on loan fees and charges
4. decide on the correct loan type for you
5. select your repayment options
6. pay less in interest
7. pay off your loan earlier than the contracted time
8. arrange a risk management plan to protect you in certain times
9. select a service provider
10. plan a gearing strategy.

Where to start from

For home purchases, banks do not fund 100 per cent of the purchase value: you have to have some savings or equity in an existing property. Start by checking with a bank as to how much savings you need to be able to go for your desired / required loan amount. If you have not started saving yet, start doing so. Do not be upset if you find that your savings are not enough for the moment and you will need more time to build your savings. An ancient Chinese adage says, “All long journeys start with a small step”.

How much should you borrow?

Let us start with ‘how much should I/ we borrow?’. While making a decision regarding the loan amount please take into consideration other related expenditures, such as:

1. Council rates
2. Strata fees (if applicable)
3. Stamp duty (if applicable)
4. Home and/or contents insurance premiums
5. Risk Insurance premiums, e.g. premiums for:
a) Loan protection, or
b) Income protection, or
c) Any other risk insurance plan.

The banks/ lenders can assess how much you can borrow, but do not necessarily take that amount as the final amount you will be able to borrow. The first thing you should be looking at is calculating your budget that also reflects the loan repayment, council rates fees, home and/or contents insurance premium. How much of your single or combined (in case of joint borrowers) income can you afford to use towards the repayment? Does it force you to compromise your life style? Importantly, after all the expenses are you able to save something? This saving is important because you always should prepare for an unforseen event. If you have sound savings it may help you tackle uncertain days.

The best idea is never push yourself/ yourselves to the limit, borrow a little bit less than your capacity to borrow the maximum amount. Please give the above mentioned factors a consideration. Consider two other traps:

1. Do not borrow too much just because your colleague or a friend has borrowed ‘x’ amount of money
2. Do not borrow too much just because of peer pressures.

Always remember in your difficult times it is you and not them who have to arrange the repayments and keep your life easy.

What are the associated fees and charges?

Let us focus on another important topic: ‘home loan fees and charges’ and it will be discussed in conjunction with another topic ‘the best deal’. The most common fees and charges are loan establishment fee, monthly loan services fees, top up (if you want to top up your home loan) fees. In many cases these fees can be waived if you go for bundled offer (most often referred to as ‘packages’). These packages may cost you an amount every year but saves you a significant amount through the discounts and fee waivers. When you are shopping around ask bank staff to explain how these packages work. If you already have a loan ask your loan manager or a staff from any branch to explain if your loan is already on a package or if there are ways to get a package deal for the existing loan or what can be a better deal for you.

What loan type should you select?

We can look at the issue of loan type: fixed or variable or something else. On the positive side, fixed rate gives you a mental peace of the certainty for a fixed period that your repayments will not increase as the interest rate for that period is fixed. On the negative side:

1. You can make only limited amount of additional repayments
2. If you are planning to sell the house for some reason it might cost you a lot as the cost of breaking a fixed rate loan may be too high
3. Fixed rate does not give you any redraw facility
4. The offset account may not be 100% offset.

A variable rate loan, on the positive side, gives you:

1. The flexibility of unlimited additional repayments
2. Redraw facility and 100% offset facility (not all variable loans have offset facility though).

On the negative side, there is a chance interest rates may go upwards or downwards and consequently your repayment may also increase or decrease. It always depends on you (the borrower/s) to decide which option to go for but you may also consider a split loan (part fixed, part variable).

A lot of people go for line of credit without even understanding what the product is just because their friends have suggested them to take it. There is a huge risk if you do not manage/ repay the line of credit properly, you may run the risk of never paying it off in full even though you might have paid huge amounts in repayments but — as the line of credit is a revolving line of credit — at the same time spending the credit again.

What repayment options do you have?

Let us consider repayment types now. You normally have the options of making repayments weekly, fortnightly or monthly, except for interest only loans where you can repay only monthly. Repayments are sometimes decided by people on the basis of how they get paid – weekly, fortnightly or monthly. As a rule of thumb, the best thing to do if you want to repay your mortgage ASAP is repaying the loan weekly or fortnightly. Interestingly it does not increase your monthly commitment but it reduces your loan term, potentially saving you thousands of dollars. If you get paid monthly you may request your bank to give an overdraft facility on your main transactional/ savings account so that you can use this facility to repay your mortgage weekly or fortnightly.

