How to clean up your credit rating
In the same way that property buyers pay attention to a lender’s rate, lenders cast a beady eye over their potential customer’s credit rating.
They will check if you have ever been late with a payment, whether it be a mortgage repayment or payment on a bill or some other debt. If so, and it happened less than five years ago, you may have a black mark against your name.
Check with the agencies
Can you afford the home loan repayments for the sort of property you’re considering? Are you confident you could still cope with repayments through events such as interest rates rises, pregnancy or job loss? Do you want the financial and physical burden of keeping a property in good order?
Would you be better off renting and diverting your cash to assets other than property?
How much can I borrow?
Having determined that you really do want to be a home owner, you need to get down to the nitty gritty of what you can actually afford. Do this before you start house hunting and you’ll lessen the danger of falling in love with a property that’s out of your reach.
What you can afford comes down to two things: what sort of deposit you have (most lenders require a deposit of at least 5 per cent and preferably much more), and how much you can afford in repayments.
The general rule is that repayments shouldn’t be more than 35 per cent of your gross income. (One loan manager divvied it up this way: a third for the tax man, a third for me, a third for you.)
If you borrow more than 80 per cent of the value of a property – and this is highly likely in expensive cities like Sydney – you’ll also have to consider the cost of mortgage protection insurance. Most lenders will insist on it, but it’s an added burden if you’re already fully stretched.
Be aware, too, that this insurance doesn’t necessarily protect you – it protects the lender against you failing to meet repayments. The lender gets their money but you don’t necessarily get to keep your home if you remain in ‘default’ on payments. You should seriously consider taking out income protection insurance.
There are many other fees and charges that won’t be immediately apparent, pushing the cost of borrowing even higher. They include solicitors’ fees, loan application fees, property valuation fees, stamp duty and the cost of building and pest inspections.
And don’t forget the costs after you pick up the keys: removalists’ charges, building and contents insurance, connections for gas, electricity and telephone as well as ongoing costs such as maintenance and council and water rates.
Lenders: Show me the money
With thousands of different home loans available, how do you find the right one for you? Do you go to the traditional lenders – banks, building societies and credit unions – or try ‘non-bank’ lenders such as Aussie Home Loans or Wizard? Should you use a mortgage broker?
No matter where you go, make sure you compare apples with apples. Lenders have all sorts of attractive-looking interest rates, but check the annualised average percentage rate (AAPR) on the loans you’re considering. This is designed to provide a more accurate reflection of the cost of a loan, taking into account upfront fees, the temporary nature of ‘honeymoon’ rates, ongoing fees, different compounding periods – whether interest is applied daily or monthly – and other factors.
Also consider the other features of a loan. Can you pay your mortgage fortnightly or weekly if you wish, and make extra repayments? More frequent repayments mean you’ll pay off your loan faster.
What fees are involved (application fees, valuation fees, legal fees, monthly loan service fees, discharge and early-exit fees, mortgage protection insurance)?
Is it possible to switch loan types, from variable to fixed rate, for instance? Can you combine variable and fixed rates in the one loan? What other facilities does the loan offer – can you redraw early repayments?
Once you’ve asked your own questions and zeroed in on a lender, you’ll be asked some too. Just as you wouldn’t lend money to just anyone, your lending institution will want to know something about you and your ability to repay a loan.
When you talk to a lender, make sure you have at hand details of:
Not every instance will have been recorded, but it may pay to check with credit rating agency Baycorp Advantage to see if you have a clean bill of health. There’ll be a charge for a copy of your personal credit record if you need it within 24 hours – otherwise it’s free.
If you don’t have the time to sort through the myriad lenders and home loans out there, you might want to speak to a mortgage broker.
Be aware, though, that not every broker has every lender or loan on its list, so it pays to still do some of your own research. Test their recommendations against other loans you’ve investigated. Many of the cheapest loans are not sold through brokers.
Also, some brokers charge a fee for their services while others accept commissions from lenders. You’ll want to ensure that any recommendation is truly independent, and that fees don’t wipe out the better mortgage deal you think you’ve achieved.
