The debate about housing affordability, and speculation about the direction of interest rates, have brought housing loans back into the spotlight.
Many borrowers are even considering changing lenders to take advantage of what may seem to be a cheaper rate. Unfortunately, it is not as simple as it sounds.
Right now, the banks are more interested in competing for deposits than they are for loans, and even if you did find a friendly bank you will almost certainly end up confused, as there are now over 1000 different home loan products in the market. Sorting through them is just as tricky as working out which phone plan is best for you.
A useful guide is the comparison rate sheet that all lenders are required by government legislation to provide, but keep in mind that it is only a starting point. Even though it includes the basic loan costs, such as set-up fees, interest rates and ongoing charges, it does not include bank fees that are only charged in certain circumstances. These include fixed loan early termination fees and redraw fees.
But there is more to a loan than the interest rate and the fees and charges. One of the most important things to consider is flexibility. You might believe that a no-frills loan with low fees is perfect for you right now because your affairs are simple and your present intentions are to stay in the one house for many years, but keep in mind that change is always with us, and your present loan may not be appropriate if things change.
What happens if you decide to move house, or borrow some money for renovations or investment, or need to reduce your repayments when the kids are at high school? If you have a no-frills loan it might not have a redraw facility and you might be required to take out a second mortgage for the extra money. Naturally the bank will be looking for a higher interest rate on the second mortgage.
Offset accounts are also a highly desirable feature. If you deposit money in a normal interest-bearing account you will probably earn less than 2 per cent a year and then lose at least a third of that in tax. However, when you deposit money in an offset account the notional interest credited should be the same as that charged on the housing loan.
And it gets even better: instead of the interest being credited to your account, leaving you liable for tax, the interest is taken off the principal on your non-deductible home loan. So funds in an offset account earn you the same as the loan rate (currently around 5 per cent) after tax. That's equivalent to getting more than 7 per cent before tax on an interest-bearing deposit.
You can put offset accounts to good use if you intend to move home and keep the old one. This is because you can build up funds in the offset account instead of paying them off the housing loan. There is no difference in the interest costs, as the offset account is credited at the same rate charged on the housing loan, but there can be a huge difference when you decide to make the move.
Think about two neighbours who started with a housing loan of $400,000 some years ago. Karen used all her resources to reduce the loan as fast as possible, while Katya banked all her spare money into the offset account, leaving the original loan high. Today, Karen owes only $100,000; Katya has a debt of $400,000 with almost $300,000 in the offset account. They both decide to upgrade to another residence, but want to keep the old one as a rental.
Katya is far better placed for tax purposes, as she can simply withdraw the $300,000 she has in the offset account for a deposit on the new home, leaving a debt of $400,000 on the existing house – this debt is now deductible as she is renting the house out. In contrast, Karen will be paying tax on a large portion of the rents from the original property as it has a very low debt, while suffering the burden of a huge non-deductible debt on her new home.
Noel Whittaker is the author of Making Money Made Simple and numerous other books on personal finance. His advice is general in nature and readers should seek their own professional advice before making any financial decisions. Email: noel@noelwhittaker.com.au