This Idea Could Save Aussies $260k On Their Home Loan

During my church's 14 days of prayer and fasting, I have been given a game-changing idea which would shake up the way banks assess home loans, make it easier for first home buyers to afford a loan and have millennials debt free faster. Let’s talk about the assessment rate buffer and what I believe would work better. 

Rate buffer background:

A few years ago, with record low rates the government set a firm action for lenders to assess home loans with a higher ‘assessment rate’. This assessment rate is 3% higher than the loan's actual interest rate. Knowing interest rates would increase, the idea was borrowers would not be caught out with rising interest rates and unable to pay their mortgage, as they were only approved if they could take a 3% interest rate ‘hit’. The idea is great in theory, however it doesn’t work in execution. 

Why it Fails

After buying a home, people start upgrading the rest of their lifestyle and increase their financial commitments. In fact, most new home owners will buy a better car within the first 18 months of settlement. The well-known phenomenon of ‘life-style creep’ mixed with the fact that most Australians live pay check to pay check, means that ‘buffer’ no longer exists. It really just hinders home ownership at the time of the application and protects the bank against any claim of wrongful lending practices. Now, a buffer is important, however, I have a better idea on how to incorporate one. A very different one. 

Loan Term Woes

Let’s quickly look at loan terms first. To compete with the affordability challenges this ‘fake’ buffer has, lenders are now starting to offer 35 and 40 year loan terms. With the average first home buyer being 36 years old, this means they’re not paying off their loan until 76. We are at risk of having a whole generation retiring with home loans or unable to retire at all.

My Idea - The Flexi-Term loan

I would love to see an alternative where we don’t have a rate or repayment buffer at all, instead we have another lever to pull when times become hard for home owners.

I would propose we actually decrease the loan terms and use real repayments allowing Australians to pay off their mortgage in 20 years and still have a built in buffer to help when they need.

The concept is a 20 year loan term with a background 10 year buffer. We assess repayments on the 20 year loan term and this is what the home owner must pay as a minimum, more if they would like. When interest rates go up, they adjust their spending so the RBA is still able to control inflation with interest rates. If they find themselves in a position where they can’t meet high repayments, and only when they can’t, the loan term is temporarily extended to reduce repayments and provide relief. 

When interest rates go down, repayments on unextended loans will go down to help the RBA stimulate the economy. However, for the few people who needed to extend their loan term previously, their repayments will remain the same affordable amount and their loan term will reduce until it is back on the 20 year deadline, keeping them on track and saving them interest. In fact this method will save $259,453 on the average home loan during the term.

That was a lot of words…Let break down the numbers in an example:   

You are applying for a home loan. 

Your repayment will be $3,747.

You need to be able to easily afford $5,074 or your application will be declined.

What happens to that spare $1,300 per month? It disappears with the small everyday financial choices we make and these lead to ‘locked in’ financial commitments, such as car loans, caravans, private school fees, etc. Now I’m not saying that no one has discipline, but this is what I see from the majority. When rates go up, you are going to need to adjust your spending regardless of the buffer method.

Using Lisa’s Method: 

I propose you are assessed on the actual repayments of a 20 year loan term, which you will actually be making under this change. 

This amount is $4,540 ($534 a month less than the assessment rate and easier to get the loan).

You pay $4,540 until rates change, and you adjust accordingly knowing that if you need, and only if you need, you can have the repayments adjusted by extending the loan term while rates are high or you are experiencing personal hardship. You can do this knowing you can still catch up, save interest and retire comfortably in your own home. 

Under the current ‘standard practice’ you would have a 30 year loan term and pay $689,066 in interest by the end of it, more than double the amount you started with.

With my flexi-term suggestion, you would pay $429,613 in interest, more if you need to adjust the term but still significantly less. 

Now this method would need to gain traction with the banks and legislators but it could be a total game changer for a whole generation who are buying homes later in life and paying them off well into retirement. I can't imagine banks jumping on board considering the amount of interest they lose from us.

My Calculations are Based on: 

The average home loan which is now $660K (just over but we’re rounding) 

I used 5.50% as the interest rate is pretty common at the moment.

$3,747 per month in repayments is the minimum based on a 30 year loan term for the above loan amount and interest rate. 

For the assessment figure I used a 3% buffer meaning a rate of 8.50% and a repayment of $5,074. This is what a lender would assess you on.