6 low-rate home loan traps to avoid

Adam Smith 14 July 2017 NEWS

House suspended over cliff

Learn how to spot low-rate home loans that will cost you more in the long run.

Home loans that advertise rock-bottom interest rates are certainly enticing. After all, the interest rate you’re charged on your home loan will be the biggest factor in determining how much the loan costs you in the long run.

However, not all low-rate home loans are equal. Some products advertise a rate that appears too good to be true. And in many cases, if it appears too good to be true, it probably is.

There are four main traps to avoid when researching low-rate home loans. Recognising these traps can mean the difference between getting a good deal and being fooled by what amounts to interest rate smoke and mirrors.

1. Low loan-to-value ratio

Some loans may advertise a low rate, but offer an extremely low maximum loan-to-value ratio (LVR). LVR is the percentage of the property’s value a lender is willing to lend you. For instance, an 80% maximum LVR means a bank will lend you up to 80% of a property’s value, meaning you’d need a minimum 20% deposit.

When you see a low-rate loan advertised, make sure to pay attention to the maximum LVR. If it’s below 80%, you’ll need to have a substantial deposit saved in order to qualify. These loans can be a great option for some borrowers, but those with a minimal deposit could be enticed by an advertisement for a low rate, only to be disappointed by the loan’s borrowing criteria.

2. Low maximum borrowing amount

Much like loans with a low maximum LVR, some home loans offer a low maximum borrowing amount, often as little as $500,000. Considering the median house price in Australia’s capital cities is currently $630,000, many borrowers would be excluded from this loan.

In addition, many loans have different rates for different borrowing amounts. When you’re researching home loans, pay attention to the borrowing amount associated with the advertised rate. Depending on how much you need to borrow, the interest rate you’re offered could be very different from the one advertised.

3. High fees

Some low-rate loans might look attractive, but be hiding high fees. Monthly or annual fees can make a significant difference to the amount you pay over the life of a loan. So how can you identify high-fee loans at a glance? This is where the comparison rate comes into play.

A comparison rate takes into account both a home loan’s interest rate and all associated fees, and expresses this as a single annual percentage. While it isn’t a perfect method for comparing loans, it can help you easily identify loans that come with high fees.

As an example, let’s consider the situation when the difference between the advertised rate and the comparison rate is 15 basis points. Below you can see just how dramatically this would affect the total cost of a loan over a 30-year term.

Advertised rate: 4.00%

  • Total paid on $500k loan over 30-year term: $859,347.53

Comparison rate: 4.15%

  • Total paid on $500k loan over 30-year term: $874,985.98

Over the course of 30 years, the loan above would cost $15,638.45 more than the advertised rate would suggest. The cause is an ongoing monthly fee that, over the life of the loan, would add thousands to its cost.

You can see for yourself the difference a few basis points can make by using the repayment calculator below:

4. A high revert rate

A revert rate is the interest rate a home loan reverts to after a certain period. This is relevant in a couple of different home loan situations.

  • Introductory or discounted variable rate loans. An introductory variable rate loan will offer a discount off the lender’s standard variable rate for a set period of time, usually known as a “honeymoon period”. The rate may change during this time, as market conditions or the Reserve Bank of Australia (RBA) cash rate dictates, but it’s guaranteed to always be a specific amount lower than the lender’s standard variable rate. After this honeymoon period expires, generally at around 2 years, the loan will revert to the lender’s standard variable rate.
  • Fixed rate loans. Fixed rate loans lock in a certain rate for a predetermined period of time, usually between 1 and 5 years. Your rate won’t change during this period, but at the end of the fixed rate term your home loan will revert to the lender’s standard variable rate, although you may have the option to lock in for another term.

The difference between introductory variable rates, fixed rates and a lender’s standard variable rate can be huge. There are examples of the introductory rate on offer being a full 1% below the lender’s standard variable rate.

As you can see below, this could mean a big jump in your monthly repayments:

Advertised rate: 4.00%

  • Monthly repayment on $500k loan: $2,387.08

Revert rate: 5.00%

  • Monthly repayment on $500k loan: $2,684.11

Using this hypothetical comparison, your monthly repayment would jump by $297.03 once the loan reverted to the standard variable rate, potentially dealing you a big shock. A high revert rate can completely derail what appears to be a low-cost home loan.

This doesn’t necessarily mean you have to avoid introductory rate or fixed rate home loans, but it does mean you need to pay close attention to the rate the loan will revert to. If you intend to refinance at the end of the introductory or fixed rate period, make sure the costs involved won’t eat up any savings you might see.

You can figure all that out using our refinancing calculator.

5. Rigid repayments

If you get a bonus at work or unexpectedly come into some extra money, putting those funds towards extra home loan repayments is a good idea. But don't automatically assume that this practice will be approved by your lender.

With many fixed rate loans, you're not allowed to make any extra repayments at all during the fixed rate period. Other lenders may impose a limit on the amount of additional repayments you are allowed to make each year, for example, $10,000. Exceeding this amount could once again result in a hefty fee.

If you want to be able to make extra mortgage repayments whenever your finances allow, make sure to check whether you will be allowed to do so under the terms and conditions of your loan.

6. A lack of features

Home loans often offer features that can help you manage your mortgage more easily, take charge of your debt and even pay off your home loan years ahead of schedule. Features like redraw facilities, offset accounts and split facilities can offer flexibility and even save you tens of thousands of dollars in interest over the life of your loan.

While some home loan features come with ongoing fees, a feature that allows you to save on interest or have more control over your home loan can be well worth it. Take some time to think about the features that might be helpful for you and help you reach your financial goals, and look for home loans that offer them.

The last word on low-rate home loans: always do your research

Low-rate loans are an attractive proposition, and many are very good, legitimate deals. But when you’re comparing home loans with what appear to be very low interest rates, it pays to dig a bit deeper. What seems to be a great deal could cost you dearly in the end.

Check out some of our cheap loans here

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