Some people don’t qualify for a conventional home loan for various reasons, including a poor credit history. In this event, one option is to visit a so-called non-conforming lender.
Non-conforming lenders don’t rely on the computerised credit scoring methods widely used by mainstream lenders. Instead, they assess each borrower on his or her merits, looking at factors such as employment, income, repayments record and overall credit history. Some are more rigorous than others.
Carefully weigh up the pros and cons of using a non-conforming lender. They usually charge a higher rate of interest to compensate for what is perceived to be the higher risk and that could amount to thousands of dollars over the life of a loan. These lenders usually also impose stricter repayment conditions.
Get back on track
Then again, one or two years of making payments on time will help you establish a good credit record, allowing you to have another go at securing a conventional loan elsewhere.
A subset of this category is the low-doc loan (where borrowers don’t have to go to the same lengths to substantiate their income). These loans are aimed at self-employed people who can’t easily – or don’t want to – substantiate their income.
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Types of loans
Variable versus fixed
The two most common home loans are variable-rate and fixed-rate loans.
Variable-rate loans track movements in the official cash rate, which is set by the central bank, the Reserve Bank of Australia. If the official cash rate goes up, all things being equal so does the interest rate on your loan, along with your repayments. The flip side of the coin is that you save money if the RBA cuts rates. You can ride the swings and roundabouts of interest rate movements.
With fixed-rate loans, you choose a term – usually one, three or five years – over which the interest rate will remain the same, regardless. You might do that because you think interest rates are going to rise or because you need some certainty about your repayments – perhaps because you’re borrowing to the maximum. However, if you lock into a fixed mortgage and rates fall, you’ll miss out on the lower rate.
Traditionally, fixed-rate loans don’t offer the same flexibility or features as variable ones. Many variable loans offer redraw facilities, for instance. A redraw facility allows you to make additional repayments on your mortgage, with access to the funds if you need the money back later.
It’s a useful facility, but bear in mind that it’s usually only available on ‘standard’ variable-rate loans, which are about 1 percentage point more expensive than ‘basic’ variable loans. And there may be a minimum amount you have to redraw and a fee.
A way to take advantage of the features offered by the two types of home loan is to split your mortgage, putting half on a fixed rate and half on variable-rate terms. Check your lender doesn’t charge you twice for a split mortgage though – you don’t want to pay two sets of establishment fees and two sets of ongoing fees.
Be aware, too, that there’ll be a difference between the rate on a fixed loan and that on a variable loan – the security of a fixed rate often comes at the cost of a higher rate.
Home equity loans
The more you pay off your home loan, the more of the property you own – the more ‘equity’ in the property you build up. These days it’s possible to borrow against this equity for further investment – perhaps another property, or shares.
The advantage of borrowing against this equity rather than taking out a personal, investment or business loan is that the interest rate will be much lower. But remember that you’re putting your home up as security for this loan.
Many lenders offer ‘honeymoon’ rates. The rates on these loans can be significantly lower than the prevailing variable interest rate. But they last only a limited time – usually six to 12 months – then the loan reverts to the standard variable rate.
It’s a dud deal if the short-term gain of the honeymoon rate is outweighed by higher interest costs over the full term of the loan. Do your sums – and make your repayments in those early months at the level they’d be if the standard interest rate applied.
Lenders don’t necessarily advertise the fact, but many offer what are sometimes dubbed ‘professional’ packages to borrowers in certain jobs, those above certain income levels, and good clients who have most of their accounts with bank.
You can probably shave half a percentage point off the interest rate – but if you don’t ask, you don’t get.
Line of credit loans
The idea behind line of credit loans, also known as revolving credit loans, is that you pay your salary directly into your mortgage account so it goes to work straight away, reducing the principal owed and thus the interest charged on the loan.
Of course, over the next week, or fortnight, or month you’ll have to draw on some of that money, but it’ll be at work in the meantime – and with any luck you might leave more than the required repayment behind, making a permanent dent in the principal.
That’s fine, but these loans often attract a higher interest rate in the first place, and the danger is that if you’re not disciplined about withdrawals you’ll actually make your mortgage bigger rather than smaller.
