Month: December 2020

What Could Go Wrong? – Tricks and Traps

Simple Tricks
Banks are not nasty. They’re just in business to make a profit. Nothing more, nothing less. They aren’t out to rip you off. They’re simply out to make a business profit, pay their staff and keep their branches making more money.

In the name of making that profit, however, bankers can sometimes be brilliant at talking “Bankese” – that’s a secret banking language that only another banker can understand. This means that the average customer can often become confused by the terms they use in order to sell you a loan product that you might not really need.

By using this strange language, banks can often seem like the bad guy to a regular customer, who might feel ripped off or cheated.

Let me show you a real example, based upon the same numbers used in our biweekly section:

Let’s assume you call your local bank and tell them you wish to make biweekly payments on your mortgage from now on. Your friendly teller might be very helpful and arrange for the change in payment frequency at once. Easy, right?

This is where is gets a little more difficult.

In Bankese, the term fortnightly, or biweekly, means every second week on the same day from the specified repayment commencement date (or settlement date, if it’s a new loan). In Bankese, the term mortgage repayment translates loosely into Profit Making.

So, when you ask to have your repayments altered to biweekly, the teller should do exactly as she was trained to do – and divide your monthly payments into “True BiWeekly Payments” – which will mean you are NO better off at all.

Let me show you…

We’ll use our example loan to work out the numbers. Your monthly repayments for a loan of $120,000 at 7.5% over 30 years are $839.06 per month. This means the bank know they’re going to get a minimum of $10,068.72 per year (I just multiplied the minimum monthly payment by 12) Understand that the banks don’t always want you to pay extra on your repayments. If you pay extra, you’re going to get out of debt faster (meaning less potential profit for them).
If we divide $10,068.72 by 26 fortnights, then your new fortnightly payment will be $387.26 per fortnight (instead of $419.53). At first glance, this lower fortnightly payment looks great – but in reality it can mean bad things…

If you pay the new fortnightly payment, then you should still take precisely 30 years to pay off your loan, and still have paid $302,061.60 by the end of the term. That’s no saving in interest at all and no time cut off the term off your loan. The banks could still get more out of you even when you think they’re helping!

Are you still with me?

To make things worse, if you are paying the “True biweekly payments” of $387.26 per fortnight, then you’re not making a full monthly payment each month. In fact you’re only paying $774.52 per month for those months where there are only two payments due during that month.

More problems…
The bank expects you to pay a minimum of $839.06 per month – meaning you’ve missed out on paying $64.54 for that month. Only when the next ‘three payment’ month arrives will you catch up.

Now – even though your friendly teller might have helped you set up your new biweekly repayments, you will soon find that after your first month of payments at True Biweekly Payments , your loan is in ARREARS!

If you take some time to read through your mortgage contract, you will soon learn how much your bank expects to charge you in default fees and penalties if you fall into arrears.

At the time of this writing, my own bank expects to charge me a $35 default fee for each month that I might fall behind. On top of this, they will charge a 2% penalty interest rate ON TOP OF my existing interest rate until I catch up the payments.

How Much?
So – if your true payments don’t cover the minimum required monthly payment for let’s say 4 months, then the bank stands to charge you the following fees and penalties:
4 x $35 default fee = $140
2% default interest = $169.97 per month x 4 = $679.88

That’s a potential grand total of $819.88 in arrears penalties if you only paid the amount your bank expected on true biweekly repayments. The bank could stand to take a little more money from you – and your loan gets paid of NO faster at all!

Don’t forget, though – just because you catch up the payment you fell short on earlier, doesn’t mean you’re out of the woods. You STILL must repay the penalties as well, and until you pay those, you could end up with even more penalties on top.

How Do I Fix It?
It only takes a few minutes of your time to do your own quick check on how much you should be paying. You can visit our mortgage calculators page and see for yourself how much your real monthly payment should be – and then divide that number by two. No fancy calculations, no working out how many fortnights. Just divide your expected minimum payment in half and then pay it every second week.

If you pay HALF the minimum monthly payment due, you could benefit by cutting your loan term down and saving yourself thousands of dollars in interest. (see our biweekly section for more details.)

When you go in (or call) to arrange your own payment frequency, you should also be able to request a predetermined payment amount, too.

Your predetermined payment amount is the amount YOU choose to pay off your mortgage each fortnight. You are free to tell the bank whatever figure you choose – whether it’s exactly half the minimum monthly payment, or whether you choose to round that figure up, or even add a little extra. It’s up to YOU.

My Bank Won’t Let Me…
Most banks are a lot more flexible than they would allow you to believe. There is much truth in the saying “If you don’t ask, you don’t get”.

For example, if you don’t ask a bank to change your payments to biweekly, they’re not likely to offer. With most lending institutes, you must ask for certain options on loans. If you wish your payments to be half of your minimum payment (and NOT true biweekly), then you must remember to ask.

Then remember to check that the amount being paid is correct. Bank computers are still run by human beings, who are still capable of making simple mistakes.

The same is true if you wish to make any extra payments. They’re not likely to offer to take extra money from you. You must request the payment variation.

Also, your bank is not always going to offer you the very BEST mortgage for YOUR situation immediately. A Standard Variable loan could potentially make more money for a bank branch, so unless you ASK what other alternatives are available, they’re not always likely to offer them as a choice.

Remember – this is YOUR mortgage and it’s going to affect YOUR life, so ask lots of questions and don’t be satisfied until you learn the answer. The only silly question is the one you DON’T ask.

Home improvement loans

Many people equate home improvement loans with home equity loans. And in fact, many financial professionals suggest that the best use for a home equity loan is for the purpose of home improvement. The reasoning behind this suggestion is that you are using your home equity to improve it and thus increase its value. It’s investing relatively low-cost money in your home, which will inevitably increase in value. You’re just helping it along with the addition of a pool, a garage or an irrigation system.

A home equity loan is secured by the equity you have gained in your property and probably offers the best interest rate available for a home improvement loan. Because this choice for a home improvement loan is in fact a second mortgage, the interest paid on the note is tax deductible. If you opt for a personal home improvement loan that does not involve using the house as collateral, interest on any portion of the loan that is actually used for home improvement is tax deductible.

There is a difference between home maintenance and home improvement in the eyes of the IRS. Interest on funds used for home improvement is deductible, while money used for maintenance is not. If you add a deck on the back of the house, that’s an improvement and qualifies for a tax deduction. Painting the kitchen is a maintenance cost and does not qualify for deduction.

If your home improvement loan is a second mortgage, generally you can also deduct the points paid for the loan in the year that you receive it. Home improvement loans can truly be a quality investment when they are loans taken as second mortgages. The interest rates will be for a secured loan – much lower than a personal loan for the same purpose – and the interest helps with tax reduction. There is a limit to the deductible interest for home improvement loans secured by home equity. The maximum loan for which deduction is allowable on the interest is $100,000.

If you choose the home equity route to fund your home improvements, be sure that the loan does not throw you into a situation that requires insurance on the principal mortgage. Most lenders will not allow the aggregate debt of the primary mortgage and the home improvement loan to extend beyond 80% of the home’s current appraised value – so personal mortgage insurance is not an issue. If your home improvement loan takes to the point where you have mortgages against 90% of 95% of the home’s value, you may be required to institute – or reinstitute – a mortgage insurance policy.

You should also make sure that your home improvement loan has no prepayment penalty. If you should decide to sell the home and move, it’s important that you be able to close out your mortgages with a minimum in additional costs.