Mortgage traps to avoid if you're looking to buy property

Rising interest rates have had multiple knock-on effects. Aside from the significantly higher cost of borrowing, the average Aussie's ability to borrow has been reduced.

Lenders are clamping down on affordability, which is creating a multitude of unforeseen issues for borrowers looking to purchase or refinance property.

These are some of the traps that unsuspecting borrowers are falling into, with tips on how to spot them and avoid them.

Pre-approval no longer works

When purchasing a property, a borrower will usually seek pre-approval from a lender before they make any formal commitments to finance.

This allows the borrower to purchase a property up to a set amount of money and have the confidence that the bank will fund the purchase up to that set amount.

A pre-approval is valid for 90 days before it needs to reassessed by the lender.

There have been instances of would-be buyers looking to purchase a property that was on the cusp of their affordability. As such, they requested the highest pre-approval possible.

Having the pre-approval in place, the buyer bid on a property at auction and was successful and then used the pre-approval to complete the funding. As the Reserve Bank increased rates by .50% for consecutive months, the loan rate was now 1% higher than when the original pre-approval was granted. The lender re-assessed the loan at the higher rate, which tightened their affordability metrics, meaning the buyer's ability to borrow had been reduced, resulting in them not qualifying for the loan that was pre-approved 60 days ago.

While these deals can be fixed, it puts undue stress on the borrower and is usually avoidable with foresight.

To avoid this situation, ask your mortgage broker about the timings associated with your pre-approval. Each lender has its own policy on when transactions need to be re-assessed. Make sure you understand this and the options available to you should this happen.

Fixed rates - what you need to know   

Fixed loans are not fixed until the day of settlement. This means if you elect to have a fixed loan and the price of the loan increases before the day of settlement, you will be fixed at the higher rate even if the loan is approved and you have signed the loan docs.

Your broker should have talked to you about an additional product called rate lock. This is essentially an insurance product that protects you from increases in the fixed rates between submission of your application and settlement.

If you apply for rate lock and the fixed rates offered by the bank increase, you will have the benefit of the lower rate. The cost of the rate lock varies by lender, but is usually somewhere between $500 and $1500 depending on the size of the fixed loan. In this rising market, it is definitely a good idea to consider this product, particularly if you have a long settlement date.

Your settlement date can affect your approvals

The banks generally do things in blocks of 90 days. Pre-approvals, unconditional approvals and rate locks are all generally valid for 90 days. On this basis, I recommend that clients try to settle within three months (90 days) to avoid problems.

For example, if you buy a property, are approved for a loan and take out rate lock today, the approval and rate lock are valid for 90 days. If you were to settle in 120 days, the rate lock will not protect you for the entirety of the period and the formal approval will need to be reassessed before settlement.

Having a settlement time less than three months will avoid a lot of these problems.

Avoid "mortgage jail"

As interest rates increase, so too do the banks' serviceability requirements. They will add a buffer beyond the interest rate the borrower will pay to ensure they can afford the loan should the rate increase over the loan term.

In addition, the regulator APRA increased this buffer late last year. This creates a "double whammy" where interest rates have increased significantly in addition to buffer assessment rates. This means a borrower who qualified for a loan 12 months ago may not qualify for the same loan today. (See table, above.)

You can see the impact that rising interest rates are having on borrowers as serviceability requirements are compounded by buffers for an identical loan a little over a year later.

This can potentially create issues should this borrower wish to refinance for a better rate.

It's something to be aware of when selecting a fixed rate. Many borrowers who took out a low fixed rate two or three years ago could be in for a shock as it reverts from a number beginning with 2% to one beginning with 4% or 5%. We recommend voluntarily putting additional cash into your home loan every month so if you do have a period where you are struggling to pay there is a buffer in your repayments.

Get help when buying property and applying for debt

As with most things, knowledge is power. The borrowing landscape is complicated and more tumultuous than ever. You're not going to know everything - and nor should you.

Find a knowledgeable broker who can guide you through the process. Utilising a broker is a great way to access value with little to no cost to you. The broker is paid a commission directly by the lender for assisting in setting up your loan and can often negotiate better rates than what you would be able to get yourself should you approach the lender directly.

Additionally, they won't just help you find a loan, they will give you advice on the best way forward and help you build a plan that will empower you to reach your goals over time.

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