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The mortgage seesaw

The mortgage seesaw

A new type of loan is gaining momentum in Australia, but not many brokers or borrowers know about it. Tas Bindi explores how this obscure loan product is helping Australians achieve home ownership faster.

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A nascent loan structure, which we will refer to as “rate shifter”, could help mum and dad investors shave years of repayments off their home loans, but very few lenders offer it and very few brokers know about it.

While there appears to be no consensus on the name of this type of loan, it is essentially a bundling of investment and owner-occupied loans that allows borrowers to shift some of the interest from their owner-occupied loan (or “bad debt”), which is not tax-deductible, to their investment loan, making it a fully tax-deductible loss.

As such, customers are able to pay a cheaper rate on their owner-occupied loan while increasing the capacity for tax deductions on their investment loan.

The idea is that borrowers continue paying the previously established minimum repayment amount (or something similar) on their owner-occupied loan, perhaps contributing some of their tax deductions, and achieve home ownership faster.

One product that enables lenders and mortgage managers to offer a “rate shifter” loan is Loan Reducer, which launched into the Australian market in April 2015 under an Australian Taxation Office (ATO) product ruling. The patent-protected software allows lenders (who must also obtain their own individual product rulings) to establish their required interest margin for risk against each investment and owner-occupied loan and calculate the best rates possible for the customer.

Mark Ashenden, founder and executive director at Loan Reducer, explains that the company’s patented calculator takes into account the ceiling rate of 6.25 per cent on the investment loan (the Reserve Bank of Australia’s cash rate of 1.5 per cent plus 4.75 per cent), a floor rate on the owner-occupied loan as low as 2 per cent (RBA cash rate plus 0.5 of a percentage point) and the lender’s required margins, to calculate the discounted interest rates.

He says that, on average, borrowers are able to shave off 10 years from their loans, assuming they consistently contribute to the principal of their owner-occupied loan.

“Capital gain and inflation is one way people build up equity and net worth. But the best way is to pay off the debt, and the best way to pay off debt, is to have the lowest interest rate possible,” Mr Ashenden adds.

“If you shift the loan across to a [Loan Reducer-powered] product, maintaining the [previous] loan repayment, you’re no longer paying dead money on interest.”

Rising from the cracks of obscurity

One of the few mortgage managers to offer a “rate shifter” loan is Crown Money Management (Crown Money) through its product called Rate Reducer, which uses the Loan Reducer software to provide the loan either directly or through accredited brokers.

Scott Parry, CEO of Crown Money, says that demand for this type of loan has been “phenomenal”, with at least 60 per cent of the company’s qualifying customers willing to switch to the Rate Reducer product.

Mr Parry notes that customers are particularly impressed with the annual rate reduction that the product enables as they pay off the principal of their owner-occupied loan.

“There are very few products out there in the market where you get a rate reduction every year as you pay down principal. So, as soon as that [owner-occupied] rate gets down to 2 per cent [floor rate], then the investment rate starts reducing every year as well,” the CEO says.

“We’ve been running [Rate Reducer] for three years now and every month we’re seeing more inflow.”

However, the nature of this loan means that it’s only suitable for a small portion of Australian mortgagors. First and foremost, the customer must have both owner-occupied home loans and investment loans.

For the customer to derive any benefits from a Rate Reducer loan, Mr Parry says that the remaining amount in each loan must be less than $750,000, their home loan debt must be lower than their investment debt and they can have no more than four investment properties.

“Otherwise, the numbers don’t work out that well,” the CEO says.

“This is for the everyday Australian with their two and a half kids who wants to get ahead financially and [take advantage of] a better structure.”

Neil Brett, a financial planner and managing director of CSC Home Loans, which has a bundled loan product of its own called Mortgage Down, concurs that the product is not ideal for everybody, estimating that it’s only suitable for around 10 per cent of mortgagors in Australia.

However, this is still “quite significant”, he notes, given the size of the mortgage market.

For the customer to benefit from a Mortgage Down loan, which draws from a non-bank funding line, Mr Brett says that their owner-occupied debt should account for around 30 per cent to 40 per cent of their total debt, the remaining being their investment debt.

According to the CSC Home Loans MD, the appeal of this type of loan, which he likens to a “see-saw” due to how the interest rates go up and down, is less around the mathematics and more around the incentives.

“There’s no point switching someone from a home loan interest rate of 4.2 per cent, for example, down to 2 per cent if all they’re going to do is pay the minimum, because you’re still going to have a home loan over 25 to 30 years,” Mr Brett says.

“The big advantage around this [product] is that it encourages the client to make an extra contribution to their mortgage. Like anything, people have to be self-disciplined with the product.”

“This is for the everyday Australia with their two and a half kids who wants to get ahead financially and [take advantage] of a better structure.” – Scott Parry, CEO, Crown Money Management

The CSC Home Loans MD adds that the question that new Mortgage Down customers regularly ask is: “Why are the major banks not doing this?”

He explains that he usually replies with something along the lines of: “It’s actually quite complicated in the back office, so any funding line that does this has to introduce an extra level of management responsibility to put [the loan] together. It’s not stock standard.”

Mr Brett also admits that it takes some time for customers to completely understand how they’re benefitting from the Mortgage Down loan structure, but once they do, the product is “incredibly sticky”.

“It’s only six months down the track that the penny starts to drop; it grows on them,” the MD says, adding that many customers have then used the product for the subsequent investment properties they purchased.

Some customers have even used the product to acquire their first investment property, Mr Brett says, meaning that the product also presents an opportunity to drive entry into the property investment market.

“The big advantage around this [product] is that it encourages the client to make an extra contribution to their mortgage.” – Neil Brett, managing director, CSC Home Loans

Growth through brokers

Mr Ashenden, Mr Parry and Mr Brett agree that a significant portion of brokers, if not the majority, don’t know much about this “rate shifter” loan. But why?

Aside from being a relatively new type of loan, the Crown Money CEO suspects that it could be because the major banks or aggregation groups are not talking about it and so brokers are not being informed.

The lenders who do offer these loans don’t market it heavily either, the CSC Home Loans MD adds.

Mr Parry and Mr Brett both note that brokers need to either have an Australian Credit Licence or be part of an accredited aggregation group to be able to write this loan, which cuts down the number of brokers who would qualify as providers. (At present, Finsure brokers are able to write Rate Reducer loans while Outsource brokers are able to write Mortgage Down loans.)

But the demand for “rate shifter” loans is anticipated to pick up in the upcoming years, especially given the rise in rates for interest-only (IO) investor loans, and the fact that many borrowers will be thrust into principal and interest contracts upon expiration of their IO contract, which could hike up their bad debt repayments by $7,000 a year.

“A lot of people are [thinking]: ‘I’m paying a higher interest-only cost now, so if I could get a reduction on my owner-occupied debt, then that would be a huge benefit’,” Mr Parry says.

Mr Ashenden also expects a ramp-up in demand once major lenders are on board. However, the founder admits that Loan Reducer’s discussions with such lenders have been progressing slower than he would like. He also notes that brokers are well positioned to drive the future adoption of this unfamiliar loan type.

The mortgage seesaw
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Tas Bindi

Tas Bindi

Tas Bindi is the features editor with The Adviser magazine, Australia’s leading magazine for mortgage brokers. She writes about the mortgage broking industry, fintech, financial regulation, and mortgage market trends.  

Prior to joining Momentum Media, Tas wrote for business and technology titles such as ZDNet, TechRepublic, Startup Daily, and Dynamic Business. 

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