The Devil's In Detail Of Home Loans

Newcastle Herald

Thursday March 24, 2005

Noel Whittaker

THE rise in interest rates has made everybody think about their housing loans, and many are even considering changing lenders to take advantage of what may seem to be a cheaper rate.

Of course, the banks have jumped on the bandwagon and the papers are full of advertisements offering fixed rates at what appear to be bargain basement prices.

Unfortunately it's not as simple as it appears, because the advertisements all contain two figures, the annual rate and a comparison rate.

For example, one bank is running huge advertisements headed Home Loan Sale, in which the two-year fixed rate is advertised at 6.59 per cent, but showing a comparison rate of 7.3 per cent.

It would be reasonable to think the message here is that home loans usually cost 7.3 per cent but, because it's a sale, you are getting a bargain at 6.59 per cent.

That is not the case at all. The comparison rate gives the effective rate after taking into account other costs such as fees and charges.

The true rate in this example is 7.3 per cent if you take out a loan on the terms and conditions spelt out in the fine print in the ad.

This publication of the comparison rate has been forced on lenders by the Government in an attempt to help consumers make better choices.

This is all very well, but the comparison rate does not include government fees and charges, or bank fees that may be charged only in certain circumstances.

A typical example may be termination fees if you quit a fixed-rate loan before the end of your loan contract.

It also does not take into account other features such as fee-free banking, or flexible payment arrangements that make a loan more attractive.

If you are taking out a loan, be aware that there are many aspects besides the interest rate and the fees and charges.

One of the most important things to consider is flexibility.

If your affairs are simple and you intend to stay in the one house for many years, then certainly it is possible that a no-frills loan with low fees is fine for you.

But, as you progress through life, circumstances change.

What happens if you decide to change houses, or want to borrow some money for renovations or investment, or need to reduce your repayments as the kids are at high school?

If you have one of the no-frill loans it generally won't have a redraw facility and you may be required to take out a second mortgage for the extra money you want.

Naturally the bank will charge a higher interest rate on the second mortgage.

Offset accounts are a highly desirable feature.

If you deposit money in a normal interest-bearing account, you will probably earn less than 2 per cent per annum and then lose nearly half of that in tax.

However, when you deposit your money in an offset account, the notional interest credited should be the same as that charged on the housing loan.

But it gets even better. Instead of being credited to your account and leaving you liable for tax, it is taken off the interest on your non-deductible home loan.

Therefore, funds in an offset account earn you the equivalent of the loan rate (currently around 7 per cent) after tax.

That's equivalent to getting 13 per cent before tax on an interest-bearing deposit. You can put offset accounts to good use if you intend to change residences and retain 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 as being 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 $200,000 some years ago.

One used all their resources in reducing the loan while the other poured all their money into the offset account.

Today, the first owes only $50,000 on their loan but the other has a debt of $190,000 with $140,000 in the offset account.

They both decide to upgrade to another residence, but want to keep the old one as a rental.

The second couple would be much better off for tax purposes as they can simply withdraw $140,000 from the offset account to use as a deposit on the new home, leaving a deductible debt of $190,000 on the existing one.

In contrast, the other couple will be paying tax on the rents from the original property and suffering the burden of a huge non-deductible debt on their new home.

Noel Whittaker is joint managing director of Whittaker Macnaught Pty Ltd, AFSL number 246519. Email noelwhit@gil.com.au

© 2005 Newcastle Herald

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