Short term gain leads to long term pain

SOME HOMEOWNERS are unwittingly refixing their mortgages from 25 to 30 years, prompting warnings from Auckland mortgage broker Karen Tatterson.

Tatterson, who works for Loan Market brokerage and is on the board of the Professional Advisers Association, says homeowners are switching banks in pursuit of the sharpest interest rates. But they often don’t realise that, when they do so, the default position of banks is to set mortgages for 30 years, she said. That means your monthly repayments will be cheaper in the short-term but overall you’ll end up paying more interest on the loan.

Homeowners who do switch are often prompted by the search for lower interest rates, but Tatterson says she has seen instances of people assuming the lower monthly repayments are a factor of saved interest when the reality is that extending the term by five years is playing a big part.

‘‘If they go from one bank to another to refinance, if they don’t ask the bank for a 25-year term, it will default to 30 years,’’ she said. ‘‘They feel they are winning because they are getting lower monthly repayments, but they are paying more in the long term.’’

Tatterson has calculated how costly another five years is on a standard mortgage.

‘‘In the first few years of your mortgage, you mostly pay interest – it takes a while to start chipping away at the principal. This is especially important for those thinking about refinancing their mortgage to another lender in the first five years.’’

‘‘Assuming the same rates and fees, an initial loan of $350,000 refinanced at the end of year five at the standard term of 30 years, will be $10,068 higher in principal at the end of the next five-year period simply due to moving banks.’’

And they’d have reduced monthly payments by around $100 only.

Using that thinking, she suggests anyone with a 30-year loan look seriously at shortening the term.

‘‘If you are on a 30-year mortgage, ask the bank what it will cost to switch on to a 25-year term, or even shorter,’’ she says.

‘‘It may only be around $100 extra a month.’’