The High price of lower mortgage repayments with interest only home loans

With Mortgage finance there is no such thing as a free lunch. Home buyers and homeowners scrambling to lower their mortgage repayments need to think about all the implications for they change to an interest only home loan.
Because there is a high price to pay, eventually, for interest-only mortgage home loans.

The latest interest rate rise has seen many borrowers scrambling for strategies to make their home loan repayments more affordable.

Options include extending the loan term, refinancing on a better rate, old-fashioned belt-tightening and, more controversially, opting for an interest-only product.

Cannex figures show only one in every 100 Australian owner-occupiers sign up for interest-only deals, but anecdotal evidence suggests more people are being tempted to cut growing repayments any way they can.

"I've had a number of clients asking about them recently [because] they're much cheaper than a principal and interest repayment loan," says Anna Mandoki, a financial counsellor with the Financial and Consumer Rights Council in Victoria.

However, she notes a pattern of emerging problems associated with these products: "I would caution people to really think carefully before they consider interest only repayments."

For borrowers suffering the pinch, the appeal of interest-only loans is obvious. Home buyers grappling with a typical $250,000, 25-year mortgage would save themselves $270 a month by abandoning attempts to chip away at the principal and resigning themselves to covering only the outstanding interest bill, according to Cannex calculations.

And those struggling to cover the cost of higher-priced properties in cities such as Sydney and Melbourne, the "savings" would be even more considerable, allowing them to get a toehold in the market at minimal cost.

For all these reasons, a product that was solely a property investor option now has strong appeal for cash-strapped owner-occupiers, says Lisa Montgomery, the national manager of marketing and consumer advocacy with Resi Mortgage Corporation.

But she warns that with the property boom over, home owners can no longer rely on capital gains to carry them through, and that the short-term relief associated with lower repayments can have serious long-term ramifications.

And as David Tennant, director of the Care Financial Counselling Service in Canberra, says, the proliferation of home loans that don't require people to put down deposits, or even stump up their borrowing costs, means many borrowers are already starting out behind the eight ball.

"It's just digging people further into crisis," he says. "It's quite conceivable that we could see situations which started out as negative equity get so much worse."

There's a high price to pay, eventually, for interest-only loans.

The latest interest rate rise has seen many borrowers scrambling for strategies to make their home loan repayments more affordable.

Options include extending the loan term, refinancing on a better rate, old-fashioned belt-tightening and, more controversially, opting for an interest-only product.

Cannex figures show only one in every 100 Australian owner-occupiers sign up for interest-only deals, but anecdotal evidence suggests more people are being tempted to cut growing repayments any way they can.

"I've had a number of clients asking about them recently [because] they're much cheaper than a proper principal repayment loan," says Anna Mandoki, a financial counsellor with the Financial and Consumer Rights Council in Victoria.

However, she notes a pattern of emerging problems associated with these products: "I would caution people to really think carefully before they [go ahead]."

For borrowers suffering the pinch, the appeal of interest-only loans is obvious. Home buyers grappling with a typical $250,000, 25-year mortgage would save themselves $270 a month by abandoning attempts to chip away at the principal and resigning themselves to covering only the outstanding interest bill, according to Cannex calculations.

And those struggling to cover the cost of higher-priced properties in cities such as Sydney and Melbourne, the "savings" would be even more considerable, allowing them to get a toehold in the market at minimal cost.

For all these reasons, a product that was solely a property investor option now has strong appeal for cash-strapped owner-occupiers, says Lisa Montgomery, the national manager of marketing and consumer advocacy with Resi Mortgage Corporation.

But she warns that with the property boom over, home owners can no longer rely on capital gains to carry them through, and that the short-term relief associated with lower repayments can have serious long-term ramifications.

And as David Tennant, director of the Care Financial Counselling Service in Canberra, says, the proliferation of home loans that don't require people to put down deposits, or even stump up their borrowing costs, means many borrowers are already starting out behind the eight ball.

"It's just digging people further into crisis," he says. "It's quite conceivable that we could see situations which started out as negative equity get so much worse."

In Britain, alarm bells are already ringing over the number of interest-only mortgages being taken out, with the regulator, the Financial Services Authority, sending a thinly veiled warning to lenders to get their house in order and putting such products at the top of its list of "emerging retail risks".

One in four borrowers are taking out the mortgages but many have little hope of paying off the capital sum at the end of the term, The Guardian newspaper reported recently.

"Many borrowers, particularly those who have remortgaged to a cheaper deal, may not even understand that they have a loan which, when it matures in 15, 20 or 25 years' time, will leave them with a huge bill," it reported.

"In the worst case, householders in their 50s and 60s could face repossession if they cannot stump up tens or even hundreds of thousands of pounds."

The Australian situation isn't so dire, but in a case which she describes as "the tip of the iceberg", Mandoki says she recently saw a client lose her house after she fell ill, and became unable to meet the repayments on an interest-only mortgage secured through a non-mainstream lender.

