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10 mortgage rules to live by

ByDavid Gordon

Ever wonder how successful property owners manage to stay on top of their mortgage? Wonder no more as Your Mortgage outlines 10 rules to make your mortgage work for you.

1. Save money upfront
It’s easy to get caught up in the excitement of buying a new house, especially when you find your dream home, complete with double garage, bay windows, a covered balcony – and did you say French doors?!

It’s enough to prompt you to nudge your pre-determined, strict, ‘can’t go a single cent over $400,000’ budget up, just a little, to $410,000 – and then a little more, to $420,000 – and then finally, once you’ve really fallen in love and need to live in the property whatever the cost, to $425,000.

Many homebuyers fall into this trap of buying based on their emotions, explains Janet Spencer, director of Melbourne property consultancy Buyers Solutions – and it’s the number one way to ensure you pay more for the property than you need to.

“It’s really important to do your research on price, and make the effort to inform yourselves to prevent overpaying,” she says.

“If you overpay at the beginning, the cost of paying off that extra debt will be significant in the long term.”

Instead, Spencer advises homebuyers to “work on their cash flow” to boost the amount of lending they can access – and then, once a price range has been determined, stick to it.

2. Budget before you buy
One of the keys to managing your mortgage effectively is to draw up a budget to work out how much you can borrow, says Steven Ramage, head of mortgages at Citibank.

“It’s not enough to know how much a lender is prepared to loan to you: you also need to know how much you can comfortably afford to live on,” he explains.

“You also need to think about the type of lifestyle you want to live, and whether you’ll want to put extra money aside to pay off your mortgage sooner.”

One of the best ways to draw up a budget is to list your total monthly income and your anticipated monthly expenses.

Factor in all costs associated with owning a home, such as council rates, insurance, strata fees, maintenance costs and mortgage repayments. Also include an amount each month for unexpected or infrequent expenses, such as doctor and dentist visits, car repairs, presents and school fees.

“It’s worthwhile allowing an extra 1.5–2% per annum on top of current interest rates, so you can see how easily you could maintain your repayments if rates rise in the future,” Ramage says.

If you’re not sure where to start, there are plenty of online resources available to help you, including a detailed Income and Expenditure Worksheet at www.yourmortgage.com.au.

It’s important to review your budget every three or four months as your income and outgoings will vary. “Also, give some thought to where your career is headed, and your plans for the future,” Ramage advises. “For example, is a salary increase likely? Or, do you intend to spend some time travelling, or wish to start a family. These could all have a significant impact on your budget, now and in the future.”

3. Develop cash reserves – and ditch the credit card
Credit cards are possibly one of the biggest debt traps Australians regularly find themselves in, says Andrew Rocks, financial planner and director of financial advisory firm the Announcer Group.

They offer an easy source of credit and the opportunity to conveniently deal with those emergency expenses that you may not have budgeted for; the only problem is, small credit purchases here and there can add up into one major debt, and before you know it, you have a $5,000 balance on your hands – and you’re paying 17% interest on those late-night taxis and a couple of pairs of shoes.

“Credit cards should be used wisely and with caution,” Rocks says.

“You should limit yourself to one credit card if possible, and shop around before you sign up, to get a low-rate card. Also, keep your maximum limit low and request the bank to stop automatic limit increases.”

And instead of using your credit card to pay for everyday items and emergency purchases, create a cash reserve in your budget for these items.

“Cashflow is crucial to financial independence, and a healthy circulation of cash enables life to continue without creeping into debt,” Rocks says.

“It doesn’t have to be a large amount every week or every month, but little and often is always a far better approach than sporadic chunks. Consistency is the key.”

4. Stay calm
These are definitely turbulent times, and with the uncertain economic climate, there’s plenty for homeowners to consider, says Jennifer Nielson, CEO, Loan Market Group.

“My main advice to mortgage holders is: don’t panic,” Nielsen says.

Late in 2007 and into 2008, as interest rates rose and the global economy began to falter under the weight of the sub-prime crisis, homeowners – and all Australians – were fearful. The share market took a beating, mortgagee repossessions skyrocketed, and many people saw their superannuation funds significantly depleted, and even wiped out.

It was, and still remains, an unstable and challenging environment to be attached to a sizeable mortgage within – which is why it’s critical to “carefully consider your own circumstances and examine your finances”, Nielsen says.

“For those paying off a substantial housing loan, there’s relief from the latest interest rate reductions, and a number of well-respected economists predict further significant rate cuts,” she says.

“Added to this is the fact that the lenders have also started reducing their variable rates, independent of the Reserve Bank, and several banks have announced big reductions in fixed rates.”

Although fixed rates offer some security in an otherwise uncertain economy, Nielsen – who admits that she is “not a big fan of fixed rates” – says she’s “reluctant to advise anyone to lock in a fixed rate just yet”.

“Fixed rates are great when you hit the bottom of the interest rate cycle, but most analysts are saying that we aren’t even close to this point,” she says. “Think about fixed rates when we get to 6%.”

5. Boost your cash flow with interest-only
The reduction in variable rates provides two significant opportunities for homeowners, according to Nielsen.

“It will obviously reduce your payments, but also, if you’re still struggling to make ends meet, you can free up a considerable amount of cash by switching to interest-only payments. On a $250,000 loan, this can amount to around $300 a month,” she explains.

