GUIDE TO THE TYPES OF HOME LOANS
Mortgage managers, banks, credit unions, brokers, insurance groups all offer a seemingly endless choice of loan options – introductory rates, standard variable rates, fixed rates, redraw facilities, lines of credit loans and interest only loans, the list goes on. But with choice comes confusion.
How do you determine whether a home loan is suitable for you?
- Set your financial goals, determine your budget and work out the term of the loan (i.e. how long you will be paying it off). You may do this yourself or with your financial advisor or accountant.
- Ensure the organisation or person you choose to obtain your loan from is a member of the Mortgage and Finance Association of Australia (MFAA). The MFAA Member logo means you are working with a professional who is bound by and subject to a strict industry code of practice.
- Research the types of loans available so you can explore all options available to you with your mortgage provider.
BASIC HOME LOAN
This loan is considered a no-frills loan and often offers a very low variable interest rate with little or no regular fees. Be aware they usually don’t offer additional extras or flexibility in paying off extra on the loan or varying your repayments.
These loans are directed towards people who don’t foresee a dramatic change in personal circumstances and who may not need to adapt the loan in accordance with any lifestyle changes, or people who are happy to pay a set amount each month for the duration of the loan.
INTRODUCTORY RATE OR ‘HONEYMOON’ LOAN
This loan is attractive as it offers lower interest rates than the standard fixed or variable rates for the initial (honeymoon) period of the loan (i.e. six to 12 months) before rolling over to the standard rates. The length of the honeymoon depends on the lender, as too does the rate you pay once the honeymoon is over. This loan usually allows flexibility by allowing you to pay extra off the loan. Be aware of any caps on additional repayments in the initial period, of any exit fees at any time of the loan (usually high if you change immediately after the honeymoon), and what your repayments will be after the loan rolls over to the standard interest rate.
These loans may be appropriate for people who want to minimise their initial repayments (whilst perhaps doing renovations) or to those who wish to make a large dent in their loan through extra repayments while benefiting from the lower rate of interest.
Tip: If you start paying off this loan at the post-honeymoon rate, you are paying off extra and will not have to make a lifestyle change when the introductory offer has finished.
REDRAW FACILITY
This loan allows you to put additional funds into the loan in order to bring down the principal amount and reduce interest charges, plus it provides the option to redraw the additional funds you put in at any time. Simply put, rather than earning (taxable) interest from your savings, putting your savings into the loan saves you money on your interest charges and helps you pay off your loan faster. Meanwhile, you are still saving for the future. The benefit of this type of loan is the interest charged is normally cheaper than the standard variable rate and it doesn’t incur regular fees. Be aware there may be an activation fee to obtain a redraw facility, there may be a fee for each time you redraw, and it may have a minimum redraw amount.
These loans are suited to low to medium income earners who can put away that little extra each month.
LINE OF CREDIT/EQUITY LINE
This is a pre-approved limit of money you can borrow either in its entirety or in bits at a time. The popularity of these loans is due to its flexibility and ability to reduce mortgages quickly. However, they usually require the borrower to offer their house as security for the loan. A line of credit can be set to a negotiated time (normally 1-5 years) or be classed as revolving (longer terms) and you only have to pay interest on the money you use (or ‘draw down’). Interest rates are variable and due to the level of flexibility are often higher than the standard variable rate. Some lines of credit will allow you to capitalise the interest until you reach your credit limit i.e. use your line of credit to pay off the interest on your line of credit. Most of these loans have a monthly, half yearly or annual fee attached.
These loans are suited to people who are financially responsible and already have property and wish to use their property or equity in their property for renovations, investments or personal use.
ALL IN ONE ACCOUNTS
This is a loan which works as an account where all income is deposited in the account and all expenses come out of the account. The benefit of the All In One Account is its ability to reduce the amount owed and thus the interest payments while providing a one-stop finance shop where your loan, cheque, credit and savings accounts are combined into one. Normally these loans will be at the standard variable rate or slightly higher and may incur monthly fees. Be aware that if the account is split into the loan account, with credit, cheque and ATM facilities placed into satellite accounts, you will need to check your access to funds, how many free transactions you receive, and what associated fees the loan may have.
These loans are suited to medium to high income earners.
100% OFFSET ACCOUNT
This loan is similar to an All In One Account however the money is paid into an account which is linked to the loan – this account is called an Offset Account. Income is deposited into the Offset Account and you use the Offset Account for all your EFTPOS, cheque, internet banking, credit transactions. Whatever is in the Offset Account then comes directly off the loan, or ‘offsets’ the loan amount for interest. Effectively you are not earning interest on your savings, but are benefiting as what would be interest on savings is calculated on a reduction on your loan. The advantages are similar to the All In One Account. These loans normally have a higher interest rate and higher fees due to their flexibility.
These loans are directed at medium to high income earners, and to disciplined spenders as the more money kept in the offset account the faster you pay-off your loan.
Partial offset account and an interest offset account are also available.
SPLIT LOANS
This is a loan where the overall money borrowed is split into different segments where each segment has a different loan structure i.e. part fixed, part varied and part line of credit. These loans are directed at people who seek to minimize risk and hedge their bets against interest rate changes while maintaining a good degree of flexibility however subject to the proposed structure of the split loans taxation issues may arise in some circumstances.
Tip: Your mortgage provider will assess your personal circumstances then recommend and explain loan types to suit your circumstances.
Disclaimer: This document is for information purposes only, and must not be relied upon as a substitute for professional services or legal advice.
