risk_homeloans2

Risky Types Of Home Loans That You Should Avoid Applying For

Rates and Fees verified correct on December 7th, 2016

With housing prices on the rise and desperate homebuyers looking at alternatives to regular mortgages, risky home loans have become more popular.

Kim Wight, Personal Mortgage Advisor at Smartline, explains why you should steer clear of these loans.

Since the start of 2013, the median price of the average Sydney property has increased to over $600,000 making it increasingly difficult to afford a new home. Many Australians are now considering ‘risky’ home loans — but don’t sign on that dotted line until you’ve taken a second look at the features of these loans.

Kim Wight

  • Hurstville Council Business Excellence Award Winner 2011 and 2012
  • St.George Business Awards Finalist 2010, 2011 and 2012
  • Smartline NSW/ACT Client Service Award Finalist 2011 and 2012
  • Winner of the Spirit of Smartline Award 2009

Kim Wight from Smartline Personal Mortgage Advisor Shares home loan considerations

- START

When people are looking for a home loan and they need to take on a guarantor — which is mainly because they do not have enough savings to cover mortgage insurance and stamp duty — the risk really isn't to the borrower. The risk is all placed on the guarantor. And I think a lot of young people think, "Oh, mum and dad will just put the house up for me," which might seem like a really good idea to you, but isn't the best thing for the parents. So there's a definite risk involved, and I think a lot of people don't think about it completely before they enter into these agreements.

With equity loans, it's very open-ended. So there's no set repayment schedule. What people can do, it might seem really attractive to have this equity loan where your limit might be $500,000, but you've got no set repayments. So you can have that loan and still in 30 years time, owe $500,000, because you've never paid down any of the interest. Equity loans are great for investors or people that are really controlled with their finances. But for the majority of people, though, they'll get an equity loan today and in six years time they'll say, "Kim, why do I still owe the same amount of money?" And it's because they've never kept making those regular repayments. Or if they do, they just keep drawing up to their equity limit. So a line of credit or an equity loan is really only for the very controlled borrower.

If the idea is to buy it, and then it might be your long-term property or you would be selling that to buy a family home, the best loan is a term loan with a beginning and an end date. And I advise them to pay as much as they can as often as they can. I believe a variable rate is the best for them, because fixing a rate really locks them in, and they don't know what their plans are longer term. So [use a] term home loan with set repayments, but pay as much as you can as often as you can.

- END

Guarantor home loans

In today’s property market it can be difficult to come up with a deposit for a new home. Many lenders will allow a related third-party to provide additional security to help a family member own their own home, commonly known as a guarantor.

‘Often when people cannot borrow the amount of money they want to purchase the property, they throw out the line “so and so will go guarantor” — well this just does not work anymore’ says Ms Wight. ‘Before lenders will consider a guarantor on a loan they have to be convinced that there is a commercial benefit to the guarantor to enter into the agreement. If there cannot be a financial benefit to the guarantor they will only be considered as a co-borrower on the loan.’

A guarantor is linked to the loan by a guarantee and can be released without the loan having to be repaid in full. It allows the equity in his or her own property to be used as an additional security for the borrower’s home loan, which means that the lender can also take over the guarantor’s property if necessary.

‘An example of this would be a homebuyer whose income does not service the debt. They want to have a member of their family as guarantor. In this transaction there is no benefit to the family member as they would be taking the risk in having to make payments on the loan, but not have the benefit of owning the property’ explains Ms. Wight. ‘The only way the lender will consider this is if the family member was a co-borrower on the loan and have a percentage holding in the property.’

If the bank is unsure that you will be able to meet the minimum repayments for a home they may ask for a guarantee from somebody else. In some cases, it may be the parents. ‘The other guarantee used is commonly known as a Family Guarantee’ explains Ms Wight. ‘This means that the bank will lend the borrower 80% of the value of the property being purchased while the borrower’s parents offer their property as extra security to cover the remaining 20% plus costs of stamp duty and legal fees if required.’

It can be tricky using a guarantor since quite often their home is used for security. In the past, 100% of the home was liable in the case of defaulted payments, but now lending institutions can go as low as 20% of the home being liable. The loan still poses a considerable risk, however, since both homes can be sold by the bank if there is a major problem.

Comparison of home loans available with a guarantor

Rates last updated December 7th, 2016.