“Obviously, if you can afford to maintain your payments at the current level then do so, as homeowners will find that if they can continue payments at the same level they were committed to prior to the reduction in interest rates, they’ll slice several years off the term of their loan and save tens of thousands of dollars.”

Interest-only is a handy option for investors as it helps them manage their cash flow better, however, for homeowners, this should only be considered as a short-term solution. By paying interest only, you’re not making headway with your mortgage repayments. So as soon as your financial situation improves, you should get back to paying interest and principal to get rid of your mortgage sooner.

6. Say no to interest-free offers
If you’re about to take on the largest debt of your lifetime – a home loan – you need to avoid the tempting offers extended to you by department stores and credit card providers, says Ken Sayer, managing director of Mortgage House.

Finance providers may offer 24-month interest-free terms and an affordable repayment schedule, but the devil, he says, is in the detail.

“Interest-free only applies if the closing balance is repaid in full on or prior to the end of the interest-free period allowed – otherwise, interest is charged on the entire balance, and it’s backdated to the date of purchase,” Sayer explains.

“You really do need to understand the implications of obtaining ‘interest free’ credit cards or store cards before signing up.”

This means that if you don’t repay the full balance of your television, lounge suite or whitegoods purchase within the set timeframe, you could be up for hundreds – or even thousands – of dollars in interest fees. These types of products charge excessive interest rates of around 25%, meaning a debt of $4,000 would attract interest charges of $1,000 per year.

“You should only apply for a credit or store card if you have the desired credit limit in cash, in another account or redraw facility – and purchases should only be charged to the credit card if the borrower can comfortably afford to pay down the closing balance in the following month by the due date,” Sayer says.

7. Consider your income stream
With the economy currently in a state of flux, unemployment will inevitably rise, according to Rocks, as many companies will fold and will be unable to pay retrenchment packages.

“Insuring your income is definitely a wise and essential move in these uncertain times,” Rocks says.

Economic uncertainty is “a real issue”, adds Nielsen, particularly as it can affect your ability to earn a living.

“What would happen if you were out of work for, say, three months? How much of a buffer do you have in your home loan?” she says. “If you’re concerned about job loss, perhaps you should consider re-contracting your home loan for a fresh 30-year term, and possibly even increase the amount of available equity, to act as a worst-case repayment buffer.”

With these actions, you’ll contract yourself into a much lower monthly repayment, but Nielsen cautions borrowers to use this strategy as a last-resort: “You don’t want to fall into the trap of eroding the equity in your home, so you should maintain repayments at a higher level if you have no reason to drop them.”

8. Use and abuse
There are plenty of grants and concessions available to first-home buyers, so use and abuse them to your advantage.

The First Home Owners Grant tripled to $21,000 for brand new homes, and these federal grants are in addition to state government incentives. In Victoria, for example, first-home buyers can access a further $3,000 when they buy their first home – or $5,000 if they build – and an additional $3,000 if they build the home in regional Victoria. That’s up to $29,000 in grants to spend in a market where the median house price is $272,000 (Residex, September 2008).

“For those entering the property market for the first time, obviously conditions are terrific with the federal government doubling the first home buyers’ grant to $14,000,” Nielsen says.

“With so many decisions for homeowners and would-be homeowners to make at the moment, my advice would be to get a mortgage broker on your side. A broker won’t cost you a cent, and is the best person to advise you on your options, help you with all paperwork and negotiate with banks and the range of non-bank lenders.”

9. Create your own equity – and leverage it
“The most important thing that I can tell people is that it’s crucial that you cut to the bone of all of your spending – and then everything that you have leftover has to go into your mortgage,” says Margaret Lomas, director of Destiny Financial Solutions.

“These days, mortgages are usually flexible enough to allow you to redraw your money if you need to, so I think that if you’re going to park your money anywhere, you might as well have it there.”

By paying additional amounts off your loan, in addition to paying the loan off sooner, you’ll be creating more equity in your property.

“You’re reducing the amount you owe, so the equity grows more quickly than it would if you were just waiting for the market to grow,” Lomas explains. “Equity equals a deposit on another property, and more property equates to more exposure to the market.”

If you increase your property portfolio and have four properties worth $200,000 each, and they increase in value by 10% in one year, you’ll be on the receiving end of an $80,000 gain – which is obviously much better than having one property valued at $400,000, which would only put half of that amount back in your pocket.

“Putting in extra repayments into your loan shouldn’t just be seen as a way of reducing a loan – it should be seen as an opportunity to improve your equity position. It’s the leveraging that’s really important.”

10. Compare apples with apples
When selecting a loan, it’s important to be aware of both interest rates and the fees involved, and to compare each loan product in its entirety.

You need to be aware of all of the fees and charges involved – for example, a professional package might set you back $400 a year, but for that outlay you receive fee-free transactional accounts, an offset facility and redraw.

However, these features might be meaningless to you if you have an existing bank account with fees of a few dollars a month, and limited savings to offset your debt. In this case, you’d be better off going for a basic variable loan product with minimal trimmings and low fees.

“Comparing the total cost of a loan is more important than simply comparing the interest rate,” says Mark Borg, financial planner with AMP.

“Although variable rates tend to be more cost effective for most people, a fixed rate might be wise if you’re extending yourself to the edge over a long period of time.”

Your best bet is to decide, at the very beginning, which features are most important to you, and seek out the loans with these qualities to compare.

(from your mortgage magazine)

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