With all residential lenders (big banks, 2nd tier lenders, and mutuals), the current low interest rates for home loans are very enticing for first home owners, investors and customers wishing to refinance for a “better deal”.
Over past years we have seen the growth of new banks, non banks, mortgage managers and finance brokers who have taken the hassle out of the process of applying for home loans. The lenders have fashioned various loans with all the “bells and whistles” to capture your custom. In essence, the most valuable loan feature has not really changed, that being the flexibility to place more payments off your loan.
Since the last Reserve bank reduction of the Official cash rate, the financial institutions reduced their mortgage rates to less than the RBA 0.25%. Presently, we see and experience the lowest home loan rates in over 60 years.
This has enabled potential borrowers to purchase a property in a higher price range , thereby having to increase their potential home loan. However, recent data has shown that home loan borrowers entering into Mortgage Default is on the rise.
There are a number of ways that a potential borrower can avoid a Mortgage Default. Some being :-
- Before purchasing an expensive property , keep a cool head and consider all fundamentals.
- Ask yourself, If mortgage rates increased, could you meet the repayments?, OR if your financial and personal circumstances changed could you still meet the repayments.
- Build in a buffer into your loan payments , example calculate repayments at 1% above the rate being charged. This will assist you to ensure you have accumulated repayments.
- If it is a rental property, are you solely relying on rental income to pay the loan? You need to buffer a 1% additional loan payment, as most Investment loans are higher than owner occupied loans.
- Consider a transaction account with an 100% Off Set, as this could save interest on the home loan
- Consider setting up loan as a Re Draw facility, if Off Set is not available. This could assist with additional funds later on.
- Avoid Interest only loans, as lenders will assess your loan repayments on the terms after the interest only period has ended.
- Retain loan payments if interest rates reduce, and if they rise, the increase immediately.
- Calculate your loan payments at 2% higher than the lenders standard variable rate, to ensure that you can afford loan payments in the event of an rate increase.
We are seeing that lenders are gradually increasing their Serviceability Or Stress Test Rate. As a general rule of thumb, the various lenders would add an additional 2% to 2.5% to their standard variable rate as a “stress test” or safety net. This is to ensure that any borrower would have the capacity to meet increased loan repayments, should the interest rates move upward in the future.
In addition, the lenders have a basic “Living Expense” formula which is incorporated into their criteria. Take the following example of a husband and wife with 2 dependents. A lender would allow approx. $36,000 per annum to cover all the applicants living expenses (excluding any financial commitments). The more dependents, the higher the annual living expense allowance becomes.
Many borrowers become disheartened when they discover that they cannot afford to borrow the amount they require. Therefore, it is vital that all potential borrowers review their net monthly income and prepare a detailed monthly budget for all expenses and allow for a loan repayment at “buffer” repayment to ensure that they have the capacity to meet loan payments in case of an interest rate increase.
Fixed Rate versus Variable Rate
Whilst there is more emphasis on the variable rates set by lenders and media, one must also consider the fixed interest rates.
Presently lenders are offering excellent fixed interest rates that are not commonly promoted. Any potential borrower should seriously consider splitting their loan into part fixed and part variable so as to provide some form of “insurance/ safety net” for any potential future interest rate increase.
Whether you are buying an investment property or an owner occupied property it’s important to carefully focus on the financing options. Obtain advice on your borrowing capacity, serviceability and loan options.
Lenders move to credit scoring approvals
Over the past few years the major banks have been modelling their home loans approvals using a credit scoring process. This would greatly improve turnaround times from application to full approvals.
Some of the pitfalls a borrower may face under the Credit Scoring Models are :-
- Adverse Veda CRAA report
- Numerous enquiries for credit being recorded against one’s name
- Poor history of current loan repayments ( loan payments not being made on time)
- Employment changes ( not consistent within applicants industry)
- Ability to service borrowings( present and future)
The lenders, willing to approve loans, must ensure that the customer has the ability to service a loan without any potential hardships and they have a duty of responsible lending practices.
Some other non-bank lenders do not credit score their applications and assess the transaction manually. Whilst this may be cumbersome, it enables the finance broker to liaise with the lender directly to discuss any issues that have arisen with the application.
Therefore, it is suggested that should first embark on a finance application you discuss with a reputable finance broker to ensure that the application is fully completed thereby addressing any issues.