Loan Types

What the ‘best / most suitable home loan’ means for you

The “best” home loan is a very individual proposition. To decide what the best home loan for you might be, you need to consider your individual circumstances now and proposed in the future. Some things to take into account might be:

Your “current” financial needs

What sort of repayment options are best suited to your current situation? Your interest rate and your loan term will impact your monthly repayments. Making “Interest Only” repayments is also an option usually popular with investors, because interest repayments are tax deductible and over the course of the year investors can claim this and recently the government has forced most lenders to increase “Interest Only” & “Investment” rates. You may also be paying only “interest” repayments during a construction loan if you are building a new house, as these repayments are lower than regular “principal and interest” repayments. This allows you to make smaller monthly repayments because you are probably still paying rent until your new house is built.

Your “future” financial needs

A home loan is a long term, financial tool that will help you buy one of the biggest assets you will own. To find a home loan that grows with you, you’ll need to think about your needs and wants for now and the future. For young professionals for example, a no-frills home loan with a fixed interest rate could help you get used to repayments. When the fixed rate period ends, you have the ability to refinance to a more flexible (variable) home loan as you become a parent or have bigger, financial goals or go for another fixed term…or a mix of both.

The purpose of the home loan

Whether you are buying a property as an investment or as your own home can affect grants you are eligible for, stamp duty costs and interest rates etc, and how you manage your repayments and interest at tax time. There can also be some BIG rate differences between “home loans” and  “investment loans” so make sure you are comparing the right type of loan where your needs are being met.


VARIABLE

Standard variable “Principle & Interest”  loans are the most popular home loan in Australia. Interest rates go up or down over the life of the loan depending on the official rate set by the Reserve Bank of Australia and the lenders funding costs. Your regular repayments pay off both the interest and some of the principal. and they allow you to make extra repayments to reduce the balance quicker…any “extra” repayments are usually available as “redraw” ie accessible if you need the money.

You can also choose a basic variable loan, which offers a discounted interest rate but has fewer loan features, such as a redraw facility and repayment flexibility.

Pros

  • If interest rates fall, the size of your minimum repayments will too.
  • Standard variable loans allow you to make extra repayments. Even small extra payments can cut the length and cost of your mortgage.
  • Basic variable loans often don’t come with a redraw facility, removing the temptation to spend money you’ve already paid off your loan.

Cons

  • If interest rates rise, the size of your repayments will too.
  • Increased loan repayments due to rate rises could impact your household budget, so make sure you take potential interest rate hikes into account when working out how much money to borrow.
  • You need to be disciplined around the redraw facility on a standard variable loan. If you dip into it too often, it will take much longer and cost more to pay off your loan.
FIXED

The interest rate is fixed for a certain period, usually from one to five years of the loan and some up to 10 yrs. This means your regular repayments stay the same regardless of changes in interest rates. At the end of the fixed period you can decide whether to fix the rate again, at whatever rate lenders are offering at the time, or move to a variable loan OR move into a mix of both? ie a variable & fixed “split” (see below).

Pros

  • Your regular repayments are unaffected by increases in interest rates.
  • You can manage your household budget better during the fixed period, knowing exactly how much is needed to repay your home loan.

Cons

  • If interest rates go down, you don’t benefit from the decrease. Your regular repayments stay the same.
  • You can end up paying more than someone with a variable loan if rates remain higher under your agreed fixed rate for a prolonged period.
  • There is limited opportunity for additional repayments during the fixed rate period, but many allow for a certain amount to be repaid during the fixed term or placed into an “offset” account.
  • You may be penalised financially if you exit the loan before the end of the fixed rate period…depending where rates are at the time based on where they were when you fixed the rate.
Split loans

Your loan amount is split, so one part is “Variable”, and the other is “Fixed”. You decide on the proportion of variable and fixed. You enjoy some of the flexibility of a variable loan along with the certainty of a fixed rate loan. May set your mind at ease

Pros

  • Your regular repayments will vary less when interest rates change, making it easier to budget.
  • If interest rates fall, your regular repayments on the variable portion will too.
  • You can repay the variable part of the loan quicker if you wish.

Cons

  • If interest rates rise, your regular repayments on the variable portion will too.
  • Only limited additional repayments of the fixed rate portion are usually allowed.
  • You will be penalised financially if you exit the fixed portion of the loan early ie before the maturity date.
Interest Only

You repay only the interest on the amount borrowed usually for the first one to five years of the loan, although some lenders offer longer terms. But recent government pressure has resulted in higher rates for “Interest Only” loans.  Because you’re not also paying off the principal, your monthly repayments are lower. At the end of the “Interest Only” period, you begin to pay off both interest and principal. These loans are especially popular with investors who plan to pay off the principal when the property is sold or when planning to retire and live of the rent, or sell having achieved capital growth. You can pay off extra if you want to anyway – if variable.

Pros

  • Lower regular repayments during the “Interest Only” period.
  • If it is not a fixed rate loan, you have the flexibility to pay off, and often redraw, the principal at your convenience.

Cons

  • At the end of the interest only period you have the same level of debt as when you started.
  • If you’re not able to extend your interest-only period, you could face the possibility of increased repayments.
  • You could face a sudden increase in regular repayments at the end of the interest-only period.
Low Doc

For “self-employed” people, these loans require less and different forms of documentation or proof of income than standard loans, but usually carry higher interest rates or require a larger deposit because of the perceived higher lender risk. In most cases you will be financially better off getting together full documentation for another type of loan. But if this isn’t possible, a low doc loan may be your best opportunity to borrow money. These require different forme of income proof AND can be swapped or refinanced in the future into a FULL DOC loan when “satisfactory income proof” is available.

Pros

  • Lower requirement for evidence of income. May overlook non-existent or poor credit rating. Various different types of proof are available;
    • a signed “Accountants Declaration” as to Taxable income(s)
    • 6-12 mths BAS
    • 6 mths business banking statements
    • Self Declared income(s) …usually backed up by one or both of the 2 above

Cons

  • You will pay higher interest than with other home loan types, or may need a larger deposit, or both., but when satisfactory proof is available can swap to a lower “Full Doc” loan / rate.

 


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