First-home buyers mostly just want “a mortgage” and that means a 30-year table loan for most. But it’s not the only choice and there are smarter ways for some people, says Peak Financial Services adviser Jonathan Battersby.
Some people are good with money and can benefit from flexibility. Others may have lumpy earnings with annual bonuses or commission. Spenders may be better off with a mortgage they can’t tinker with.
A bank or mortgage adviser (broker) can give advice on the other types of loans such as interest only and revolving credit.
1. TABLE LOAN
Start your property search
With a table loan the repayments are the same each fortnight or month, providing the interest rate doesn’t change. Each payment covers a combination of interest and principal (outstanding loan balance). At the beginning, a larger portion of the payment is interest and a smaller portion pays down the outstanding principal. As the principal is paid off over time the monthly interest payment reduces and more of the payment goes to paying down the outstanding principal.
About 90% of home buyers take out table loans, says Battersby.
Pros and cons:
• Straightforward and good for people who require certainty.
• Not good for people who have irregular income.
• Don’t encourage borrowers to pay their mortgages off faster.
2. REDUCING LOAN
These mortgages are similar to table loans, but the principal repayments start higher and remain the same as the interest portion reduces over time. These aren’t common in New Zealand.
Pros and cons:
• The overall cost of the loan is lower because the principal is paid off faster
• Initial payments might be higher than a table mortgage
• It makes more sense to keep payments higher if a borrower can afford them and pay the loan off quicker.
3. REVOLVING CREDIT
A revolving credit mortgage is more like a bank account with a huge overdraft, than a traditional mortgage. On payday the borrower’s wages or salary are paid into the account, reducing the overall outstanding overdraft [mortgage] by a larger sum than just the minimum payment would. Interest is charged daily on the outstanding balance, which is less at the beginning of the month than the end. Each month the balance should be reduced by at least the minimum payment.
Some mortgages will suit first-home buyers more than others. Photo / Peter Meecham
Battersby is careful to have good long conversations with clients who want a revolving credit mortgage to ensure they’re financially disciplined. It can be risky for people who can’t control their spending or are from families or communities that may want to borrow some of the credit for their own purposes.
Revolving credit can be very useful for investors who run all the rent and expenses through the same account. It also makes life easier for their accountants.
Owner-occupiers who take out revolving credit usually only have a portion of the loan revolving, combined with another more traditional type of mortgage repayment facility such as a table loan. That ensures the principal is paid off.
Pros and cons:
● It’s easy to pay down the mortgage faster;
● It’s too easy to dip in and spend on the mortgage for cars, and consumer goods and fail to get ahead;
● Some banks charge monthly fees, which add up over time;
● Fixed rate interest options not available. Only floating.
4. OFFSET MORTGAGE
Instead of earning interest on money in other accounts, an offset mortgage is linked to those other accounts. Savings and current account balances are offset against the mortgage, reducing the outstanding capital, and thus the interest paid. Considering most current accounts pay no interest and savings accounts have low rates, offsetting that money against the mortgage means it’s effectively earning the same rate as the mortgage, which is a good deal. Any fees associated with an offset account need to be balanced against the interest savings to ensure that it makes financial sense to go down this route.
Battersby’s own mortgage is offset because it suits self-employed people who are saving a chunk of money to pay a large annual tax bill. “It’s a way to make money smart as opposed to having money sitting in an account [not earning interest].”
Pros and cons:
● Higher fees;
● First-home buyers may have no other savings to offset;
● Fixed rate options not available. Only floating.
5. INTEREST ONLY
With an interest only loan, the fortnightly or monthly payments only cover the interest. The principal is not reduced, although inflation does slowly erode the true value of the outstanding debt. In order to pay the loan off, a homeowner would need to sell, remortgage to another style of loan, or find money from somewhere else such as an inheritance. Most banks won’t lend interest-only to owner-occupiers for anything other than a very short period of time.
Banks will be able to advise you which mortgages they have on offer and which one best suits your needs. Photo / Steven McNicholl
Most interest only loans are taken out by investors, says Battersby. “For investment purposes they will do a period of time on interest only. If the [investor’s] goal is cash flow, then interest only is a good option. If the goal is growth, then you might not want to do it all on interest only.”
Battersby says non-bank lender Resimac is offering a 20-year interest only mortgage for investors currently, which is popular.
Pros and cons:
● Lower payments mean more cash to spend on other things, such as renovations, or building up a new deposit to buy more property
● Interest charges don’t reduce over time as they would with another style of mortgage.
6. MIX AND MATCH
It’s possible with some banks/lenders and types of mortgages to mix and match. That might mean having a portion of the loan on revolving credit or one portion fixed and the other floating, which hedges the bets against rates falling and having the entire mortgage stuck on a higher rate. It also allows the homeowner to make extra repayments without penalty and pay the loan down faster.
Fix or float?
With many mortgages it’s possible to fix the interest rate for a period from six months to five years. The repayments remain the same for the entire fixed period, regardless of rises or falls in the floating (variable) rate charged by the bank or other lender. A floating mortgage goes up or down if interest rates change.
Mortgage terms?
Most first-home buyers take out a 30-year mortgage because the fortnightly or monthly payments are lower. A shorter mortgage term costs less over the life of the mortgage because there are fewer interest payments. For example, a $600,000 mortgage at 6% over 30 years costs a total of $1,294,408. The same mortgage over 25 years costs $1,159,071, or over 15 years costs a total of $910,611. The other way to do this, if the mortgage allows, is to overpay when money is available. It reduces the outstanding capital, meaning lower interest payments each month. Borrowers are tested on a rate that is 1% to 2% higher than they actually pay. That means they have the capability to pay extra, or reduce the term.
