Mortgage 101

Mortgage 101

Read on to obtain an in-depth understanding of land investment mortgages and home purchases. You can understand the kinds of mortgages available after reading this article and the best way to organise a mortgage to pay off your home loan faster. Amongst your mates, you will become the go-to property guru! You could save hundreds of thousands of dollars over your lifetime by studying and implementing mortgage best practises.

## What is a Loan Value Ratio (LVR)?

Loan to Value Ratio (LVR) is a figure that calculates the amount of the loan relative to the value of your land. The LVR is determined using a simple formula which the volume of the loan is divided by the value of the property. This figure is used to decide how much of the loan can be kept either by single security (property) or by an entire portfolio. The reserve bank controls the cap on how much a property can hold. E.g., if your property is worth \$250,000 and your mortgage is \$200,000, your LVR would be 80 per cent (or 0.8 as the calculator will show). When you pay off the principal of your loan or raise the value of your house, your LVR will decrease, which means that your equity in the property has increased which is good! If your LVR hits 0 per cent, it means you've completely paid off your mortgage, and this property can be discharged from the bank to be what's known as a "freehold."

## What is a fixed rate term?

A fixed-rate term is the period of the overall loan term which you and the bank negotiate on a fixed interest rate and exact payment terms, such as the sum you will pay within a specified period. If you do not have a fixed rate term, you will be on a floating interest rate. It means that the interest rate you are paying will vary every day. If the floating interest rate of the banks goes up, the interest payments will go up. If the banks' floating interest rate is going down – your interest payments are going down.
The alternative to a floating or "variable" rate is the fixed-rate term, which is where you or your mortgage broker negotiates with the bank to secure the interest rate for a specific period. E.g., on 20 November 2018, a bank advertises its home loan rate to customers with an 80 per cent LVR home loan as follows:

• Floating (Variable)      = 5.80%
• 6 month fixed term     = 4.95%
• 12 month fixed term = 3.95%
• 24 month fixed term = 4.29%
• 36 month fixed term = 4.49%
• 48 month fixed term = 4.95%
• 60 month fixed term = 5.09%

Often mortgage brokers, and sometimes even clients will be able to negotiate a better rate than those advertised (referred to as "carded rates"). As an example, some of the mortgage brokers offered a 54% LVR loan from the same bank on the same day were:

• 12 month fixed term    = 3.95% (same)
• 24 month fixed term = 4.15% (0.14% better)
• 36 month fixed term = 4.48% (0.01% better)

If you agree to a fixed-rate term, you are contractually expected to remain with the bank and pay the interest rate for the fixed-rate period. If you try to pay off the mortgage quickly than the negotiated instalments, raise the duration of your repayments, or cancel your fixed term for some other reason (restructuring, refinancing, etc.)-the bank will charge you 'break charges' or 'early termination fees.'

## What are mortgage break fees (early termination costs)?

Break fees are the fee you pay the bank to leave your fixed-rate period agreement early. Technically, this is for them to recover their losses, rather than a profit centre for them. Break charges are measured using a wide-ranging method for the bank to recover any of the damages that would be sustained as a result of the violation of the fixed agreement. Break charges are measured using three very complicated factors: amortisation, time value of money, and wholesale interest rates. All these figures are dynamically shifting as you pay off your debt and as the economy turns every day. Calculation by statute must be included in your loan documents – so that you can locate it and take a look at it. You can also call your bank to ask what your break fee will be, but you have to remember; this amount changes daily – so it's not a quote that you can hold on to and use three months later. If you don't want to split up with your bank in person, you should ask your broker to find out about it. We're doing it all the time!
Do I have to pay break fees if I sell my house and buy another one? Sometimes, you will retain the original loan term and the fixed-rate term –although the underlying protection is adjusted. It means that you don't have to pay any break fees. Again, talk to your bank or broker.

