When you take out an additional loan on your existing mortgage, you effectively enter a new contract and the bank is entitled to reset the mortgage rate on your entire home loan. Given the tight lending criteria banks are now applying, even if you apply for a relatively small additional loan, you could see a significant increase in your mortgage rate.
As a real example, one bank customer applied for an additional R25 000 on his existing R900 000 home loan. The bank approved the loan but increased his mortgage rate from 8,75% to 10,5%. This effectively increased his total repayments by R480 000, which meant his kitchen upgrade cost him R455 000. In this case it would make more sense to take out a personal loan even at triple the interest rate.
The reason the bank can change the interest rate is that you sign a new contract. According to Nedbank, a further loan requires an additional bond to be registered over the property and “as such the existing contract will be replaced in its entirety with a new loan agreement”.
The problem is that even if your risk profile is exactly the same one that qualified you for a 2% below-prime rate three years ago, the dramatic deterioration in the economy has increased the cost of lending and has reduced the banks’ appetites for risk.
Standard Bank says the cost of funding a home loan changes depending on the market conditions, which are mainly governed by the availability and the price of liquidity in local and foreign markets. “When a customer applies for a further advance, additional funding needs to be secured, and this funding comes at a much higher cost to the bank because of the increases in funding costs experienced to date.”
Although this comment may explain why the new loan rate is higher, it does not explain why the costs on the original loan are increased. Standard Bank’s response is that a “further advance can reset the agreed loan term, which in turn impacts on the funding costs associated with the original loan”.
But the reality is that many home loans do not make the banks any money. During the property hype, between 2005 and 2007, banks competed aggressively with one another to grow their home-loan books, often at the cost of profits. The idea was that once you had the customer’s home loan you could sell them other bank products to make them profitable. With the financial collapse, that strategy blew up in their collective faces. If you have a mortgage rate of less than 2% below prime, there is a good chance the bank is losing money, so it will use any opportunity to increase that rate.
Then there is also the personal risk factor. By taking a further loan you are affecting your risk profile. The bank will reassess your affordability levels and will re-check your credit record. Any deterioration in these areas and the bank will have no trouble throwing on an extra percent or two to your mortgage rate. The bottom line is that if you re-negotiate your loan today, the bank will invariably increase your rate.
But it is important to note the bank is obliged to inform you of the rate change before you accept the loan. There have been complaints that banks have failed to inform their customers fully and Banking Services ombudsman Clive Pillay says the bank has to follow rules based on the Code of Banking Practice, which undertakes to explain a variety of matters to customers.
With regard to mortgage loans, Pillay says there is an onus on the bank to explain to the customer that the interest rate will change should he or she apply for an additional loan. Such an explanation should be given when the additional loan is applied for, otherwise the customer can’t make an “informed decision” if he or she is not aware of the financial implications.
Better still, the explanation should be given right at the beginning, when the principal loan is applied for, says Pillay.
Standard Bank says that because of the large number of variables involved, it is only once the further loan is granted that a new “consolidated” rate can be quoted but that customers can still opt out before signing the credit agreement.
What this really means is: “Read before you sign.” Do your maths first and ask your bank to do a comparison between taking out a new mortgage or applying for a personal loan.