Need A New Car? Mortgage Redraw Vs Secured Car Finance
Redrawing on your mortgage to buy a new car? Secured car finance may be a much better option.
Thinking of purchasing a new car and don’t have the cash to buy it outright. As a homeowner you have 2 choices. You can redraw on your mortgage or you can get secured car finance. Peter, from AAA Finance, explains why redrawing on your mortgage can be detrimental to your long-term financial success.
Many a bank manager has told their clients that they have equity in their home and that they can use this equity to make purchases. A new car or camper trailer, some home renovations or even a holiday. Sounds great, but what are the pitfalls of using this equity?
So, you have decided to redraw on your mortgage to buy a new car. The bank calculates how much your repayments will increase over a 30 year term. The repayment increase is minimal and is easy to manage. Additionally, mortgage interest rates are at record lows - in the 2-4% mark. So, what’s the problem?
Let us look at the figures…
According to the Australian Bureau of Statistics (ABS), the average mortgage size in Australia is $500,000 (December 2019). In 2020 new car purchase prices start around the $15,000 mark for a Honda Jazz or Kia Picanto and go up to over half a million dollars for a Bentley Mulsanne. For us mere mortals the $40,000 range would get a new Jeep Cherokee, Mini Countryman or a Subaru WRX. https://www.whichcar.com.au/car-news/whichcar-price-guide. For this example, I will use a $500K mortgage with a $40K new car purchase.
Figures for redrawing on your mortgage
A mortgage for $500K at an interest rate of 2.92% over a 30 year term would cost $251,142 in total interest.
If you added a car purchase amount of $40,000 to your mortgage, the new mortgage amount will be $540K. A mortgage for $540K at an interest rate of $ 2.92% over a 30 years term would accrue a total interest of $271,234. Effectively, by adding the purchase price to an existing mortgage and not paying any additional amounts to offset the increase in mortgage size, an additional $20,092 in total interest is paid. Your new car has actually cost you $60,092.
If you do redraw on your mortgage you need to know how much extra you need to pay as top up or additional repayments to make sure you pay off the asset over a reasonable amount of time, such as 5 years. If you do not make these additional mortgage top up repayments, you end up paying your new car off over a 30 year period. The car is not so new then!
Figures for secured car finance
If you were to get secured car finance the interest rate would be higher but the term shorter. Although the interest rate is higher, at AAA Finance we have access to over 40 different lenders and can get extremely competitive rates. For an asset backed client, i.e. for those with a mortgage or who own their own home, a new vehicle interest rate is currently 3.99% (as of 8/10/20). This interest rate is fixed for the life of the secured car loan. Secured car loan terms range from 3 to 7 years. We will work on the average of 5 years.
A secured car loan for $40,000 at an interest rate of 3.99% will accrue a total amount of interest of $4317.87 over a five-year term. Your new car would cost you $44,317.87 at the end of 5 years.
Mortgage redraw $60,092 v's Secured car finance $44,317.87 = $15,774.13
Save $15,774.13 with secured car finance!
Upfront, it is quite easy to make the mistake that the lower interest rate of a mortgage will be better than that of a secured car loan. As shown above, even though you are paying a higher interest rate the total amount of interest will be significantly less because the term is so much shorter. It does not make financial sense to redraw on your mortgage to buy a new car UNLESS you make extra repayments.
One other issue with adding a car to a mortgage, is when you upgrade your car in 5 or so years’ time. If you have not made extra repayments, then you have not finished paying off the last car before you purchase another one. This further impacts the total amount of interest you will pay.
Interest rates – variable mortgage vs fixed secured car finance
Another consideration when looking to redraw on your mortgage is interest rates. Just how long are interest rates going to stay so low? As interest rates increase, which they will, the amount that car will eventually cost will increase too. With a secured car loan, the interest rate is fixed for the entire term of the car loan, giving you absolute confidence in the total cost of purchasing a new vehicle.
But I will make extra repayments!
Lots of people have fallen into the trap of using their credit card to make purchases with the intent to pay off the credit card before the interest free period ends. Its temping, but a lot of people do not pay of their credit card debt before the interest kicks in. This is a similar situation when thinking of redrawing on your mortgage to make purchases. It is just a much larger chunk of money.
People always start out with the best of intentions, but the reality is that the majority of people do not make the extra repayments. These extra repayments need to cover the cost of the asset over a set period of time. If you do not make the extra repayments regularly to ensure that extra borrow is paid off in a reasonable time then you will be significantly out of pocket in the long term.
Is that really equity?
A concerning situation is that many current mortgage holders, that have owned their property for 5 to 10 years, DO NOT have a lot of ‘real’ equity in their property. They have been paying the minimum repayments and have not paid down their mortgage by much. The initial mortgage repayments have been paying off the interest.
Ask yourself the question – Where is my equity coming from – am I really paying down my mortgage or is the value of my property increasing?
With interest rate cuts and property value increases, many have refinanced and been told by the banks that they DO have a lot of equity in their home. The only reason for this equity is that the value of the property has increased. When refinancing their home, and told of this equity, many want to use this equity to make purchases. It is tempting, who does not want a new car, a new caravan or a new boat. Effectively this equity is not really money they have paid off the asset, their home. It is just the value of the asset going up. Their mortgage amount is now more than when they initially bought the home. They are going backwards financially, even though they think they are better off.
Using this equity is a short-term view which will have long term implications. It will affect their retirement age and finances. And it will push out the age at which they will actually finish paying off their mortgage and finally own their own home.
When will I own my own home?
When you refinance your home the term of the mortgage usually starts again. That is your mortgage resets with a term of 25 to 30 years. Quite often, consumers are rolling their mortgage over and over. The property market goes up and they refinance. The interest rate goes down and they refinance. They are consolidating the debt again and again without actually paying their debt down and all the while extending the time to when it will be paid out. This is an extremely dangerous financial situation to be in. Do you still want to be working at 70?
Interest rates will go up!
House values may not go down significantly in the short term. Historically their value will only go up in the long term. But what about interest rates? Interest rates have been at record lows for a number of years. However, historically, there is a cycle and at some stage they will go up. Retirees remember the days of 17% and 18% interest rates. While interest rates are at record lows people should be focused on paying off their mortgage debt as much as possible.
But I want a new car! What should I do?
If you are going to purchase a new car or a new ‘toy’, such as, camper trailer, boat or jet ski, then the smartest way is by using a secured loan. This will mean you are financially better off in the long run. Secured car finance is a fixed interest rate loan contract anywhere from 1 to 7 years in duration. This will ensure that you are making regular repayments off both your mortgage and your new asset. AAA Finance are the experts in secured car loans. Get in touch today to speak with a finance expert.
Read more about our Secured Car Loans here.