Mortgages – everything you need to know
Read on to gain a deep knowledge of mortgages for property investment and home purchases. After reading this article you will understand the types of mortgages available and the best way to structure a mortgage to pay off your home loan faster. You will become the go-to property guru amongst your friends! By learning and implementing mortgage best practices you could save hundreds of thousands of dollars over your lifetime.
What is a mortgage?
A mortgage is a loan that is secured by the value of a property. Legally the loan issuer has a lien on the title, which is a legal ‘block’ preventing the owner from selling and transferring the title to another individual – until the lender removes the lien. If you stop making payments to your lender the lien owner (typically the bank, but it could also be a different lending institution such as a “2nd-Tier lender”) can force your house to be sold to recoup the outstanding balance of the loan. If you have multiple properties banks will often take security over them all – this is known as cross securitisation, where a bank can choose to sell either or all of your properties to recoup any outstanding debts. Initially, you are allowed to repay your loan at any point -unless you’ve entered into a fixed rate term agreement- using either cash, upon the sale of the property, or in the instance of a refinance with another lender.
What is a Loan Value Ratio (LVR)?
The Loan to Value ratio (LVR) is self- explanatory in that it is a figure which determines the amount of lending in comparison to the value of your property. LVR is calculated through a simple formula in which the amount of the loan is divided by the value of the property. This figure is used to determine how much lending can be held by either a single security (property), or an entire portfolio. The limit to how much a property can hold is regulated by the Reserve Bank. For example, if your property is worth $250,000 and the mortgage is $200,000, your LVR will be 80% (or 0.8 as the calculator would show). As you pay off the principal of your loan or the value of your home increases, your LVR will decrease, meaning the equity you have in the property has increased- which is good! When your LVR reaches 0% it means you have fully paid off your mortgage and this property can be discharged from the bank to be what’s known as a “freehold”.
What is a fixed rate term?
A fixed rate term is the length of time within the total loan term, in which you and the bank agree to a fixed interest rate and consistent payment details such as the amount you will be paying and how frequently, within the fixed term. If you don’t have a fixed rate term you will be on a floating interest rate, which means every day the interest rate you are charged will change. If the banks floating interest rate goes up – your interest payments go up. If the banks floating interest rate goes down – your interest payments go down.
The alternative to a floating, or “variable”rate is the fixed rate term, this is where you or your mortgage broker negotiates with the bank to secure an interest rate for a period of time.
For example, on the 20th November 2018, a bank is advertising their home loan rates for customers with an 80% LVR home loan as:
Floating (Variable) = 5.80%
6 month fixed term = 4.95%
12 month fixed term = 3.95%
24 month fixed term = 4.29%
36 month fixed term = 4.49%
48 month fixed term = 4.95%
60 month fixed term = 5.09%
Often, mortgage brokers and even sometimes customers will be able to negotiate rates better than what are being advertised (referred to as “carded rates”). As an example; some of the rates mortgage brokers were being offered for a 54% LVR loan from the same bank on the same day were:
12 month fixed term = 3.95% (same)
24 month fixed term = 4.15% (0.14% better)
36 month fixed term = 4.48% (0.01% better)
When you agree to a fixed rate term you are contractually expected to stay with the bank and pay that interest rate for the duration of the fixed rate term. If you want to pay off the mortgage faster than the agreed payments, increase the amount of your repayments, or break your fixed term for whatever other reason (restructure, refinance etc)- the bank will charge you ‘break fees’ aka ‘early termination costs’.
What are mortgage break fees (early termination costs)?
Break fees are the cost/fee you pay the bank to leave your fixed rate term agreement early. Technically this is for them to recoup their losses, rather than a profit centre for them.
(You can read more about them in this article from the Banking Ombudsman)
Break fees are calculated using an extensive formula for the bank to recoup some of the losses they will suffer from you breaking the fixed agreement. Below is the formula the Westpac uses to calculate their break costs:
Source: Westpac Website (20 November 2018)
Break fees are calculated using three fairly complicated factors; amortisation, the time value of money, and wholesale interest rates. All of these numbers are dynamically changing as you pay down your loan and as the market goes through daily changes.
The calculation by law has to be included in your loan documentation – so you could find it and take a look through. You can also contact your bank and ask what your break fee will be, but be warned; this number changes daily – so it is not a quote you can hold on to and use three months later. If you don’t want to break up with your bank in person you can ask your broker to find out for you. We do it all the time!
Do I need to pay break fees if I sell my house and buy another? Often you can have your original loan term, and fixed rate term kept – while the underlying security is changed. This means you do not need to pay break fees. Again, talk to your bank or broker.
What is interest rate averaging?
