Home loans used to be relatively simple.
Most had a straightforward “principal, plus interest” set-up and the biggest decision the majority of borrowers faced was whether to pay off more than the minimum repayment each month.
But nowadays, there’s many different types of home loans and each can have an array of features. While it’s great to have choice, trying to understand all the options can be overwhelming.
Types of loans
Let’s take a look at the different types of loans
As the name suggests, this home loan is as simple as it gets. There are no special features, such as an offset account or redraw facility, with a basic loan.
While you miss out on some of the savings or flexibility these features can potentially provide, with a basic loan, you should get a low ongoing rate and in many cases, lower or no fees.
So, who does a basic loan generally suit best?
- Borrowers wanting a loan under $250,000, as the interest rate will most likely be lower than the standard variable rate.
- Those who want to keep things simple.
- People looking to reduce costs, as basic loans avoid many fees often associated with some features.
A 100% offset loan allows you to pay off your home sooner. It does this by linking your loan to a bank account you use every day, then uses the balance in that account to “offset” your home loan.
Say you have $50,000 in your offset account and you have a home loan of $400,000. The $50,000 is used to reduce your mortgage principal to $350,000, so you only pay interest on this amount, not the full $400,000.
What’s appealing about this type of loan?
- Reduces home loan length and interest.
- It has benefits whether you’re a spender or a saver, as any funds going into the offset account have immediate impact.
- Creates good savings and money management habits.
- Offers convenience, because you still have instant access to funds in the offset account.
A home equity loan enables you to access the wealth you’ve accumulated in a property. Equity is the difference between what the current market will pay for your property and what you have remaining on your mortgage.
If you have a home that could sell on the current market for $500,000 and you have $200,000 remaining on your mortgage, your equity is roughly $300,000.
In almost all cases, you won’t be able to borrow the full $300,000 in this loan, but the equity should give you access to at least a portion of it.
Who does a home equity loan best suit?
- Those looking for financial flexibility. If an unexpected cost pops up, you can possibly use your equity to gain access to more funds.
- People wanting to renovate or improve their property.
- Home owners who have paid off 20% or more of their property. The more equity you’ve built into your home, the greater the scope you should have for a home equity loan.
Learn more about what is a Home Equity Loan.
Low Doc Loan
A low doc – short for low documentation – loan is an option for those who can’t meet the standard income verification requirements for most home loans.
Anyone who has difficulty proving a consistent income or ability to pay off a loan can fall into this category.
Who can apply for a low doc loan?
- Self-employed contractors.
- Business owners.
- Commission-based workers.
Learn more about the types of home loans available.
Home loan features
Now we’ve gone over the types of loans, let’s look at the various features and add-ons you can possibly access, depending on your circumstances.
Variable Rate Loan
This type of loan involves an interest rate that will vary depending on changes in lending market conditions. The Reserve Bank changing official cash rates is one such example.
- If rates drop, your interest payments will too.
- Extra repayments on top of scheduled ones are generally allowed.
- Variable rate loans often come with other features, like redraw facilities and offset accounts, offering savings and flexibility.
- If interest rates rise, so do your interest payments.
- Lack of certainty, because your rate is pegged to market
Learn more about the choosing between variable and fixed rate loans.
This feature is where a period of your loan is set at a fixed interest rate before reverting to a variable rate loan, or you negotiate for another fixed-interest period. When the rate is fixed, it will stay the same, regardless of any changes in lending market conditions.
- Budgeting certainty. Irrespective of changes in lending market conditions, your interest payments stay the same.
- Lack of flexibility. In many cases, you’ll have to pay penalties if you make pay more than your scheduled payment, but some lenders will waive this.
- Depending on market conditions, you may pay more interest over the life of your loan.
- Many carry break fees if you pay out early.
Split Interest Rate
Another interest rate option for your loan is to have a portion of each type, so for example, having 50% of your interest at a fixed rate, while 50% is variable.
Having both options in your loan will provide some of the pros and cons of both, so you can have the certainty of set payments with the fixed rate while also taking some advantage if rates fall with your variable portion.
- More budgeting certainty with some of your rates fixed, while reducing your exposure to possible rate hikes.
- Savings when interest rates fall.
- Access to features such as a redraw facility or offset account, as well as no penalties for extra repayments.
- Splitting the interest portions means you don’t reap the full benefits of either interest rate type.
Click here to learn more about how to split your home loan.
Principal and Interest
This is a blanket term that applies to the vast majority of home loans. The term principal relates to the amount you borrowed, while interest is what the bank charges you for the loan and is calculated on the size of your principal.
In this loan, you pay towards both every month, gradually reducing your interest bill as you reduce the principal.
- You pay your mortgage off from the start.
- Builds equity over time.
- Generally cheaper in the long-term than an interest-only loan.
- Not suitable for some types of investment loans.
- Doesn’t offer some of the flexibility an interest-only period can.
These loans offer the flexibility of only paying back the interest on your loan, freeing up capital you would have paid towards the principal.
This feature is normally only offered for a set period and the expectation is you’ll repay the principal during the life of the loan. This type of loan can cost more than a principal and interest loan, but it depends on your circumstances.
- Flexibility. Not repaying the principal means lower costs during the interest-only period and access to more capital for that time.
- Investors can reduce costs if they pay out the loan before the interest-only period expires.
- In most cases, costs you more over the normal life of a loan.
- Mortgage payments after the interest-only period will be higher than they would have been at the same point in a principal and interest loan.
Want to learn more about Interest-Only home loans? Click here.
Line of Credit Facility
This facility acts like a cheque account, enabling you to draw funds against the equity in your property whenever you need them. You then repay the part of the loan used monthly.
You’ll need to have sufficient equity and need to be good at managing your finances, so you don’t overcommit.
- Payments are flexible so you can pay more without penalty.
- The credit can be used for any legal purpose.
- Interest is calculated only on what you use in the facility, not the total amount of the mortgage.
- Higher than basic and standard variable rates generally apply.
Making extra repayments above the scheduled ones can often save you money in the long run, as you’re reducing your principal faster.
Usually only applicable to variable or split rate loans, some lenders will allow some extra repayments on fixed-interest loans before imposing fees.
- Save money on the overall cost of loan.
- You can likely make as many as repayments you want on a variable interest loan.
- Your available funds are lower, as you’ve paid them toward your loan.
This facility gives you access at any time to any payments you’ve made above your required monthly loan repayments.
- Access to funds whenever you need them.
- While funds sit in the mortgage, interest is reduced by offsetting principal.
- Harder to access than an offset account in some cases.
Repayment holidays are temporary suspensions or reductions in mortgage repayments. Some lenders may only consider them if you’ve been making extra repayments and have excess funds to access.
- Flexibility in situations where income is affected.
- Repayments may increase or mortgage period extended.
- Interest is still charged during holiday.
Home loan top-up
Top-ups are when you increase the borrowed amount in your current mortgage instead of taking out a new loan.
In many cases, lenders will require you to have equity already built and will also assess your ability to make the increased repayments before approving the top-up.
- Quick access to more loan funds.
- Usually lower cost than setting up a new loan.
- Opportunity to consolidate all debt into one, lower-interest mortgage.
- In many cases, top-up is not available.
- Increased repayments and mortgage term.
Are you looking for a home loan and and trying to decide which home loan features are right for you? Then contact eChoice, our brokers have access to 100’s of products, so we could help find you a competitive mortgage.
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