The honeymoon trap

One of the most common mortgage traps, the honeymoon loan, often seems like a wonderful offer on the surface: “Low introductory rate for the first 12 months”. If you’re buying your first home, you might imagine this to be a great way to ease into home ownership without being hit too hard by the loan repayments.

However, just as Christmas always comes around sooner than you think, so too does the end of the honeymoon period. For many borrowers who haven’t done enough homework, this anniversary can bring very bad tidings in the form of a whopping repayment increase.

Key Point: Beware of lenders bearing gifts and skip the honeymoon.

Introductory, or honeymoon rates have long been an important marketing tool for lenders. They initially offer you a cheap rate on your loan to get you in the door, but once the honeymoon period is over, your loan switches to a higher variable rate of interest.

There are two problems with this scenario:

  1. First, the later variable rate is usually higher than some of the available lower basic loans are, so you end up paying more.
  2. Second, you need to clearly understand that a honeymoon rate applies only for the first year or two of the loan and is a minor consideration compared to the actual variable rate, as that rate will determine your repayments over the next 20 or so years.

When tempted with one of these loans, consider what you will do at the end of the honeymoon, when you suddenly have to come up with an extra $400 or so per month.

This tactic is such an issue that the government introduced mandatory “Comparison Rates” to combat the often misleading advertising associated with honeymoon rates. When I compare loans, I present the True Rate of the loan, which takes into account any introductory rates and ongoing fees. In some cases an introductory rate can be worthwhile; especially if you plan to have land for only a short period of time or if the loan reverts to a competitive rate after the honeymoon. Just make sure you fully understand what you are getting yourself into before setting off on a “honeymoon” with your lender. Before jumping headfirst into an attractive introductory rate loan, make sure you take the time to compare the ‘post introduction’ rate with other loans on the market. At the end of the day, what really counts is how much you will pay for the other 29 years of the loan. After all, choosing an expensive loan product can really impact your ability to achieve your financial goals.