Ironically, with a different type of loan, the situation may have been salvageable through the Mortgage Relief Scheme that operates out of Victoria's Department of Human Services, Mandoki says. The scheme offers home owners short-term interest-free loans to help overcome difficulties with home-loan repayments resulting from an unavoidable change in circumstances, such as becoming sick or losing a job.

"But one of the conditions is that it can't be an interest-only loan," she says.

Yet even during affordability crunches, Phil Naylor, chief executive of the Mortgage Industry Association of Australia, says the Australian dream of home ownership is still alive, and recent research shows 90 per cent of borrowers want to pay off their loan sooner.

However, he notes that industry, governments and regulators, need to keep a close eye on trends in this area.

"As it's a time when house prices are high, savings are low, lifestyle compromises are minimal, and people are made to be more responsible for their finances for retirement, the use of these loans for owner-occupants, particularly first-home buyers, should not be encouraged," Naylor says.

Montgomery says that while financial institutions won't turf undisciplined borrowers out of their homes at the end of the term, opting for an interest-only deal means you can only postpone, rather than evade, the repayment of principal: "It must be paid back at some time or another," she says.

And while some suggest proceeding with caution when it comes to interest-only loans, Tennant advises borrowers not to even go there.

"If the only way you can get into the housing market is to take out an interest-only loan, then you can't afford it and you need to rethink your housing needs," he says.

In Australia, about 8.7 million individuals are affected by rate hikes.
Source: Sydney Morning Herald and Cannex

Mortgage shopper warning: Use caution at the real estate auction

The key to buying wisely at a real estate auction is to establish what you want first and to decide on what you are prepared to pay for a property before the auction.
Its wise not to get carried away by the emotions that course in your veins at the typical auction. These emotions can include:

• The urge to own.
• The fear of loss.
• The desire to win at all costs.
• The need for fun and good cheer.
• The fear of suffering loss of face.

It all happens at the auction, because auctions create a super hot sales environment where all of the above can fester and thrive. First they gather a lot of potential buyers all cashed up with money burning a hole in their pockets to bid on just one property. Then they create the illusion that the property can be bought for a song, where you can steal the property from the hapless, desperate seller.

The other illusion auctioneers want you to buy into , like all real estate agents is that they are on your [the buyers] side. Believing this is the biggest blunder that buyers can make. The Real Estate Agent is sworn to his or her fiduciary duty to look after the principal's best interest. The principal is the one who pays the agent the commission. At auctions, that is always the buyer! So, if the agent is ethical, he or she will take every last dollar that he can from you, the buyer, because that's what he or she is paid to do. So don't try to become friendly with the Auction agent, because he or she will only assume you are sucker that can be taken advantage of. Be warm, be civil, be polite, but be disinterested and vague. It could save you thousands.

Then the auctioneer removes from the buyer the time to think and ponder. You are forced to bid faster than you can think. A good auctioneer creates an avalanche effect and all the dreams of buying a bargain evaporate as the reality of what's happening sinks in. You don't want a bargain any more, you want to pocess this scarce property before you, you want to win at all costs. You are being worked by a master of psychology and he's winning, not you.

Finally the last two bidders slug it out as the early dreamers are tossed aside as also-rans. The auctioneer will spur the competitive spirit out of these last to drive bidders till one drops exhausted, beaten and ashamed he didn't have the resources at his disposal that the winner did. anyway he reasons, the guy had more money than sense.

The winner is then congratulated and can celebrate whilst the losers can do as they please.

Then when you think it couldn't get any worse, the last deep cut. No cooling off. You can suffer buyers remorse at your leisure. The auction system has removed all your consumer rights that Ralph Nader and others that followed him fought so hard to win for you.

Now you have been slapped into reality land, let's see what you can do to equalise the situation in your favour.

• Here are some tips on how to do it:
  After finding out how much you want to spend, make inquiries about the contract, what the property includes and be certain it's clear of major defects.
• Have a building report and pest inspection done before the auction.
• On auction day, make sure the contract has not been altered.
• Arrive on time for the auction, never early.
• Never introduce yourself to the auctioneer and let them know you are interested in the property. Stay out of his figuring. Auctioneers feed on this desire to big note yourself and know how to work it. Under no circumstances let the auctioneer know what price you are willing to pay.
• Remember that the Auctioneer has to work in the best interest of the Vendor, not you.
• That's your job, so do it well.
• Never make the first bid. [The one's that do never finish up with the property, but do add to the price.]
• Slow the bidding down, don't add to the feeding frenzy.
• Never bid till you know that the property is "on the market."
• Always look disinterested.
• Always think before you bid. Tease the auctioneer and the other bidders.
• Never allow the auctioneer to flatter you or bully you. He's in control of the auction, but you must in in control of you.
• If he tries to squeeze you, relax and disassociate yourself. See it happening from a distance. Never take it personally.

Follow these simple rules and you won't get badly burned at the auction. If you find that you can't buy value at an auction, you now know why. All the bargaining chips have been snaffled by the one that set the rules. The auctioneer is master of his domain, so maybe you need to find another way to win.