Beat the hikes with a zero interest mortgage

By Gillian Bullock, ninemsn Money

With interest rates on home loans close to 10 percent, how about a home loan that has a zero interest rate?

Late in 2007, Adelaide Bank and Rismark International launched its Equity Finance Mortgage (EFM) home loan where the lender takes equity in the property but does not require the borrower to make any interest or principal repayment for up to a maximum of 25 years.

Sadly this loan can only be taken out on a maximum 20 percent of the value of the home, so you have to finance the balance in the traditional manner. When the EFM loan is repaid then the lender takes a share of the capital gain which will be capped at 40 percent, giving the borrower a minimum of 60 percent of the growth.

And if the house price does not rise then the lender will wear up to 20 percent of the losses and reduce the original loan amount accordingly.

In a falling market, it can therefore become a very attractive option. Does it all sound too good to be true? According to figures provided by Infochoice, using an equity finance mortgage (EFM) in conjunction with a traditional home loan can see you come out on top when compared with just a fixed rate or a variable rate home loan on the entire amount.

So let's set the scene. Say you bought a house at the median property value of $485,319 and then sold it five years down the track during which time the house increased in value by 4.91 percent a year. In all cases you start with 20 percent equity in the home and are only seeking to finance the balance.

If you had taken out a 25-year mortgage over the property, then on current figures you would pay 8.4 percent with a basic variable rate and 8.65 percent with a five-year fixed rate on 80 percent of the value of the property.

If you used the EFM facility, then you would pay the Adelaide Bank's branch rate of 8.4 percent on 60 percent of the value of the property at purchase. At the end of the five-year term, the house sells for $616,754, but how much do you actually have in your pocket once you have repaid the loan?

With a standard variable loan you would still have an outstanding debt of $359,860 so you would have $256,893 in equity. But when you allow for the interest and principal payments that you have made over the period at $3100 a month, the cash in your pocket post sale is $70,880.

As the fixed interest rate is higher than the variable rate, your cash in pocket post sale would be a lower $65,986.

However, it's a different scenario with the EFM. Let's assume you were in an equal financial position at the start of this exercise so had the money to repay 80 percent of the house price but chose to take the EFM option.

This would mean you were paying approximately $680 less a month in mortgage repayments as you have borrowed a smaller amount.

If you had invested the money in an online saving account earning seven percent a year then you would have accumulated $44,616 which would go some way to offsetting the lower equity you have in the home because you could not benefit from the full capital growth.

In fact, you would have ended up with $102,327 in your pocket.

Of course, most people who take up the product do so because they cannot afford the higher loan repayments. In those cases, the borrower will not necessarily be in such an advantageous position.

Nevertheless Denis Orrock of Infochoice says this innovative loan is part of a solution to the problem of housing affordability and it gives Australians a stepping stone into the market.

The product is the brainchild of Christopher Joye who was involved in the housing affordability study for the Menzies Institute.

Check out our mortgage calculator and compare home loans.