Getting a home loan can be easy. But it can also be easy to muck it up by making rookie mistakes. Here are some of the most common mistakes I see made by new borrowers.
Mistake No.1: They make too many applications
Whenever you apply for a loan it gets recorded on your credit file. What you might not know is that it doesn’t say whether or not the application was approved. So if you apply to a number of lenders, they will start to wonder whether you have been turned down by all the others and will get a bit nervous and are more likely to knock you back. This is where a good broker can be worth their weight in gold. They will know what each lender can offer you and which ones are more likely to provide you with the right loan products and services for your individual situation.
Mistake No.2: They don’t clean up their credit first
A credit file with too much activity, or too many defaults or judgments can be a major hurdle in obtaining the loan that you want. It’s also possible that an error has been made and your report includes items which are not relevant to you which may be detrimental to your loan application.
This is why it is really important for you to obtain your credit report before making any application for finance. This way you can get any mistakes corrected and know what the lender will see when they check you out.
Mistake No.3: They take on more than they can handle
Be wary of how much lenders (and their online calculators) say they will lend you. Often a lender will give you more than you can really afford which will lead to you getting a loan that severely cramps your lifestyle and lead to financial stress.
Borrowing more than 4 times your gross pay will result in repayments exceeding 35% of your take home pay. This should be approached with extreme caution and only when you have a clear plan to increase your income or reduce the payments over time.
Mistake No.4: They obsess about the interest rate
Whilst your interest rate is certainly important, it is far from everything. There are two other considerations you need to take into account which may impact your decision as to which product to take out. The actual rate you pay can be seriously affected by costs such as up front establishment fees and Lenders Mortgage Insurance (LMI). I was doing a review for a client the other day who wanted to borrow $500 000, which was 95% of the value of the property she was looking to buy. Loan A had a rate of 4.99% and the other (loan B) had a rate of 5.16%. The fees were roughly the same and both offered an offset account which the client wanted. Loan A was clearly a winner on the surface.
But when I did the LMI quote, Loan A was $27 493 whereas Loan B was only $12 977. This meant that it would take 17 years to pay for the extra LMI premium with the interest difference of $850 per year. For younger borrowers, who are more likely to need a loan with a higher LVR, the cost of Lender’s Mortgage Insurance may be a bigger determinant of overall cost. So make sure you are clear on all costs which will be applicable to your loan.
Prioritise features and benefits
Think about what features are most important to you, and which ones you are actually prepared to pay more for. Using an offset account for example can make a huge difference to the time it takes you to pay off your loan and the difference in rate may become insignificant. Rank loan features according to those you must have, those you want (and are prepared to pay a bit more for) and those you would like (but are not prepared to pay more for).
Mistake No.5: They drain their Emergency Stash to make the deposit
When you see the price of Lenders Mortgage Insurance, it is tempting to try to minimise it by gathering every dollar you can to maximise your deposit. While this may be instinctive, it can be very risky. Maintaining an Emergency Stash is a key foundation of the Life Sherpa® way to reduce financial stress. It is important because it gives your finances resilience to cope with unexpected events or loss of income.
The likelihood of unexpected expenses increases substantially when you become a home owner. At the same time, the impact of losing your job increases dramatically. Now is the time you really need an Emergency Stash. In fact, it is probably a good time to increase the number of month’s expenses you keep on hand.
Mistake No.6: They use a redraw facility to fund the Emergency Stash
The benefit of an Emergency Stash is lost if you can’t get to it when you really need it. Tempted by the interest savings to be gained from repaying a home loan, many people are lulled into a false sense of security by the availability of a redraw facility. A redraw is no substitute for a deposit. Access to the funds is always subject to the banks control. During the GFC many people found access to their redraw cut off when they lost their jobs because of the lenders desire to reduce their risk and exposure.
An offset account is better and gives the same economic effect. But access to the funds can still be restricted if your lender thinks you may not repay their loan. The lender also has what is known as a lenders right of set off, allowing them to apply the balance in your offset account against the loan if you default.
Don’t put all of your Emergency Stash into your offset account. Keep some at another bank. How much is a personal choice. Think of the difference in interest rate as a form of insurance premium.
Mistake No.7: They don’t factor in all the costs
Buying a home involves a huge number of expenses – some small, some larger. These range from the obvious things like stamp duty, loan fees, legal fees and inspections to the more obscure, like replacing the locks in your new home. The one that catches a lot of people is the adjustments made on settlement. These relate to expenses such as rates, land tax and utilities charges that have been paid by the previous owner but relate to the period after you take over. These are pro-rated on settlement. You may be expecting rates to be paid quarterly and then find that the previous owner has paid the full years rates leaving you with a bigger bill than you expected.
There are always minor (or not so minor) repairs to be done at the new house that you may not have spotted in your inspection. But there can also be costs to clean the old house and fix up any damage so you can get your bond back.
Mistake No.8: They don’t have the right insurance cover
When you take out a home loan your lender will insist you take out building insurance. If you buy a strata title apartment, the Body Corporate usually organises this. Ensure you have insurance to cover the contents against fire, theft or flood.
If you are going to rent out your property, you should also consider Landlord Insurance to cover you against public liability, in case a tenant or a guest injures themselves, or your tenant damages the property. Landlord Insurance can also help cover lost income if your property is damaged and can’t be rented.
Most important is to insure your ability to keep paying the mortgage if you get sick or injured. This is the big benefit of Income Protection Insurance which will replace some of your income if you can’t work due to sickness or injury. Mortgage Protection Insurance is also available to protect you against losing your job.
With over 25 years in Financial Services from consulting to management, Vince Scully is the go-to guy for wealth management and financial advice. Before creating Life Sherpa®, Vince founded the Calliva Group; a fund manager, product issuer, adviser and lender. Vince is an adviser to the Wealth Management Industry, and prior to his role as CEO at Calliva, a senior member of Macquarie Bank’s infrastructure team.