For The Term Of Your Natural Life

Sydney Morning Herald

Wednesday August 16, 2006

By Michelle Innis

Extending the length of your home loan could double your interest costs.

Taking out a 40-year home loan, or extending the term of your existing loan, may give you immediate financial relief from higher interest rates but it could double your loan costs and benefit the lender more than you.

For that reason, you should do the sums and consider the risks involved.

While 40-year home loans have been in the news a lot lately, the reality is most lenders will extend an existing mortgage, making a switch unnecessary.

John Symond, the managing director of the Aussie group, which includes Aussie Home Loans, says borrowing for 40 years is madness: "We show our customers how they can pay off their loans as quickly as possible. This is encouraging the opposite behaviour."

Symond says a $400,000 loan at 7.25 per cent over 50 years will cost $1.5 million. The same loan, at the same interest rate but paid off over 40 years, will cost $1.25 million.

A shorter term, of 25 years, will result in a payment of $867,000 in total. Symond says a longer-term mortgage means that interest charges soak up repayments for a longer period at the start of the loan. This means it is harder to build equity, unless the borrower is making extra repayments.

Those taking out long-term loans are unlikely to have extra cash to make those repayments.

"You risk getting stuck in one of these loans," Symond says. "The housing market is flat. You're better off renting, saving like crazy for as much deposit as you can and then getting a loan that has a good rate and a reasonable term."

Housing affordability is close to an all-time low, according to the Housing Industry Association. It says Australian first-time home-owners spend on average about 26 per cent of their income on mortgage repayments.

The HIA says the March quarter of 2005 was the absolute low in affordability, when 27.9 per cent of income was spent on mortgage repayments. At that time, the average price of a property in Australia was $334,100 and the average interest rate was 7.30 per cent.

Since then property prices have eased slightly and wages are up but interest rates have gone up too.

"The number of 25- to 39-year-old first-home owners has been falling dramatically," says Simon Tennent, HIA's executive director of housing and economics. "They are now genuinely priced out of the market."

But those already in the market may also be feeling the strain.

HIA data shows that in the March quarter, we spent almost as much making mortgage repayments as we did in late 1989, when home loan rates peaked at 17 per cent.

This is because Australians have so much more debt than they did in 1989.

If you're worried that the next round of rate rises might bust the family budget, consider strategies to help you cope. All the major banks say they encourage borrowers to talk to them if they are having problems making mortgage repayments.

"ANZ has put in place measures to help customers who are having difficulty with repayments on their home loan, personal loan or credit card, principally by extending the term of variable rate loans," says Mairi Barton, a spokeswoman at the bank.

A GE Money spokesman, Keith Ritchie, says in cases of genuine hardship it will consider extending the term of the loan or offering the customer "a breather". "We have a range of options," he says.

GE is the only major lender to offer long-term loans.

"Our 40-year loan has been around for some years. The fact is that some people are going to have to look at longer-term loans to make sure they can afford to get into the housing market. It means your monthly repayments are not as high. It does not mean that you will still have a mortgage in 40 years," he says. Ritchie says many borrowers with 10-, 25- or even 30-year mortgages refinance those loans.

The Commonwealth Bank is the only other lender that might consider introducing a long-term loan if the demand is there. "We could review that, although there are no plans to do so," Steve Batten, a spokesman, says.

The average life of a home loan for an Australian borrower is now 12 years, up from seven years, because people are borrowing more, according to the HIA.

Andrew Russell, Virgin Money's director of mortgages, says Virgin's longest-term mortgage is 30 years.

He says the company won't offer 40- or 50-year loans but adds: "They could help some people get into the market. You are paying off less in principle in the early years but maybe you can get in, work hard to pay the loan down and then refinance to something shorter."

Andrew Willink, the managing director of research firm Cannex, says: "There's an advantage for young or first-home buyers or those on a low income. These loans mean lower monthly repayments and they mean some people can increase their borrowing capacity."

Craig James, an economist with Commonwealth Securities, says the latest rate rise adds $35.70 a month to an average mortgage of $222,200.

"Having access to a 40-year loan means you've got more choice as a consumer," James says. "But the best thing you can do is pay off your non-deductible debt and get your mortgage out of the road. Clearly, that's the case whether the loan is a 25- or 40-year loan."

But Queensland Legal Aid senior solicitor Catherine Uhr says those who hit retirement and still have a mortgage to pay off frequently struggle. She warns that if you take out a 40-year loan, it's because you can't make the higher repayments needed for a shorter loan.

"It's doubtful you would have any money left over to make extra repayments," Uhr says. "And it won't get any easier in the short-term. People are already struggling with higher petrol prices and interest rates. There is no clear indication rates won't rise further."

Aussie's Symond agrees: "You don't build any equity in your property with these loans for a long time. You've got no back-up if something goes wrong. All you will have done in the first few years is pay interest on your loan.

"If you have to sell, in a flat property market, you'll be selling for less than your loan. Don't do it. Rent, save and then get the best mortgage you can with the lowest rate," he advises.

© 2006 Sydney Morning Herald

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