## What is interest rate averaging?

Segmenting your overall mortgage to 2 or 3 chunks and placing each piece in fixed-rate terms that end at various times—for example, splitting a \$900,000 mortgage into three shares of \$300,000 each. Portion 1 was then fixed for one year, Portion 2 was fixed for two years, and portion three was fixed for three years. And, when each section is up for renewal, you'd have to patch it for three years. Since you've spread the fixed term renewal dates over time, you'll get average interest rates. If you want the lowest possible interest rate today, you will have to fix your whole mortgage on the lowest fixed term available. However, for a few different reasons, this isn't necessarily a smart idea. If next year's rates were dramatically higher, you would have to repay your entire home loan at a much higher rate and face a huge rise in your interest payment. If you're going to dive into it, talk to us.

# Mortgage Types

## What is a Table Loan (aka Principal and Interest Loan)

The conventional and most well-known mortgage capital structure is a table loan. These loans have a fixed duration (e.g. 25 years) and are compensated in predetermined monthly instalments (e.g. \$400 per week). You are welcome to use fixed-term interest rates or floating interest rates.
The drawback of this form of loan is that your bank would not usually allow you to make significant payments off your loan, often you can only make lump-sum payments during the "refix" period.

## What is a Reducing Mortgage?

Reducing mortgages is one where principal repayments remain the same for the lifetime of the loan, although interest rates are decreased over time. They decrease because, when you pay the principal, there is less of it to charge the interest.

## What is a Revolving Credit Mortgage?

A revolving credit loan is an alternative way to structure your mortgage. A revolving credit loan acts in a similar way to a large overdraft account. This overdraft amount will be equal to what you currently owe on your mortgage. A revolving credit account is a current account. A current account is an account that can be withdrawn on without notice, that caters for frequent deposits and withdrawals. Into this account, you can credit any income you receive (wages/salary, proceeds of sales, bonuses. etc.) and pay out your expenses.

The revolving credit loan can be set up as a reducing loan. With a reducing loan, the overdraft limit is not fixed and will reduce by the same amount as your previous mortgage repayments, meaning that your overdraft limit will reduce over time. Some lenders offer an initial non-reducing term on this facility, meaning your limit stays the same for an agreed period of time before reverting back to a reducing facility.

The main benefit of this type of loan is that you will only pay interest on the balance of your account, and not on the full overdraft amount. For example, if your overdraft limit is -\$200,000 but your account balance is only -\$197,000, Interest will only be charged on the -\$197,000. This can save you a significant amount in interest over the life of your loan. These benefits are calculated daily, meaning every day your account is below the limit, you are saving in interest!

A further benefit of using a revolving credit loan is that you are able to make as many lump sum payments as you like to this account. This means any additional income; you may receive can be added straight to your loan. You are therefore able to pay off your loan much faster if you desire too, or an additional payment to this account may reduce the amount you pay in interest over a period until you withdraw that money for something else.

## What is an Interest Only Mortgage?

Interest only mortgages are short-term loans typically up to a maximum of five years, where your payments only cover the interest charged on the principal. This means that at the end of the loan term you will not have paid off any of the mortgage principal. Because you are not paying down any principal this is the cheapest mortgage option and can be useful for periods of time such as when an investor purchases a property to renovate and sell for a profit, or if you are expanding your portfolio and cash flow will be tight for a period of time.

## Mortgage Cash Back Incentives

When banks are trying to win more customers, they sometimes offer ‘cash back’ as a bonus. You can read about this in the NZ Herald.  This is often but not always limited to new lending opportunities such as a refinance to restructure or debt consolidate, or new purchase, where customers are bringing more business to the lender.

Here are some examples from the last few years.

## Getting a Mortgage Pre-approval

A mortgage pre-approval is simply an agreement with the bank saying they have approved to loan you a specific amount of money. This is useful for when you are house shopping as you will then know what you can afford. Sometimes pre-approvals will have restrictions such as ‘house value’, for example, the bank may have approved you to borrow \$600,000 as long as the registered valuation of the house is \$700,000 or more.