NAB Tailored Fixed Rate Home Loan - 2 Year Fixed (Owner Occupier)

Interest rate now 3.85%

July 12th, 2016

NAB Choice Package Home Loan - 2 Year Fixed (Owner Occupier)

Interest rate now 3.75%

July 12th, 2016

ANZ Fixed Rate Home Loan - 2 Year Fixed (Owner Occupier)

Comparative rate decreases by 0.10%

August 12th, 2016

View latest updates

Jodie Humphries Jodie
$
Loan purpose
Offset account
Loan type
Your filter criteria do not match any product
Interest Rate (p.a.) Comp Rate^ (p.a.) Application Fee Ongoing Fees Max LVR Monthly Payment
NAB Choice Package Home Loan - 2 Year Fixed (Owner Occupier)
Enjoy a fixed home loan with discounts on rates and other NAB products.
3.75% 4.87% $0 $395 p.a. 95% Go to site More info
Greater Bank Great Rate Discount Variable with Family Pledge Home Loan - Up to 110% LVR
Discounted rate available with family pledge loans. Family pledge loans require no LMI and no deposit. NSW, Qld and ACT only.
3.89% 3.89% $0 $0 p.a. 110% Go to site More info
NAB Base Variable Rate Home Loan - Owner Occupier (P&I)
A competitive no frills home loan with no application fees for a limited time. 250,000 Velocity Frequent Flyer point offer, conditions apply.
4.10% 4.14% $0 $0 p.a. 95% Go to site More info
NAB Tailored Fixed Rate Home Loan - 3 Year Fixed (Owner Occupier)
Flexible fixed rate home loan which will allow you to take a break from repayments if you're ahead of scheduled repayments. 250,000 Velocity Frequent Flyer point offer, conditions apply.
3.99% 5.04% $600 $8 monthly ($96 p.a.) 95% Go to site More info
IMB Essential Home Loan - LVR > 80% (Owner Occupier)
Enjoy a 100% offset account and no monthly fees.
4.31% 4.33% $0 $0 p.a. 95% Go to site More info
NAB Tailored Fixed Rate Home Loan - 2 Year Fixed (Owner Occupier)
A fixed rate home loan with the ability to lock the interest rate at the time of loan approval for up to 3 months. 250,000 Velocity Frequent Flyer point offer, conditions apply.
3.85% 5.12% $600 $8 monthly ($96 p.a.) 95% Go to site More info
ANZ Fixed Rate Home Loan - 2 Year Fixed (Owner Occupier)
Lock in your rate for 2 years with an interest only option.
3.90% 5.06% $600 $10 monthly ($120 p.a.) 95% More info
Westpac Flexi First Option Home Loan - 3 Years Introductory Special Offer (New Owner Occupier, P&I)
A limited time deal for new owner occupiers. Advertised rate includes 1.03%p.a. discount for the first two years.
3.99% 4.37% $0 $0 p.a. 95% More info
St.George Fixed Rate Advantage Package -  2 Year Fixed Rate (Owner Occupier)
A discounted package rate for owner occupiers with the ability to package a Qantas rewards earning Amplify credit card. $1,500 cash back available for refinancers, conditions apply.
3.99% 5.07% $0 $395 p.a. 95% More info
Commonwealth Bank Wealth Package Fixed Home Loan - 2 Year Fixed (Owner Occupier)
Fee free extra repayments available during the fixed term. $1,250 cash back offer for refinancers. Conditions apply.
3.99% 5.00% $0 $395 p.a. 95% More info
Beyond Bank Basic Variable Rate Loan - (Owner Occupier)
Enjoy 100% offset account with redraw facility and borrow up to 95% LVR with low monthly service fee.
4.40% 4.57% $445 $11 monthly ($132 p.a.) 95% More info
ING  DIRECT Orange Advantage Loan - $150,000+ (LVR > 90% Owner Occupier)
A fully featured home loan with an offset account and discounts available.
4.65% 4.86% $0 $199 p.a. 95% More info
Commonwealth Bank Standard Variable Home Loan - Owner Occupier
Standard variable home loan with a low doc option for self-employed borrowers.
5.22% 5.37% $600 $8 monthly ($96 p.a.) 80% More info
Credit Union SA Variable Rate Home Loan - $20k and above (Owner Occupier)
A variable home loan that allows you to borrow from $20,000.
5.19% 5.25% $600 $0 p.a. 80% More info
Suncorp Bank Standard Variable Rate Home Loan  - (Owner Occupier)
Enjoy a competitive interest rate, make fee free extra repayments and a redraw facility.
5.40% 5.56% $990 $10 monthly ($120 p.a.) 95% More info
ANZ Breakfree Home Loan Package  - $250,000 up to $499,999 (LVR >80% Owner Occupier)
Pay no application fee with 100% offset account with redraw facility and borrow up to 95% LVR.
4.50% 4.60% $0 $395 p.a. 95% More info
Bank of Melbourne Basic Home Loan - Regular Rate (Owner Occupiers, P&I)
Ideal for first home owners or anyone who wants a no-frills, basic variable rate home loan.
4.64% 4.69% $500 $0 p.a. 95% More info
St.George Basic Home Loan - Promotional Rate (Owner Occupier, P&I)
A no frills loan with a competitive rate and a maximum LVR of 95%.
4.08% 4.09% $0 $0 p.a. 95% More info
Westpac Rocket Repay Home Loan - Principal and Interest
The Westpac Rocket Repay Home Loan lets borrowers to own their home sooner with a 100% offset to save on interest.
5.29% 5.43% $600 $8 monthly ($96 p.a.) 95% More info
Kim Wight