Segmenting your total mortgage into 2 or 3 chunks and putting each chunk into fixed rate terms which finish at different times. For example splitting a $900,000 mortgage into 3 segments of $300,000 each. Then having Segment 1 fixed for 1-year, Segment 2 fixed for 2-years, and Segment 3 fixed for 3-years. Then as each segment comes up for renewal you would refix it for a three-year term. Because you have spread your fixed rate term renewal dates over time you will get average interest rates. If you wanted the cheapest possible interest rate today, you would fix your whole mortgage on the cheapest fixed term available. However, this isn’t necessarily a good idea for a few different reasons. If rates next year were significantly higher, you would then have to refix your entire home loan at a much higher rate and face a massive increase in your interest expense costs. If you want to see some examples and learn more about interest rate averaging read this article
What is a Table Loan (aka Principal and Interest Loan)?
The traditional and most well-known capital structure of a mortgage is a table loan. These loans have a specified term (e.g. 25 years) and are paid in predetermined periodic payments (e.g. $400 per week). You are welcome to either use fixed-term interest rates or floating interest rates.
A limitation of this type of loan is that your bank will not typically let you make large payments off your loan, often times you can only make lump-sum repayments during the “refix” period.
What is a Reducing Mortgage?
A reducing mortgage is one where the principal repayments stay the same over the duration of the loan, while the interest payments reduce over time. They reduce because as you pay down the principal there is less of it for interest to be charged on.
What is a Revolving Credit Mortgage?
A revolving credit loan is an alternative way to structure your mortgage. A revolving credit loan acts in a similar way to a large overdraft account. This overdraft amount will be equal to what you currently owe on your mortgage. A revolving credit account is a current account. A current account is an account that can be withdrawn on without notice, that caters for frequent deposits and withdrawals. Into this account, you can credit any income you receive (wages/salary, proceeds of sales, bonuses. etc.) and pay out your expenses.
The revolving credit loan can be set up as a reducing loan. With a reducing loan, the overdraft limit is not fixed and will reduce by the same amount as your previous mortgage repayments, meaning that your overdraft limit will reduce over time. Some lenders offer an initial non-reducing term on this facility, meaning your limit stays the same for an agreed period of time before reverting back to a reducing facility.
The main benefit of this type of loan is that you will only pay interest on the balance of your account, and not on the full overdraft amount. For example, if your overdraft limit is -$200,000 but your account balance is only -$197,000, Interest will only be charged on the -$197,000. This can save you a significant amount in interest over the life of your loan. These benefits are calculated daily, meaning every day your account is below the limit, you are saving in interest!
A further benefit of using a revolving credit loan is that you are able to make as many lump sum payments as you like to this account. This means any additional income; you may receive can be added straight to your loan. You are therefore able to pay off your loan much faster if you desire too, or an additional payment to this account may reduce the amount you pay in interest over a period until you withdraw that money for something else.
What is an Interest Only Mortgage?
Interest only mortgages are short-term loans typically up to a maximum of five years, where your payments only cover the interest charged on the principal. This means that at the end of the loan term you will not have paid off any of the mortgage principal. Because you are not paying down any principal this is the cheapest mortgage option and can be useful for periods of time such as when an investor purchases a property to renovate and sell for a profit, or if you are expanding your portfolio and cash flow will be tight for a period of time.
Mortgage Cash Back Incentives
When banks are trying to win more customers, they sometimes offer ‘cash back’ as a bonus. You can read about this in the NZ Herald. This is often but not always limited to new lending opportunities such as a refinance to restructure or debt consolidate, or new purchase, where customers are bringing more business to the lender.
Here are some examples from the last few years.
Getting a Mortgage Pre-approval
A mortgage pre-approval is simply an agreement with the bank saying they have approved to loan you a specific amount of money. This is useful for when you are house shopping as you will then know what you can afford. Sometimes pre-approvals will have restrictions such as ‘house value’, for example, the bank may have approved you to borrow $600,000 as long as the registered valuation of the house is $700,000 or more.
Situation Specific Mortgage Strategy
Getting Mortgages from non-bank lenders
If for any reason the main banks are not going to be able to say ‘yes’ to your finance, you may need a non-bank lender. Working with an experienced mortgage broker will ensure you have someone on your team who understands all non-bank lenders and can find you finance that has the lowest rates available to you and makes the process easy. Many non-bank lenders, sometimes called second-tier lenders, do not work with the public directly. You need a mortgage adviser to help. These loans do sometimes carry slightly higher rates and application fees, but they’re the only way to get some property deals done. Especially useful for investors wanting to purchase with an 80% LVR (or even higher).
Mortgages for new-builds
With the more flexible LVR rules for New Builds (especially for investors) the options for financing need to be navigated carefully. Approvals can last up to 12 months but you might want to double check the builder is going to be approved by the lender of choice and that the contract meets the legal and financial standards. If you are buying a new build as an investment, you might want to consider splitting the securities and for your first home, just make sure you understand income requirements and do not change jobs or income situation before settling the property. Progress payments might be required and having someone to chase bankers, lawyers, valuers and make sure the road to settlement is smooth will help you sleep better at night. Because the loans are going to be construction loans, you will want to make sure you lock in the lowest possible rates during the build. We can help.
