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If there’s one problem that has captured the attention of money professionals and amateurs alike, it’s the circumstances surrounding the sub-prime lending debacle out of the US. And while it’s a US-caused  problem, it has infected the global financial system and threatens many western economies.

Keeping the lid on rates

The concerns are such that our central bank could delay or even postpone any upcoming interest rate rises because of sub-prime concerns. With that in mind, I thought it timely to look at what constitutes intelligent and safe borrowing for real estate.

Up, up and away

In the US, these sub-prime loans were flogged at 6-7 per cent but after a few years they jumped to 11-13 per cent! No wonder many borrowers have just walked away from their homes.

Fortunately in Australia our lending practices are miles better, but still some people who line for dumb loans could find it very hard to cover.

Keep within your means
My first recommendation for smart and safe home loan borrowing is don’t over-extend yourself.

I put some figures into a home loan calculator and assumed a monthly income of $8000 a month with no other loans to pay back. The calculator told me I could borrow $680,000 and my repayments would be $5154 a month. The interest rate I used was 8.2 per cent.

Here’s the rub

But get this - by simply throwing in a $300 a month car loan, the amount you could borrow falls to $625,000 and the amount you repay per month tops out at $4906.

These calculators are based on what lenders have learnt from historical data and it says you don’t want to be earmarking much more than 60 per cent of your income for loans.

Get real

Use these calculators, face the truth and don’t ignore their suggestions unless you know and can guarantee that your income will increase year after year to bankroll over-borrowing.

Once you’re certain how much you can borrow, go out and get a great loan. Start with the your bank with and tell them you want to work with them, but you will be shopping around.

Go for a broker

Once they give you their pitch, seek out a couple of mortgage brokers to see what kind of deal you can get. It’s always wise to get a broker who belongs to the professional body called the MFAA – the Mortgage and Finance Association of Australia. Ask the broker if they’re a member and if they’re not, keep walking.

Do your own learning

While they’re out there looking for you, you should go to the Cannex and Infochoice websites, which survey the latest on interest rates.

For the $600,000 loan where the borrower does not have a wish list of things to go with the loan such as a redraw facility, the range of interest rates went from 8.57 per cent with the likes of NAB down to 6.4 per cent for a low start, six-month loan and then there were a host of loans in the high seven per cent region as well.

The honeymoon does end

Be careful of these low start loans as they come back and hit you with a bang when the honeymoon is over. Really read the fine print closely.

Use the calculator

Going back to the calculator I requested loans with an extra repayment option as well as a redraw facility. This knocked out a lot of loans and the range of interest rates was around 7.7 to 8.57 per cemt.

When I went the whole hog on the calculator and requested no ongoing fees, a flexible line of credit and a savings interest offset account the number of loans fell to nine only, but the interest rate range was interesting – 7.54 per cent at Easy Choice Home Loans up to 8.84 per cent at RAMS.

The only big bank offering such a product with all the bells and whistles was HSBC and its rate was 8.65 per cent. And the lesson is that as you add extras, you can push up your interest rates and overall costs.

Do you need the frills?

Not everyone needs all of these extras with their home loan, but many people should consider what these loan add ons can do for their bottom line.

Extra repayments can crush a home loan saving both repayments and time. A redraw facility can mean you can reduce your home loan repayments, but access the money if you need it.

This can save you from running up expensive loans on credit cards and personal loans.
An offset account can also be very tax effective and can reduce the repayments and the time paying off your loan.
Horses for courses

On the other hand, some people might simply need to have cash flow because they have kids, expenses and perhaps one partner might not be able to work full-time for a period of time. For this person a standard variable loan with no extras at the lowest possible interest rate might be the best shot.

It’s a BIG investment

The point I’m trying to make is that home loans are a big deal. It’s one of the biggest transactions we will be involved in and I reckon most of us don’t do enough homework before we sign up for a loan.

If you can’t do it yourself find a great mortgage broker to help you, but you are going to have to trust him or her. Maybe you should get a financial plan done at the same time, but make sure they are home loan experts because there is a lot of money to save and lose when it comes to jumping onto the home loan money-go-round.

Published on: Wednesday, December 12, 2007

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