HOW TO CHOOSE BETWEEN DIFFERENT TYPES OF HOME LOANS TO GET THE RIGHT DEAL FOR YOU
There are so many things to consider when choosing the right home loan to suit your needs, but luckily having a finance expert on your side can take the headache out of the process.
Variable Rate Home Loans (Basic & Standard)
These two home loan types are pretty similar but subtly different. The main differences are in the interest rate charged and what features are available as part of the package.
A standard variable home loan will usually have all the listed features, where a basic variable home loan will have fewer options included. So, it pays to get some good advice on what features you may need over the next few years, ensuring that you have the right amount of flexibility for the needs of your lifestyle and not paying extra for features you aren't going to need. Those cost savings can add up and help you pay your loan down faster.
The graphic opposite shows a summary of the usual differences between standard and basic variable rate home loans. This is a general guide only, and differences may exist from one lender to another and between specific products.
Discount Variable Rate Home Loans or introductory offers
To attract new customers, many lenders offer Standard Variable loan products that have a discounted rate of interest for a set period, ranging from 6 months to 2 years. At the end of this 'honeymoon' period, the interest rate reverts to the Standard Variable Rate. To make sure customers don't jump from lender to lender each time the introductory period expires, most lenders include a sizeable exit fee or penalty as a condition in the loan contract should the borrower repay the loan early. So it might be more effective to pay a slightly higher rate of interest to avoid being stung by fees should your circumstances change. Your broker can help you with checking your contract to calculate potential exit fees and charges and offer guidance when weighing up your options.
Fixed Rate Home Loans
This is a loan where the interest rate is guaranteed to remain the same during an agreed term, no matter what happens in the wider finance market with variable rate loans. Lenders have offered terms of between 1 – 5 years for fixed rates.
The way it works is that when the Fixed Rate term expires, the loan is either renegotiated by being repaid in full or, the preferred option by most Lenders is for the loan to revert to the Standard Variable Rate after the Fixed Rate term. So a home loan can be set up for a 25 or 30-year loan term with the first five years, or three, or whatever you've agreed, fixed at a specific interest rate.
Fixed rate loans may be popular with borrowers because they want to take a conservative approach to borrowing with set loan repayment amounts for the Fixed Rate period. Some property investors prefer to know their commitments and find comfort in guaranteed repayments.
Word of warning: I'm not a big fan of fixed interest loans. I feel it's a gamble to predict what will happen in the wider finance market. And in casinos when you bet against the House, the House usually wins, leaving you out of pocket.
If you sign up to a fixed rate home loan, then you need to understand that you are committing to a contract with the lender for the fixed rate term, or length of time. If you later wish to end the contract early, then you may have to pay substantial fees to cover the costs of breaking the contract.
So-called ‘break costs’ can be very expensive. They are determined by many factors, including the term remaining on your loan, the current interest rate market and the outstanding balance. These costs cannot be estimated when the contract is taken out.
It's also worth noting that many Lenders also restrict extra repayments on the loan during the fixed rate period. Restrictions vary from lender to lender.
Line of Credit or Home Equity Loans
Equity Loans or Lines of Credit offer similar benefits and operating features to bank overdraft.
A line of credit loan allows the borrower to set a credit limit and then draw from and pay down the mortgage without restriction. The borrower can use the entire credit limit at any time and does not have to comply with an amortised repayment schedule.
Lenders of these type of loans usually insist that the monthly interest charge be the minimum payment amount to maintain the account. Meaning that the borrower can choose how much, if any, principal repayment they want to make.
Two factors generally determine the credit limit:
the borrower's ability to repay, and
the amount of equity they hold in the security property offered.
This type of home loan allows the borrower to make use of as much of the credit limit as they choose, for whatever time frame they require, while being charged interest for the outstanding balance. Borrowers can even overdraw in some cases.
Please note: Line of Credit loans are not suitable for all people. Borrowers can reuse the full original limit over and again, so without proper discipline, it is possible that the borrower might never pay off this type of loan.
Home Loan Features & Other Terms
INTEREST-ONLY PAYMENTS
Most Lenders will allow borrowers to make interest-only payments on their loan for a short period, where the monthly repayment does not chip away at the loan principal, and the outstanding loan balance remains unchanged during the term of the interest-only period.
Generally, Lenders offer interest-only periods of between one and five years, after which the loan will revert to the regular principal and interest repayments over the remaining term of the loan.
For example, a 30-year home loan may be set up to have a 5-year interest-only period, with the remaining 25 years repayments being principal and interest.
LOAN PORTABILITY
Is a formal term for allowing the borrower the option of keeping their existing home loan arrangements but changing the property that secures it. For example, a borrower may sell their current home, and purchase a new home, and merely transfer the existing loan to the newly acquired property, instead of requiring a new loan application to be processed.
OFFSET ACCOUNT
A Mortgage Offset account allows the borrower to have any savings or credit balances in their transaction account offset against their loan facility when calculating the interest owed.
Most Lenders offer offset accounts, and most offer ‘100%’ offset, which means any credit balance in the account offsets against the outstanding balance of the loan. So, if a borrower had a loan with a balance of $100,000 and an offset account with $10,000 in it, then their interest would be calculated on the net balance of $90,000.
Note that the mortgage offset account does not earn any interest itself.
REDRAW
The loan redraw feature allows a borrower to withdraw any additional funds that they have paid off their mortgage over and above the minimum repayment.
For example, if a borrower has been paying an additional $500 per month off their loan, then after 12 months they would have an extra $6000 in the mortgage account, which they would be able to redraw and use for any purpose, should they want to. Lenders may charge a fee to redraw extra funds, with costs typically varying from nil to $50 per redraw.
SPLIT ACCOUNTS OR COMBINATION LOANS
Most lenders allow borrowers to split their loan into different parts. For example, a borrower may choose to section off the loan into pieces that are Fixed Interest and others charged at the Variable Rate. This approach can minimise the potential effect of an interest rate rise while maintaining the flexibility of a Variable Rate loan.
LENDERS MORTGAGE INSURANCE (LMI)
Lender’s Mortgage Insurance is an insurance policy for the benefit of the lender (the bank) but paid for by the borrower (homebuyer).
The LMI policy protects the lender against losses where:
the borrower defaults on their mortgage and the lender then sells the security property; and
the sale funds do not cover the outstanding mortgage (including any fees and charges that may have accrued in the process).
An LMI policy is usually required by the lender when the amount of money the borrower is applying for exceeds 80% of the value of the security property.
Disclaimer
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