Guide To Cheap Home Loans: what to watch out for?

If you’re spending weeks shopping for the cheapest home loan, you could very well be wasting your time

Property expert Chris Gray says that the way to save more pennies is to concentrate on buying better.

As a property investor for more than a decade, I’ve taken out dozens of mortgages. It might surprise you, but I’ve never really spent much time sourcing the lowest interest rates, admin fees or best add-ons such as offset or redraw accounts. Instead, I’ve always focused on buying well and being able to buy more property – and have long advocated this strategy to other home buyers and investors.

I’ll be the first to admit that a cheap mortgage could save you hundreds of dollars – and it’s worth trying to find a good product – but at the same time a well-bought property can save you many thousands. Which would you prefer? Shifting your focus from one to the other will reap rewards for both investors and owner-occupiers. If you’re an investor, you want to ensure that your property will bring you not only a steady stream of good rental returns, but also good capital growth. That’s where buying well is so crucial. Even if  you’re a first-home buyer, you’ll want to buy a property that’s undervalued and which will also see good capital growth to get you a foot-up into the property market.

What does buying well really mean? It means buying a home at less than its market value. They say that you make money in property when you buy, not when you sell. If you buy a property at $300,000 but it’s valued  $320,000, you’ve made $20,000 overnight. Can a mortgage give you savings like that within the same time frame?

The reality is that buyers get so engrossed in the details they lose sight of the bigger picture. As a educator and a mentor to other investors, I see this time and time again in the market.

Buying property – in reality, forking out hundreds of thousands of dollars – can also get emotional for buyers, freezing their decision making. This gives you another reason to keep the bigger picture in mind. Because there’s so much money at stake, it’s crucial to keep a financial perspective, not an emotional one.

Compare the savings

I bought my first property at age 22. At this age, none of my friends wanted to buy; they perceived it as being tied to a mortgage with no money left over. But I bought an undervalued property – and it was sheer luck (but a lot of time and energy invested). That first purchase was from a very motivated seller for $200,000. He had already purchased a property and needed to sell his existing home or lose the new one. The existing property had previously been sold for $250,000 but didn’t go through at the last minute. I was there at the right time and place, had the cash ready to go and wasn’t reliant on having to sell anything else beforehand. That made $50,000 overnight. No mortgage in the world could have given me savings like that.

 

Now while it did take me a long time to find that particular property, over the last 14 years it has grown at just over 10% a year, or $35,000+ a year, for a couple of hours of ongoing effort. Think about it: if you had that opportunity sitting in front of you now, would you be asking your bank or broker to get you the best possible deal, or would you ask them to get whatever deal they could as fast as they can so that you can complete the deal and make $50,000 overnight before someone else steals the opportunity from you?

Of course, buying well requires research and legwork. But it is well worth the effort when you work out the savings, or the capital gained. Here’s how:

Let’s firstly compare the difference between a cheap and average mortgage. These days, where information is so readily available and with high competition between the banks and the non banks, there’s not much difference between the interest rates on most mortgage products. But let’s just say person A finds a mortgage that enables him to save 0.25%, compared with others on the market. If person A takes up this cheaper loan, for each $100,000 of his mortgage, he will save just $250 per year, or $5 per week. On a $500,000 mortgage, that would be $1250 per year, or $25 per week. In simple terms, that’s a saving of around $15,000 over a 10-year period.

Now, let’s compare these savings with a well-bought (read: undervalued) property over a 10-year period. Let’s say person B buys a $500,000 property that was valued at $525,000 – a saving of 5%. Person A has put his energies into shopping for a mortgage instead of buying well, and so buys a $500,000 property at market value. The table below shows the difference in the values of the two properties each following year for 10 years, assuming they both grow at 10%.

 

Market Value Year 1 2 3 4 5 6 7 8 9 10
Person A 500,000  550,000  605,000  665,500  732,050  805,255  885,781  974,359  1,071,794  1,178,974  1,296,871
Person B 525,000  577,500  635,250  698,775  768,653  845,518  930,070  1,023,076  1,125,384  1,237,923  1,361,715

 

As you can see, person B’s property is worth more than $1.36 million after 10 years and 10% growth. Persons A’s property, bought at market price, rises to near $1.3 million. Person A has also made a saving of $12,500. But even taking that saving into account, Person B still makes $47,500 more than Person A – simply because they bought well.

