Investor Alert: CHOICE warns about high-risk borrowing strategies

High-risk home loans have CHOICE alerting borrowers about significant difficulties down the track.

The three products on their list are 40-year loans, family guarantees and low-deposit loans, with CHOICE head of media Tom Godfrey explaining that while they can make it easier to get from renting to buying, they carry risks.

“During the global financial crisis people were hard pressed to get a home loan approval unless they had a significant deposit. Now RAMS is offering a low-deposit loan combined with a guarantee that allows you to borrow a staggering 120% of the value of your home,” said Godfrey.
 
“Worryingly there has been a strong demand for these high-risk loans with one in three new home loan borrowers putting up less than the 20% normally required,” he said.

Consumers without a significant deposit are being offered products such as low LVR loans and family guarantees. Family assistance is becoming increasingly popular with home buyers, with Property Observer recently reporting that a survey calculated that 19% of buyers rely on their parents in some way, with 42% of first home buyers doing so. This included using them as a guarantor, borrowing money or living with them while they invest.

Godfrey warns that those who lose their jobs, get sick or cannot keep up with repayments may see the bank requiring them to sell their homes, or repossess it.
 
“Getting a family member to guarantee all or part of your home might seem like a good idea for some borrowers as a way of avoiding lender’s mortgage insurance. However, the potential downside side risk for your family member is significant because if you are unable to make repayments on your home loan they may lose their house as well,” he said.
 
“For elderly parents who are no longer in the workforce and worked all their life to finally own their home, this is a high-risk strategy and can be devastating if things go wrong.”

Of these three, however, he said that 40-year loans come with the most risk – particularly as they can backfire if the interest rate goes up again. He suggests that those who take this loan do so as they cannot afford the monthly repayments on a 30-year term, and so are more vulnerable to rate changes.

Looking at a 30 and a 40 year loan on a $300,000 home, an extra $140,800 in interest ends up being paid – despite repayments being just $4.88 more per day for the 30-year loan.

“The average interest rate for standard home loans over the last 20 years has been 7.6% compared to 5.9% today. Be prepared for rates to go up.”

CHOICE recommends the following four tips for new buyers:

1. Check if you can afford rates increasing by 3%.
   
   
2. Consider fixing part of your loan, called a split loan. You can make extra payments into the variable portion of the loan.
   
   
3. Don’t try beating the bank. Even economists are often wrong when predicting long-term interest rate movements.
   
   
4. If you’re thinking about providing a family guarantee for someone, consider alternatives and important factors such as:
   
   
   • Taking an unsecured personal loan for the amount you want to give the person and ask them to make all or part of the repayments. The interest rate will be higher but the risks are much smaller.
     
     
   • Make sure you have enough savings to cover the guarantee if problems arise.
     
     
   • If things go wrong, and the lender threatens to sell your house, immediately seek legal advice. If you make a complaint to the Financial Ombudsman Service or the Credit Ombudsman Service the bank has to pause the enforcement proceedings while the complaint is assessed.