Why Honeymoon Rate Home Loans Can End in Divorce
It is always tempting to take the cheapest rate when choosing a home loan. And the temptation gets even greater when a lender or bank offers a cheap introductory first year. All borrowers should be wary of this approach and some simple calculations will show you whether it is worthwhile taking up the offer or not.
As banks jockey for position in a tight credit market, cheaper offers can often come thick and fast with discounts of up to 1% being offered on a standard home loan. Let’s take a look at some examples and determine whether the discounts stack up.
Let’s assume a married couple is considering a home loan of $450,000 over 30 years at 6.67%. The bank then advises them that there is a special offer available, a honeymoon rate of 5.67% for the first year. The deal sounds too good to be true and the couple is tempted to sign up on the spot.
If you find yourself in this situation take a deep breath and do the five-year test. The five-year test is a simple mathematical calculation where you add up the entire repayments you have to make in the first five years of the loan. Be sure to include all application fees and any ongoing monthly account keeping fees that the bank charges.
Choose a number of products from different lenders and do the five-year calculation, you might be surprised at the results.
Let’s take the above example and compare it to another banks offering of the same amount and loan term at an interest rate of 6.1% with no introductory honeymoon rate.
For the honeymoon loan the first year’s repayments at 5.67% will be $2603.25 per month. For the next 48 months of the loan interest rate reverts to 6.67% requiring monthly repayments of $2894.80. If you do the calculations you find that the total repayments over the first five years of the loan amount to $170,189.40.
The second loan at 6.1% will require a monthly repayment of $2726.98, making the total repayments over the first five years $163,618.59, making it a clear winner.
This comparison is a typical and realistic example of what can happen. It shows that the honeymoon rate loan would eventually cost the borrowers $6570 more over the first five years of the loan and more as the term goes on.
The calculations will vary with each individual case and for the simplicity of calculation the monthly account keeping fees have been excluded from these figures. In some cases, especially for lower loan amounts, the honeymoon rate can be cheaper over a five-year period.
This big is the question of why you should use a five-year period to do this calculation. Figures show that most home loans in Australia last less than five years before borrowers look at refinancing to another lender or selling their property and moving to a more expensive one. So, a five-year comparison time is a fair one.
Although this example will not be true in every case it highlights the importance of working out the exact amount to be repaid rather than relying on interest rate to make your home loan decision.