Compare the legwork required

With savings like the above, anyone can see it’s worth investing time in scouring the market for undervalued properties, rather than shopping for cheap mortgages. But what kind of ‘time’ frame are we talking about?

The key to buying well is to first select the best area to buy in. There’s no point buying a property at a huge discount if no one ever wants to buy it or rent it from you in the future. Finding the best area will depend on how much you have to spend and how much you can support the monthly cashflow as well as other issues such as whether the property will be an investment.

There are a number of free sources of information (newspapers, magazines, property websites)  that can help you find out which suburbs are best and a number of sources where you have to pay for that information (Australian Bureau of Statistics, RP Data, Residex etc). One thing to remember is that you get what you pay for. If you want to get the best unbiased information, it’s well worth while making the investment and paying for it.

Once you’ve found an area to buy in, there’s only one way to understand prices and find that ultimate bargain – and that’s experience. You can either get that experience yourself or again invest in someone that has that experience and can do it for you. Unless you look at 50 – 100+ properties, you don’t really understand the local market and what’s what.

Think of research as being well-paid casual work. If you look at four properties per week, in just six months you can check out around 100 properties, and in those there’ll definitely be a bargain. If it saves a buyer 10 per cent on a $500,000 property, that’s $50,000.

Let’s compare the total amount of legwork required to save 10% on this $500,000 property. You’ve spent 26 Saturdays (six months) inspecting four properties each time. Based on this, a saving of $50,000 is the equivalent of paying yourself $1923 a week over six months. Not a bad weekend income!

It is worthwhile trying to get the best mortgage deal possible, but it might not be worth spending weeks and weeks haggling over a few dollars. Most mortgage brokers these days have computer packages that can compare multiple products from multiple lenders and are doing it all day every day. How can we, as consumers, possibly hope to negotiate a better deal without ringing up every lender (and by the time we’ve got round to them all, the market would have changed and we’d have to start all over again)?

Sometimes it’s best to let go emotionally and delegate to a professional that does it for a living. Brokers don’t even charge you a fee in most cases, so we have everything to gain and not a lot to lose.

Loans that work for me

On my own mortgages, I’m happy to pay high interest rates and admin fees, because as an investor, my priority is to borrow as much as possible to get the deal through. When I started investing more than 10 years ago, investors were required to pay a 1% premium for investor mortgages. When Lo doc and no doc loans came on the market they, too, cost a premium. With all the competition, those loans became as cheap as full doc loans, and now the premium is returning.

With my first few properties – as for any investor – money was tight, but once I started building equity, I started using that equity to increase my cashflow and help me afford the investments. Having a 1% premium on a $500,000 loan adds $5000 to your costs, but if you are making $25-50,000 (5-10%) in capital gains, in the big picture, does it really matter?

For some people, it is an issue as they’re concentrating on saving money. For me, as long as I’m making a profit, I’d rather concentrate on financing my next deal.

That’s why the main question I always ask my lender is: how much money will you lend me?

How do you buy well?

By now you’re probably asking yourself whether you can still buy undervalued property these days – especially in the big cities. The answer is yes.

I always pick areas that are in high demand but with a limited supply of vacant land, as that creates high capital growth. So even if I don’t buy at a discount, I’m going to make money for evermore.

Buying well is all about knowing your market so you can recognise the right property when you see it. The better you know the real estate agents in your desired area, the more likely they are to let you know when properties come on the market. And the more properties you buy, the more your contact list grows and the easier it is to find a bargain. Agents know I’m a serious buyer and they come to me if they need a quick sale. It takes years to build the experience to become a truly professional buyer, but it’s well worth it in the end.

Chris Gray is the Property Expert on Channel 9’s MyHome TV, and author of Go For Your Life. How to Turn Your Weekdays into Weekends Through Property Investing. He builds property portfolios for time-poor investors – finding, negotiating and renovating properties on their behalf. For more information and for Chapters 1-3 of his book for FREE, go to www.goforyourlife.com.au

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