Home-buyers: Three tips to avoid becoming a slave to the mortgage

Mortgage brokers suggest getting a pre-approval first, setting a price limit and structuring the mortgage around needs.
Mortgage brokers suggest getting a pre-approval first, setting a price limit and structuring the mortgage around needs. Photo credit: Getty Images.

A mortgage is a long-term financial commitment, so it's important new borrowers don't overcommit themselves, experts say.

Interest rates, currently at record lows, are forecast to rise from May, making the cost to borrow money - including repayments for existing borrowers - more expensive.

Expecting house price growth to "come to a grinding halt" and "go sideways" for a time, Reserve Bank Governor Adrian Orr told The AM Show on Thursday homeowners should "consider what interest rate they can sustain on average through time" - not just what the current rate is.

By 2025, retail mortgage interest rates could be 1 to 1.5 percentage point higher than now, ASB says. Based on a mortgage of $500,000 on a one-year fixed rate of 2.25 percent, monthly repayments over 30 years would be around $1911.  But a one percentage point increase (to 3.25 percent) would increase payments to $2176 - an extra $265 each month.

Wayne Henry, managing director of Wayne Henry mortgages, said mortgage interest rates, currently still at record low levels, may give a false sense of security.

"The cost of rising rates is going to hit people across the entire country over the next three-to-five years, something borrowers (and banks) have to factor in," Henry said.

As rising interest rates and slowing house price growth are important considerations for borrowers, Newshub asked mortgage brokers to share three tips to avoid becoming a slave to the mortgage.

1. Get finance pre-approved first  

A pre-approval is an indication of the amount a person can borrow. Together with their deposit, it tells a borrower what price-range they can afford.

Banks apply 'stress tests' to ensure repayments are affordable at a higher interest rate and allow for monthly costs.

But Henry says borrowers share responsibility in ensuring they can afford the repayments and are aware of the costs associated with home ownership.

"The buzz can and will wear off if you haven't provisioned for all costs associated with purchasing a property - for example, insurance[s], rates, repairs, urgent renovations, connecting the phone, internet, power and any extra household items you may require," Henry says.

Sarah Curtis, owner of Sarah Curtis mortgages, said being pre-approved for a mortgage is reassuring, as it provides a limit on what the bank considers affordable. But before committing to buy a specific property, borrowers need to talk to their bank (and/or mortgage broker) first.

"You'll need to make sure you're unconditionally pre-approved, as once you sign the contract you're committed to the purchase," Curtis said.

2. Set a limit on the purchase price

Competition from other buyers, particularly at auctions, may lead to rash decisions. To avoid overpaying, it's important buyers "know their numbers" before bidding - or negotiating on paper.

"[Bring] someone to support you who knows this figure. Watch auctions online (most real estate companies have them available to view) so you know how it is going to go before you turn up on the day," Curtis suggests.

Lisa Barton, senior financial adviser at Money Empire, also suggests borrowers be absolutely clear about their purchase intentions.

"Is the property a stepping stone to get into the market and move up the ladder (in which case you're not willing to pay over), or is it a dream home/ forever home, in which case you may be willing to pay more for long-term security?

"If it's a do-up, [you'll] need to buy at reasonable market value to create equity for renovations (and cost them out first)," Barton said.

3. Structure the mortgage to personal needs

By structuring the mortgage to suit their needs, borrowers can save money by reducing the amount of interest they pay.

A floating interest rate gives borrowers flexibility to make extra payments, to repay the loan faster. The rate moves up and down and is generally higher than a fixed rate. A fixed interest rate gives budgeting certainty on what repayments will be over a specified term (six months to seven years) but there's generally a fee for early repayment. Mortgages can be on a fixed or floating rate, or split between both.

Those who have control over their spending, are paid commission or bonuses and want to make extra mortgage payments, could consider a revolving credit facility. Money can be withdrawn if needed, without having to apply to the bank for a new loan.

Megin Wilton, mortgage adviser at Loan Market, explained a revolving credit facility as similar to a big credit card. It's set at a floating rate (higher than fixed rates) and has a redraw limit. If used correctly, it can save money on interest costs.

"You only pay interest on what you owe in the facility and it gives you the freedom to make additional repayments but retain savings at the same time," Wilton said.

There's no set limit for a revolving credit, but many borrowers set it between $10,000 and $50,000, depending on their circumstances.

"You can have your salary credited to the revolving credit facility, do your monthly spending on a credit card then pay the credit card in full before the due date, therefore no interest [is] incurred," Wilton explained.