Mortgage Guide

What is a mortgage?

A loan to purchase your home or another residential property held as an investment. Your property becomes security against your borrowing i.e. the lender can take ownership of your property if you default. The legal right the lender has to take ownership of your property ceases once repayment of the mortgage is made in full.

What are the different types of interest rates?

Fixed Rate

This means the interest rate you pay on your loan is fixed for the term you agree to. In New Zealand most banks offer 6 months to 5 year terms. Although there are 7 and even 10 year terms available from some banks.

Pros

  • You know the exact rate you will have to pay each at payment, which is generally your choice i.e. weekly, fortnightly or monthly. If your income is fixed you can dedicate a portion of your income to your mortgage and know that it will not change for the term you have selected. This enables you to lock in an attractive rate in an economic environment where interest rates are increasing.

Cons

  • If rates start going down, you cannot take advantage of smaller interest costs as you will continue to be charged at the fixed rate. There is no flexibility with early repayments, if you come into some money you were not expecting you cannot use it to pay off your mortgage (unless you are prepared to incur a financial penalty).

Floating Rate

Interest rates offered to customers are based on the Overnight Cash Rate (OCR) and will fluctuate with this rate and with general economic and financial market conditions.

Pros

  • Floating rate loans are very flexible, usually you can completely pay off your loan with no penalty i.e. there is no term to a floating rate loan. If interest rates are going down, you will be able to benefit from this as your repayments will decrease with the drop in floating rates.

Cons

  • If interest rates go up your mortgage payments will go up, you will have to pay more with each payment. You do not have certainty around what your financial commitments are and hence cannot plan with the same clarity that you can with a fixed loan.

Capped

A capped rate is a floating rate that is capped at a certain level i.e. you pay a floating rate but there is a limit, or cap at which your rates will stop rising.

Pros

  • As you are in a floating rate product you have the opportunity to gain from a decrease in rates should they drop. Further to this if rates rise there is a limit to how high your mortgage payments can rise.

Cons

  • As this is a tailored or specialist product you will pay a premium for it i.e. the floating rate will likely have a premium or margin added to it.

Where can I get a mortgage?

Banks

Pros

  • Banks can secure funding for loans at low rates meaning they can lend that money back out to the public in the form of mortgages at very cheap rates. Banks have a wide range of products and are heavily in competition with other banks for the consumer business, meaning you can shop around for the best deal.

Cons

  • Banks are heavily regulated and must comply with restrictions about who they lend to. For example, if you do not have a sufficient deposit or good credit history they may not deal with you.

Credit Unions/ Building Societies

Pros

  • Credit Unions and Building Societies are not for profit co-operative institutions owned by their members. Their mission is to provide their members with affordable financial services. When you open an account you become a member, this enables you to vote at the Annual General Meeting or even put yourself forward as a board member.

Cons

  • Credit Unions will typically not have the country wide reach of a bank. For example, they may tend to service a particular area rather than the whole country.

Finance Companies

Pros

  • Finance companies are not as strictly controlled in terms of regulation as a bank is so you may be able to get a mortgage with a finance company when a bank would not lend you the money.

Cons

  • Finance companies source their funds from investor deposits as opposed to the wholesales funds market that banks have access to, hence in a straight price comparison their rates will not be as low as a bank.

Mortgage Brokers

Pros

  • A mortgage broker is a middle man who sits between you the borrower and one or more mortgage providers, typically banks. As they can be on selling mortgages from many different providers they can sometimes offer you competitive rates by negotiating on your behalf.

Cons

  • A broker can only offer you mortgages from the providers they have relationships with. Hence you can get better market coverage if you approach the mortgage providers of your choice directly. By dealing with a broker you are missing out on creating a direct ongoing relationship with your mortgage provider.

What are the different types of mortgages?

Table Loan

In a table loan your payment remains the same for the lifetime of the loan. During this time, you are paying back both principal and interest. At the beginning of your loan you are mostly paying off the interest on your original debt, as you move closer to the end of the loan term the ratio of principal that you are paying off increases. This loan type is the most common.

Revolving Credit

This is like a very large overdraft facility. You have one account to manage your mortgage payments, expenditure and your income. As your pay goes in each week, fortnight or month it acts like one big mortgage payment. The income offsets against the total that you pay interest on. Interest payments are calculated daily based on your outstanding balance. The lower you can keep that the less your interest payments are. This type of mortgage is great if you are very disciplined in the way you spend your money. It can be difficult to keep a track of exactly how you are going with paying off the overall principal.

Offset Loan

Very similar to a revolving credit mortgage but uses separate accounts. You operate your mortgage account as usual with payments coming out each week, fortnight or month. However, you are able to stipulate a number of accounts (depending on the provider) where the positive account balance can be used to offset the principal amount on which you are charged interest. An excellent product if you can get it and you use it properly.

Interest Only

You take out a mortgage as normal but only repay the interest portion of your debt. Hence your payments will be smaller but you are not paying off any principal. This is really only a type of mortgage to provide temporary relief if you have cash flow issues.

Reducing Loan

Reducing or Straight Line mortgages pay off the same amount of principal with each payment but a reducing amount of interest. The overall payment amount starts high and decreases in a straight line over time. As you are paying a higher amount of interest in the beginning you pay less total interest over the life of the loan.

Mortgage Checklist

  • Negotiate

    The mortgage market is extremely competitive with many different players competing for your business. There are a lot of fees that you will not have to pay once you are borrowing over a certain amount. If you don’t ask you won’t get.

  • Credit Check

    Know your own credit rating. Lenders use your credit rating to assess your credit worthiness and hence your eligibility to borrow at lower interest rates. If you have an excellent credit rating this is a real bargaining chip for you. You can read about credit ratings at this government site.

  • Research

    Get your finance in place before you begin viewing properties, that way you can react quickly if the perfect property comes along.

  • Proof of Income

    When you apply you will need to show proof of income / employment. You'll also need to show how much your expenses are by providing a history of bank statements, usually around 6 months.

  • Proof of Deposit

    If you are changing lenders and your deposit is not currently held with the lender you will need to prove that you have the deposit. You can do this via bank statements covering the last 6 months.

  • Purchase Documentation

    If you've already bought the property you should bring any sale and purchase agreements with you when you approach a lender for finance.

  • Legal

    A lawyer will oversee the transaction and ensure all property details have been checked and that the ownership structure you choose is right for you i.e. what names will be on the contract for ownership of the home.

  • Insurance

    Your home or investment property should be covered by insurance to guard against disaster or damage.