Do you have a risk management plan?

Among the fees and charges mentioned here home and/ or contents insurance, loan protection/ income protection or any other risk insurances are not mandatory. A lot of the times people avoid these to be able to increase the loan amount but they take a big risk. Just ask yourself:

1. What will happen if the house is burnt because of a fire or the house is burgled?
2. What will you do if you lose your job or your partner loses their job?
3. How will you manage the mortgage if you die or my partner dies?
4. How will you manage the mortgage if your partner loses or I lose the ability to work because of an accident/sickness?

The solution to these situations is having a risk management plan (home and /or content insurance, loan protection/ income protection/ any other risk management plan). All banks and financial service providers these days have financial planners or risk advisors. At least have a consultation with them.

While deciding the loan amount consider a crucially important factor:

1. At loan funding time the interest rate might be comparatively low but what will happen if the interest rate goes upwards?
2. Can you afford the repayments?

What are your contingency plans?

A lot of people ignore some important factors. If borrowers have (in cases of couples) plans to have kids in the months following the initiation of the loan, it is very natural that the female income earner will go on maternity leave; and in that case, consider if the loan repayment can be done with only one income. There may be money from Centrelink for the baby and the mother (subject to assessment by Centrelink) but in most cases that amount is not enough to cover for the income gap, resulting from the maternity leave of the female income earner. Or, consider if you have any other events upcoming that may incur significant cost such as a long holiday, overseas trip or a wedding in the family.

Should you consider gearing strategies?

Gearing is another important topic, most often considered by people when purchasing investment property. Gearing can be positive or negative. A lot of the times people decide on gearing strategies and their effects on taxation just as per suggestions of friends or by making wild guesses. Just being guided by a friend or by wild guesses may not always be in your interest. It is an area where you should consult your accountant or any other professional who is qualified to advise on the issue. Nevertheless, if your friend is a qualified professional to advise on gearing and its taxation effect, and you understand what you are doing, or if you are a qualified professional yourself to explain the effects of gearing, then decide yourself.

How to select a bank?

Where to go for a home loan is undoubtedly another widely discussed issue. There are big and small banks, credit unions, and building societies to choose from. Shopping around is always a good idea. But while considering on a loan provider please be careful to check on the history and financial health of that provider. Do not take interest rate as the sole point of consideration. Always check if there is any hidden cost in the deal they are offering. If a small lender offers a cheaper rate examine it thoroughly and compare it with the deal offered by a big bank which always can serve you better through its wider network of branches, ATM’s and saving on fees on your transactional/ savings account and credit cards. If you are time poor or if you feel that the options are overwhelming why don’t you check ratings of lenders by visiting the website of Canster Cannex (https://www.canstar.com.au/)? Make a decision only after a careful consideration.

How to avoid mortgage stress?

A carefully designed plan can always help you manage your home loan better and avoid stress. Mortgage stress could be for various reasons: rise in interest rate, loss of job, loss of ability to work, death of an income earner. But if you are in mortgage stress for any reason please contact your bank/ lender to see if they can help you handle the stress. If the stress is rise in interest rate, in many cases the bank/ lender may help you by restructuring your loan (extending your loan term and thus reducing repayment, or switching to a fixed rate loan, or switching to interest only option, or even allowing a repayment pause/ holiday for a specific period). The stress may be because of uncertain events such as death, disability, loss of job and this is where your risk insurance policies (loan protection/ income protection or any other insurance policy). If you have any such insurance in place please contact your insurer to assist you.
Remember

In summary, keep the following points in mind to manage your home loan better:

1. Plan your budget properly and see how much you can afford to repay without compromising your lifestyle too much and without stressing out too much
2. Never push yourself to the limit
3. Repay the loan fortnightly or weekly if you have the option to do so
4. If you have surplus cash, park that cash in redraw or offset account as it will potentially reduce the interest that you have to pay
5. Have loan protection or income protection or any other risk insurance by consulting a qualified financial planner or risk specialist to cover for rainy days
6. If there are concerns about gearing please consult a qualified professional before you make a decision.
7. Get a health check on your home loan at least once a year.