Personal Mortgage Advisor, Smartline

My experience

In most circumstances for anyone entering into a guarantor role the lenders require they get independent legal advice so they fully understand the risk they are taking. Some lenders also require they get independent financial advice.

In regards to Family Pledge guarantees, most parents look to do this to 'save' the cost of mortgage insurance for their children. I discuss this with them and explain that there is a cost associated with them giving the guarantee. There is the cost of an additional valuation, legal costs to explain requirements, additional registration of mortgage over their security, plus it does tie their property up until the children have 20% equity in their own property to be able to release Mum and Dad’s home.

When it is explained that the mortgage insurance is added to the loan and paid in the repayments, my experience has been that the parents and borrowers do not proceed with this form of guarantee. If they are in a position to do so, they usually help with a cash gift.

Guarantor rights

Any guarantor has certain rights. Statements can be received for loan payments and they should be monitored. Before making the decision to guarantee a home loan, the guarantor should find out what would happen if the borrower could no longer make repayments and if there are chances that the home could be repossessed.

The guarantor also needs to acknowledge hidden costs such as a home valuation and whether it is possible to be released from this guarantee. Some institutions will allow a release once enough equity has been built up in the home. Sometimes this release will incur a fee so it is important to find out how much that will be.

About lenders mortgage insurance

Mortgages with a Loan-to-Value Ratio (LVR) of more than 100%

Similar to home loans with no deposits, these risky home loans were offered by some financial institutions, although they are almost impossible to find after the global financial crisis. Lenders made it available so that homebuyers didn't have to worry about all of the extra charges, such as legal fees, that go along with a house purchase. However, this loan may take a longer period to repay as it doesn't even take into account price changes in the housing market. If your home loses value, it will take even longer pay down the loan balance to reach the 100% LVR and 80% LVR mark unless you can make extra payments. If the house rises in value, you will reach these values sooner. Before getting this type of home loan you'll have to look at the potential cost of Lenders’ Mortgage Insurance (LMI). These types of loans can be very costly and unless you can make extra payments from time to time, you will end up paying extra in interest. It is always best to get as much of a down payment as you can for a house payment before applying for a mortgage. If you can save more than 20% then you'll eliminate the cost of LMI altogether.

As mentioned above, LMI only insures the lender, not you, in the case something happens and you cannot pay off the loan. If the lender had to sell the home for less than the value of the mortgage, the lender would be covered. Even though the lender is protected and gets compensated for the loss, you are still responsible for the debt. The cost of mortgage insurance can be high enough that you may want to consider looking twice before taking on high risk home loans that require it. Have a look below to see the difference between having a deposit of 15% vs a deposit of 5%.

Lenders’ Mortgage Insurance

Property value: $250,000
Loan-to-Value RatioLender’s Mortgage Insurance
85%$1500 to $2000
95%$6000 to $7000
Property value: $400,000
Loan-to-Value RatioLenders’ Mortgage Insurance
85%$3000 to $4000
95%$13,000 to $14,000

Read the box below to find out how the a home loan with an LVR of over 100% usually works in terms of paying it off and reducing the amount you owe.