If you’re organised
and disciplined, you could set up a do-it-yourself line of credit using a regular home loan and your credit card.
When the credit card debt falls due, withdraw the required amount from your home loan account and pay your card off in full, to avoid any charges. Just make sure you don’t spend more on your card than you put on your home loan in the first place.
Bridging finance is an expensive answer to the dilemma of buying one home without having yet sold the other. Without a sale, you probably won’t have the readies for the deposit on the new place and that’s where bridging finance comes in.
Depending on your financial circumstances, your lender may be reluctant to provide it, and it will be costly.
The best idea is not buy before you’ve sold. You can never be sure you’ll sell your existing property in good time, or that you’ll achieve the price you expect – and if you don’t, there could be a big hole in your sums.
Deposit guarantee bonds
One option when all your capital is tied up in your existing home is a deposit guarantee bond. The bond issuer will charge you about 1 per cent of the size of the deposit otherwise required on the house – $600 for a $60,000 deposit on a $600,000 house, say – to guarantee to the seller that they’ll get their money when the contract is finally settled (rather than the deposit upfront, now)
Parting with several hundred dollars, instead of many thousands, can seem attractive but if you fail to come up with the money when the time comes to settle, the bond issuer will pay the vendor and then knock on your door. And deposit bonds are sometimes secured against your existing family home.
Finding your dream home
You have the finance lined up – it’s time to start house hunting. You may know where you want to live and the type of dwelling you want – freestanding house, ‘semi’ or unit. But whether you can buy that type of property in the area you like is another matter.
Before hitting the pavement, it pays to do a bit of research on current house prices. You can keep an eye on sale and auction results in the papers, or buy reports on specific suburbs from researchers like Australian Property Monitors’ Home Price Guide (http://www.homepriceguide.com.au ). Talk to real estate agents and attend auctions.
If prices are looking a bit rich in your suburb of first choice, you might consider moving your target just a few kilometres to a neighbouring suburb. You could save a substantial sum by living alongside, rather than in, a trendy suburb.
Or you could lower your sights, from a freestanding house to a semi perhaps – it all comes down to how willing you are to compromise.
You could also narrow down your search by using a buyer’s agent or advocate. Popular with wealthier buyers and those overseas or interstate, advocates are also used by people at the lower end of the market who don’t have the time or inclination to house hunt.
Buyers’ advocates act on your behalf, sniffing out properties that meet your criteria and, if you wish, making an offer or bidding at auction on your behalf. All this for a fee, of course.
Advocates argue that they save buyers time and money (even after their fee), by filtering out unsuitable properties, by knowing the market and by helping you to stick to your price limit.
They argue that real estate agents have a conflict of interest because their role is to achieve the best result for the seller, not the buyer. Estate agents may suggest properties and offer advice, but in the end keeping you happy is only with the aim of keeping the seller happy and earning their commission.
When you’ve found a property you want, contact the vendor through the real estate agent and make an offer – regardless of whether the property is for sale at a set price (known as private treaty) or going to auction.
Even if your offer is accepted, though, neither you nor the vendor is legally bound to proceed with the deal until a contract is signed. While the agreement is only verbal, the owner can still accept a higher bid – you’re in danger of being ‘gazumped’.
You may have spent a small fortune in surveys, solicitor’s fees and other costs in the meantime, but that’s not their problem. The only recompense you’ll get is the return of any non-binding ‘expression of interest’ deposit you’ve paid.
The answer is to get things in writing, quickly (but still with care). If you’ve got a building and pest inspection already to hand and you’re sure you’ll proceed, you could offer to waive the five-day cooling off period to get things moving straight away.
When you exchange contracts, you’re not only agreeing to buy the property, you’re also agreeing to be bound by the terms and conditions of the contract – so make sure you’ve read every page. Look to see what’s included in the price; those fancy blinds and the dishwasher could be excluded.
After contracts are exchanged, you usually have four to six weeks to ‘settle’ or finalise the sale, perhaps longer. You’ll need this time to insure the property, sign mortgage documents, pay stamp duty and complete arrangements with your lender.
If you’re selling an existing property, the various lawyers involved should be able to juggle settlement dates so everyone moves home at about the same time.