# Situation Specific Mortgage Strategy

## Getting Mortgages from non-bank lenders

If for any reason the main banks are not going to be able to say ‘yes’ to your finance, you may need a non-bank lender. Working with an experienced mortgage broker will ensure you have someone on your team who understands all non-bank lenders and can find you finance that has the lowest rates available to you and makes the process easy. Many non-bank lenders, sometimes called second-tier lenders, do not work with the public directly. You need a mortgage adviser to help. These loans do sometimes carry slightly higher rates and application fees, but they’re the only way to get some property deals done. Especially useful for investors wanting to purchase with an 80% LVR (or even higher).

## Mortgages for new-builds

With the more flexible LVR rules for New Builds (especially for investors) the options for financing need to be navigated carefully. Approvals can last up to 12 months but you might want to double check the builder is going to be approved by the lender of choice and that the contract meets the legal and financial standards. If you are buying a new build as an investment, you might want to consider splitting the securities and for your first home, just make sure you understand income requirements and do not change jobs or income situation before settling the property. Progress payments might be required and having someone to chase bankers, lawyers, valuers and make sure the road to settlement is smooth will help you sleep better at night. Because the loans are going to be construction loans, you will want to make sure you lock in the lowest possible rates during the build. We can help.

## Mortgages for Property Investors

Kingdom Home Mortgage Advisers are specialists in property investments, most of our clients (over 1,000 investors) are mum and dad investors with 2-5 properties. Some clients have 20+ property portfolios and use our advisers to help them navigate the complex financing rules that are becoming tougher to work through each month. If you want to keep buying property and want to chat about the when, where, how, what and why of property investing. Give us a call or fill in the online profile. No costs or obligations. We have specific tools which will help you calculate rental yield on potential purchases and across your portfolio.

If you are looking to buy a home and get help from your parents, then make sure you protect them and their equity by avoiding cross security of their property with yours if you can. If you need help with the deposit but have the income side of things covered enough for the mortgage, it might be safer for everyone to use two different banks. Obviously, the advice provided by an independent mortgage adviser is going to differ from your bank because we can show you options from all lenders and are not trying to cross secure properties (tie them together legally/financially) so you will be happy to see the different options and you can decide with more information.

## Using your Mortgage to consolidate debts

People sometimes get into a bit of financial trouble and end up with high-interest short-term debts such as credit cards or personal loans. It is often wise to get a mortgage top-up to consolidate those loans into your mortgage which has a much lower interest rate – this is known as debt consolidation.

# What is a Mortgage Broker

Wherever you go overseas, the best trips are when you meet a local who takes you around town. When you get an inside guide you find the best spots, the best deals, the tastiest food, the uncrowded undiscovered jewels and on return home you are the envy of your social circle. The same deals exist in banking. When you deal with a competent adviser they will show you inside the banking world, advise you on how to structure your portfolio, how to structure mortgages to achieve lower rates and minimise risk. Always with an impartial view to which bank or lender you work with. You just can’t get that advice from a banker because they have to recommend their bank’s products – it’s their job. Mortgage Advisers also help clients who are declined at their bank get approved at that same bank all the time. The way you present the details of your applications is important.

Would you like insights on; how to pay your home loans off faster, how to structure your debts, how to apply and re-apply for interest-only mortgages on your investment properties, how to keep buying more properties quicker or how to break cross-securitisation to protect your assets… the list of advice we can provide is exhaustive and highly tailored based on your current position and your goals. We have seen clients with 30+ properties and an LVR under 40% being told they cannot buy more properties by their bank when clearly all they needed was to separate some securities and involve a few more banks. After helping thousands of Kiwi families with their mortgage goals, we have pretty much seen it all and know how to provide the pathway and the missing elements you desire.

## What Can Mortgage Advisers Do

Each adviser applies for permission to resell lenders products. A good adviser will be able to provide you with loan products from all banks plus a variety of non-bank lenders. This means they are able to complete the paperwork with you and submit it to the banks’ internal teams on your behalf – they replace the front office/front counter of the bank.

A good adviser will then touch base with other people involved in your property purchase process such as lawyers, real estate agents, accountants. In short, a mortgage adviser will help:

• you get accepted for a mortgage
• you secure a lower interest rate than advertised rates
• you get cash back or other benefits that are available
• your settlement process go smoothly