10th July 2008
The Evolution of Mortgage Products
Mortgage products have evolved and become more diversified and now offer more features and options
As the number of mortgage providers has exploded in the last two decades, so has the range of options available to the customer. One of the most important areas of change deals with repayment options that can minimize interest payments. Mortgage offset accounts and redraw facilities are features that achieve the same goal, namely allowing the borrower to repay the mortgage quicker, thereby decreasing interest payments, while providing the borrower with an option to re-access the funds if necessary. 100% mortgage offset accounts are savings accounts that reduce the interest-bearing mortgage amount on a dollar-to-dollar basis, and thus have an effective interest rate equal to the rate paid on the mortgage. Redraw facilities allow borrowers to make extra payments into their mortgage, and then withdrawing any extra repayments if necessary. By depositing their entire salary, disciplined borrowers can use these features as an effective way to minimize interest payments. Traditionally, features such as these came at a price, but recently more basic product offerings have these options available.
Other commonly offered features and options include:
- Portability - the ability to move the mortgage to another property;
- Rates - variable, fixed, or split options;
- Repayments - weekly, fortnightly or monthly frequency options, extra repayment options, interest only minimum payment options;
- First home buyer options - many lenders offer products especially geared towards first home buyers.
One of the most striking developments in the Australian marketplace has been the higher degree of leverage of the average homeowner.
Low deposit products have become very common
As a result of the difficulty many prospective home owners experience raising a deposit, low deposit products have become more common in the Australian market, although recently turbulent global credit market conditions have to some extent made lenders more cautious about these products. In the Datamonitor AFS survey, 23% of mortgagors had a deposit below 5%, as the figure below shows.
Fig 1: Low deposit products have become common in the Australian mortgage market
Source: Datamonitor Australian Financial Services Consumer Trends Survey 2007 Copyright: Datamonitor
Low deposit products are especially common with younger mortgagors. Looking at mortgagors aged 18-34 years old, almost 30% had less than a 5% deposit for their main mortgage. Only 17% of this group had a deposit of 20% or above when getting their main mortgage. Although the proliferation of low deposit mortgages has helped many Australians get on the property ladder, mortgagors with a high loan-to-valuation ratio are more vulnerable to adverse market movements.
Low documentation products cater to those who can not provide proof of income
Low documentation mortgages are products that require less documentation and proof of income than full documentation mortgages, and are popular with the self-employed and other groups of people who may not have a documented income. The growth in low documentation products has occurred concurrently to the rise of the mortgage broker channel, as the mortgage broker channel often introduces new products, providers and features to the market. In the Datamonitor AFS survey, 13% of Australian mortgagors had a low documentation mortgage. In recent years, the Australian Taxation Office has expressed interest in investigating loan applications and cross-referencing them with tax returns, which has put somewhat of a damper on this market segment. Moreover, recent global credit concerns have made these products less attractive for providers.
Longer loan terms have been introduced but are not yet popular
In Australia, the standard loan term has traditionally been 25 years, although recently 30 year terms have become more common for new loans. In 2006, 40 year mortgages were introduced by some non-bank lenders, and 50 year mortgages were being considered, with the major banks hesitating to enter this market before gauging consumer reactions. 40 year old terms are common in the US and in Europe, but have yet to become prevalent in Australia. The press reception of the 40 year terms was not favorable, with the media focusing on disadvantages such as higher total interest payments over the life of the loan. The figure below shows how longer loan terms lead to a higher total interest amount paid over the life of a loan, using as an example a A$250,000 loan with an interest rate of 9%, with annual compounding and repayments for simplicity. The figures show both the outstanding balance remaining over time, as well as total interest costs over the life of the loan.
However, with a longer loan term, monthly repayments are reduced. This is especially important for people struggling to get onto the property ladder and for first home buyers, as cash flow is often at its tightest in the first years of a mortgage. Since the average mortgage is refinanced every few years, a 40 year old mortgage can help tide some mortgagors over a tight patch. Longer term mortgages thus have similarities to introductory rate mortgages, which have plummeted in popularity. The table below shows how monthly payments would vary for an example mortgage of A$250,000, for a range of different interest rates and terms.
Table 1: Monthly repayments are reduced with longer loan terms
|Interest rate charged:
|25 year mortgage
|30 year mortgage
|40 year mortgage
Source: Datamonitor, mortgage calculator (www.mortgagecalculator.com.au) Copyright: Datamonitor
Moving from a 25 year mortgage to a 30 year mortgage, or from a 30 year mortgage to a 40 year mortgage, generally involves a monthly saving of around A$100 a month for a A$250,000 mortgage at 8%. However, the table shows how changing interest rates can erode the savings from a longer loan term.
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Head of Lending
Iain Pepper is a Vice-President and the Head of Lending for the La Trobe Group.Read full profile here.
La Trobe is one of Australia's leading independent specialist mortgage Financiers. Its business includes residential mortgages, commercial mortgages, and investment services operating one of Australia's largest Mortgage Funds under AFSL 222213. It employs over 145 staff and has raised over AUD$10Billion to assist over 100,000 customers since inception in 1952.
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