Mortgages for Property Investors
iRefi Mortgage Advisers are specialists in property investments, most of our clients (over 1,000 investors) are mum and dad investors with 2-5 properties. Some clients have 20+ property portfolios and use our advisers to help them navigate the complex financing rules that are becoming tougher to work through each month. If you want to keep buying property and want to chat about the when, where, how, what and why of property investing. Give us a call or fill in the online profile. No costs or obligations. We have specific tools which will help you calculate rental yield on potential purchases and across your portfolio.
First Home Buyer Mortgages
Walking into your bank and asking them about your mortgage options will give you just a small taste of what is available in the market for first home buyers. Your pre-approval amount is quite likely a number that can be increased if you work with a mortgage adviser because we know what bank will lend you the most based on the servicing calculations and your individual circumstances. We also know what banks are offering the best rates and cashback. Over and above low-interest rates and high approval amounts, you should want advice on structures, what and where to buy, how to buy and you simply do not want to miss the guiding light a mortgage advisor can provide if anything goes wrong with the property transaction (with finances, legals, with the agent, valuations etc) there is a lot to it. Using a mortgage adviser is free (as long as you do not need a non-bank lender which often carries a small fee).
Getting a Mortgage with a group/ buying with your parents
If you are looking to buy a home and get help from your parents, then make sure you protect them and their equity by avoiding cross security of their property with yours if you can. If you need help with the deposit but have the income side of things covered enough for the mortgage, it might be safer for everyone to use two different banks. Obviously, the advice provided by an independent mortgage adviser is going to differ from your bank because we can show you options from all lenders and are not trying to cross secure properties (tie them together legally/financially) so you will be happy to see the different options and you can decide with more information.
Using your Mortgage to consolidate debts
People sometimes get into a bit of financial trouble and end up with high-interest short-term debts such as credit cards or personal loans. It is often wise to get a mortgage top-up to consolidate those loans into your mortgage which has a much lower interest rate – this is known as debt consolidation.
What is a Mortgage Broker
A Mortgage Adviser is your Banking Insider
Wherever you go overseas, the best trips are when you meet a local who takes you around town. When you get an inside guide you find the best spots, the best deals, the tastiest food, the uncrowded undiscovered jewels and on return home you are the envy of your social circle. The same deals exist in banking. When you deal with a competent adviser they will show you inside the banking world, advise you on how to structure your portfolio, how to structure mortgages to achieve lower rates and minimise risk. Always with an impartial view to which bank or lender you work with. You just can’t get that advice from a banker because they have to recommend their bank’s products – it’s their job. Mortgage Advisers also help clients who are declined at their bank get approved at that same bank all the time. The way you present the details of your applications is important.
Would you like insights on; how to pay your home loans off faster, how to structure your debts, how to apply and re-apply for interest-only mortgages on your investment properties, how to keep buying more properties quicker or how to break cross-securitisation to protect your assets… the list of advice we can provide is exhaustive and highly tailored based on your current position and your goals. We have seen clients with 30+ properties and an LVR under 40% being told they cannot buy more properties by their bank when clearly all they needed was to separate some securities and involve a few more banks. After helping thousands of Kiwi families with their mortgage goals, we have pretty much seen it all and know how to provide the pathway and the missing elements you desire.
What Can Mortgage Advisers Do
Each adviser applies for permission to resell lenders products. A good adviser will be able to provide you with loan products from all banks plus a variety of non-bank lenders. This means they are able to complete the paperwork with you and submit it to the banks’ internal teams on your behalf – they replace the front office/front counter of the bank.
A good adviser will then touch base with other people involved in your property purchase process such as lawyers, real estate agents, accountants. In short, a mortgage adviser will help:
- you get accepted for a mortgage
- you secure a lower interest rate than advertised rates
- you get cash back or other benefits that are available
- your settlement process go smoothly
Mortgage Brokers Cost You Nothing
Banks and lenders realise the value a Mortgage Adviser adds to their clients, and to them as a business. Therefore ,whenever an adviser organises a loan product for their business, they pay the adviser. This means there is no cost to you. The banks love it because it saves them money by negating the need to hire and train more staff, and the bank knows that when a mortgage adviser places a customer with their bank they will be a good fit. Remember, the bank pays your mortgage adviser. Meaning you get insider knowledge, unbiased structuring advice, help with the process and it costs you absolutely nothing. So take a look at the iRefi mortgage broker team, or give us a call to get in touch with a mortgage broker who will take care of you.
After you complete the 90-second mortgage snapshot, you will be invited to complete the online profile tool that enables us to fully audit your current situation, available options and provide you with options going forward. Some investors prefer to email us a spreadsheet of their portfolios and mortgage structures for us to review. For accurate answers, we do require a lot of information but the advice provided should make it worth your effort. We do review this for free and share our findings with you without hesitation or requiring a commitment from you. If you have not had independent advice for some time, or feel that your current mortgage broker might be missing something, feel free to fill in the details or send us an email with what you want to achieve.