For example

Title

You could previously get a loan for $250,000 for a home that has a value of $236,000, meaning the loan had an LVR of 106%. If you took out a mortgage for 30 years at a rate of 8% and made all the repayments that are minimally required, you would not be down to an LVR of 100% for 5 1/2 years. To get down to an LVR of 80% of the home's value would take you 15 1/2 years.

Long-term mortgage

The new 40 year mortgage may seem appealing at first because it offers lower monthly payments, but don't be fooled by it. It's not cost effective and you may end up paying thousands more in the long run.

If you take out a long-term mortgage simply to save money on a monthly basis on a 30 year mortgage, you will end up paying thousands of dollars more in interest. If the rate of interest goes up, you will be left in a serious situation and may end up losing the house anyway.

40 year mortgages

Here are two examples of getting a mortgage with different year terms.

Mortgage$400,000$400,000$250,000$250,000
Loan term40304020
Interest rate5.7%5.7%5.7%5.7%
Interest paid$616,539.20$435,776.00$385,337.60$169,539.20
Difference$180,763.20$215,798.40

These differences are very substantial and not always recognised unless the numbers are first crunched. While it can seem very positive to pay less money every month for a mortgage on a longer yearly term, you will end up paying the price in the end.

Mortgage specialists will tell you that you should always leave a 2% buffer for the interest rate whenever you are considering a home. Different banks and financial institutions are making 40 year mortgages available to their customers. The positive note to this type of mortgage is some institutions will allow you to pay extra on your monthly payments without having to incur any penalties. This means that if your financial situation doesn't improve, you have the option to get it paid back in as little as 30 or 15 years.

Considering interest charges, you may want to consider taking the shortest mortgage term you possibly can. As you can see from the case studies there is a big difference in the interest charges you will have to pay. Also, consider that any rise in interest rates can lead to problems in the future.

Equity Finance Mortgage

A shared equity home loan is available in every state except Tasmania and the Northern Territory. It is offered in some metropolitan areas and capital cities. It allows you to get a loan for 10%, 15% or 20% of the property value under a shared appreciation mortgage, which provides the deposit aspect of your purchase. When you sell the house in 25 years the initial amount of the EFM loan needs to be paid back plus a percentage of the increase in value in the property since it was purchased. If you take a loss on the sale of the home, a percentage amount is usually is covered by the lender. This amount will then be deducted from how much you have to pay back. You may or may not be able to combine this type of loan with a home loan from another bank. Another downfall to this type of mortgage is that the capital loss is not shared by the lender if the house is sold for a lesser amount than it was originally purchased for and if you have gone into default on the loan.

EFM home loan example

Year19872007
Property value$100,000$461,490
Amount you need to pay back$164,000
Amount paid back in interest charges10.6%

If a normal home loan had been taken at the same time as the above example, the interest rate would have only been 9.5%. Regular payments would have been made with a regular loan instead of paying a lump sum.

If instead you had been able to repay the $20,000 within a couple of years, after the jump of prices in housing during 1988 and 1989, you would have owed the bank $49,137. This calculates to an interest rate of 45.8%. It can be very difficult to estimate whether property values will be going up or not, which could make this home loan rather risky.

When borrowing money to purchase or refinance a home, you should always proceed with caution. The type of mortgage you choose can make the difference between owning your property outright, or finding yourself in a stressful financial situation. There are many different home loans available from a wide range of lenders, but if your financial situation necessitates risky loan, you may want to review all the conditions and terms of the contract with an advisor beforehand.

Kim Wight is a Personal Mortgage Advisor at Smartline.

Marc Terrano

A passionate publisher who loves to tell a story. Learning and teaching personal finance is his main lot at finder.com.au. Talk to him to find out more about home loans.

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2 Responses to Risky Types Of Home Loans That You Should Avoid Applying For

  1. Default Gravatar
    Sarah | January 8, 2014

    Are there any financial institutions in Australia that offer home loans with a friend as guarantor?

    • Staff
      Marc | January 8, 2014

      Hello Sarah,
      thanks for the question.

      There are some lenders who will allow a friend of the borrower to become a guarantor for a home loan. You may wish to carry out a search on the internet to find lenders who will offer this service. It’s important to also know how a guarantor arrangement works, so I’ve sent you some information regarding this.

      I hope this helps,
      Marc.

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