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An auction pits a number of buyers against each other at a specified time and place. The main difference between a private treaty sale and an auction is that private treaty generally allows for a cooling-off period, whereas an auction doesn’t.
If the property you want is being auctioned, you’ll need to have your finances in place beforehand. When the hammer falls on your bid, you’ll have to pay a 10 per cent deposit on the spot. (This is when a deposit guarantee bond can come in handy.)
Most properties being sold at auction have a ‘reserve’ price that is the lowest amount the vendor is prepared to accept. It’s not usually revealed, but if the highest bid falls short the property is usually ‘passed in’. Generally, the highest bidder is then offered first opportunity to negotiate with the seller, through their agent.
Auctions can be stressful, and it’s possible to get carried away, so:
Once bidding is under way, it is up to you to decide in what increments you’ll bid. Even if the auctioneer wants bids to rise by $10,000 a pop, you can chip in with any amount you like – $1000, for example.
Some people suggest standing at the back of the room, so you can see what’s going on. If there’s a bidder you can’t see, ask the auctioneer to identify them. You don’t want to be the victim of ‘dummy’ bids being made by parties friendly to the seller.
In NSW, new rules require bidders to register upon arrival at an auction to guard against dummy bids. However, the seller has the legal right to make one bid.
See the website of the consumer rights body in your state for local rules.
Paying off your mortgage
Ask a financial planner for advice on building wealth and, almost without fail, they’ll tell you that the best thing you can do is pay off – or at least substantially reduce –your mortgage.
That’s because the interest on your home loan (as opposed to that on an investment property mortgage) is not tax deductible, and because you need to free up cash flow to make other investments to build wealth.
One of the most common ways to pay off your mortgage early is to make more frequent payments. Pay $2000 a month on your mortgage and you’ll be ahead $24,000 at the end of the year; pay $1000 a fortnight instead and you’ll have eaten away $26,000 in capital and interest.
Even putting a spare $50 a month – or just over $10 extra a week – on the mortgage could shave a couple of years off the life of a $200,000 loan and save thousands of dollars in interest. It’s worth doing even if the money will be needed later – each day that it’s on your mortgage is another day your interest bill is lower.
Extra payments can take the form of higher scheduled repayments or ‘redraw’ amounts you transfer to your home loan account from time to time.
A good discipline is to leave your scheduled repayments as they are even when there’s a rate cut on your variable loan. Yes, you could enjoy the lower repayments – but you’ll eat into your loan if you don’t.
That said, some financial advisers argue that there’s a point where putting excess funds on your mortgage is no longer the best use of your money. Once you’ve got your loan down, it may pay to redirect funds towards other investments.
Offset accounts have a similar impact to extra repayments. With an offset account, the rate of interest you’d normally earn if the money were deposited in a conventional account is set off against your mortgage.
Say you have a home loan of $100,000, at an interest rate of 7 per cent. You also have an offset account holding $20,000. Instead of receiving interest on the $20,000 deposit, the equivalent interest is deducted from your mortgage.
In the end, if you think you’ve got a dud deal you could consider refinancing – switching out of your current loan into a new arrangement with a better rate or features.
However, look at the costs carefully. If you’re in a fixed mortgage you could find the exit penalties prohibitive. It’s cheaper to get out of a variable loan, but it still hurts.
Try talking to your existing lender to see if they’ll match a better deal elsewhere.
- Income, including evidence of your salary (recent pay slips or, if you’re self-employed, your last two tax returns), and of other income such as rent and dividends.
- Assets you own, including investments, savings accounts, life insurance and superannuation policies, and items such as cars and jewellery.
- Expenditure, such as monthly living expenses.
- Debts you’ve accrued, such as other mortgages, personal loans, vehicle finance and money owed on credit cards and store cards.
- Set yourself a maximum price and stick to it.
- If you think you’ll get too emotional, get somebody to bid on your behalf.
- Go to as many auctions as you can so you know how they work.
- Pre-arrange your finance.
- Make sure your solicitor has seen the contract before the auction.
- Have all pest and building inspections conducted beforehand.