Find out what types of home loans and features are available….
Types of home loans and their features can become confusing.
Your mortgage broker will help you through this process, but to give you the heads up, the following information will help you understand the types of home loans available, as well as the features they may offer.
STANDARD VARIABLE HOME LOAN
This is the ‘benchmark’ variable interest rate for each lender. This home loan is usually flexible, but not competitive as far as interest rates, fees and charges go. The interest rate will rise and fall in line with the Reserve Bank of Australia – although as we all know the lenders do not always stay on par with the Reserve Bank they can choose to pass on all or only some – or none of the rate cut, and they also have to ability to increase rates at any time independant from the Reserve Bank. The rise and fall of the standard variable rate will affect repayment requirements.
BASIC VARIABLE HOME LOAN
This is a ‘no frills’ variable rate home loan with a discounted interest rate. They generally have fewer features than the standard variable and may not be as flexible. Like the standard variable home loan, the basic variable home loan rate will rise and fall in a similar way as the standard variable rate.
FIXED RATE HOME LOAN
A fixed rate home loan is where the interest rate and repayments are fixed or locked in for a set period of time, usually 1-10 years and in some cases longer. After the fixed period ends, the loan will revert to a variable rate (usually the standard variable).
The advantage of a fixed interest rate is having certainty about your required home loan repayments making budgeting easier. It also protects you from potential interest rate increases.
The disadvantages are a reduction in flexibility ie extra repayments, redraw etc, and the fees involved if you break the terms and conditions of the facility. Obviously if interest rates fall, you will still be paying your existing repayments as the fixed rate will not change.
It is important to know how much flexibility your facility offers. Most lenders offer to ‘lock in’ the fixed rate at the time of application, however this may incurr a fee.
INTRODUCTORY / HONEYMOON RATE HOME LOAN
These are variable rate home loans with a discounted interest rate for the first 6 to 12 months of the home loan.
After the ‘honeymoon’ period, the interest rate will automatically roll onto the standard variable. Some lenders may fix or cap the rate during the honeymoon period.
The obvious advantage is the lower interest rate which reduces your repayments, and gives you the opportunity if you choose to pay more of the principal as quickly as possible.
The disadvantages are that once the ‘honeymoon’ period is over you are usually left with a less than competitive interest rate, and there may be higher exit fees.
It is important to know the exit fees and switch fees (fee incurred when you change home loan products) so you are aware of the costs to secure a better interest rate once the honeymoon period is over.
LINE OF CREDIT HOME LOAN
A line of credit is an approved limit of money you can borrow secured by a residential property (investment or owner occupied). It is a very flexible loan and gives you the choice of paying interest only, principal and interest and in some cases allowing interest to capitalize until you reach your credit limit ie you use the funds available in the line of credit to pay the interest charged on your line of credit.
There are two types of ‘line of credit’ and it is important to know which one you have.
The first has a standard 30 year term with the line of credit option being available for 1-10 years depending on the lender, after which the lender will requier principal and interest repayments.
The second is what is often referred to as ‘evergreen’ or ‘true’ line of credit in that it has no ‘actual’ term, and as long as you are conducting the facility according to the lenders terms and conditions you will only ever have to pay interest on the outstanding balance.
A line of credit facility is popular with property investors and those who are financially responsible and can stick to a budget. Whether you are building a property portfolio and like the convenience of having your loan approved and waiting, or are renovating and only having to pay interest on the funds you have drawn down as your project progresses, or you’re simply wanting to pool all of your income into your line of credit in an effort to pay your home loan off faster – this facility suits a variety of circumstances, but is definately not for those who lose track of their finances quickly.
COMBINATION/SPLIT HOME LOAN
This allows you to take part of your home loan variable, and part fixed or part principal and interest and part interest only.
When splitting your home loan between variable and fixed it gives you the advantages of fixing into a rate and having the comfort of knowing that portion of your home loan will not change should interest rates go up, while still having the full flexibility on the variable portion. Of course your variable portion is still vulnerable to interest rate changes and will rise and fall. If interest rates fall, your fixed portion will not.
Again it is important to check the interest rate your fixed portion will revert to. Also check fees and charges associated with splitting your home loan, and for rate lock fees on the fixed protion of your home loan.
CONSTRUCTION HOME LOAN
The construction home loan is similar to a residential home loan except the property used as security is yet to be built. The loan is drawn down in progress payments (usually 5 or 6) in accordance with the stages of construction.
After construction is complete you may have the option to switch to a more competitive product.
Some lenders charge ‘progress fees’ to cover the valuation at each stage.
BRIDGING HOME LOAN
Bridging finance is a short term loan that covers the gap between the purchase of a new property and the sale of the old property. Lender policies on bridging finance vary significantly so it is important to know exactly what is required under the credit contract eg. Loan servicing requirements, loan term, and allowing interest capitalization. There is a certain amount of risk involved in bridging finance, so it is important to allow for worst case scenarios.
LOW DOCUMENTATION HOME LOAN
The Low documentation are commonly referred to as low doc home loans.
These facilities have been designed for self employed (and in some cases PAYG employees) who do not have their current income and taxation details available for the home loan application.
Low docs have become increasingly popular, and therefore very competitive – to the point where most lenders, traditional and non traditional have a low doc product or policy.
The majority of lenders will only lend up to 80% of the property value under low doc policy. There are a few who will lend up to 95%, however these facilities are more expensive due to the increased risk to the lender.
Lenders mortgage insurance may also payable when you borrow over 60%, however there are some lenders who will cover the LMI premium for you – so it is important to know who will and who won’t and to consider this when choosing a home loan.
CREDIT IMPAIRED HOME LOAN
These facilities are for people who for a range of circumstances have a bad credit rating. Any thing from not paying a phone bill to bankruptcy is noted on your credit rating for lenders to see.
Non traditional lenders provide products for people with a bad credit rating. The interest rates vary significantly depending on the level of risk the lender sees in funding your loan.
EQUITY RELEASE/REVERSE MORTGAGE
A reverse mortgage or equity release mortgage has been designed for home owners over 60 years of age to access equity in their home to help fund their retirement without having to sell their home.
It is important to make sure the lender is a member of SEQUAL. Products vary according to flexibility and the amount you can borrow, as well as how the funds are paid to you – so make sure the lender you choose suits YOUR needs.
HOME LOAN FEATURES:
Paying interest only off your home loan is an option that you may choose. The payments are a lot less than if you were to pay principal and interest. As the term suggests, you only pay for the interest accrued on the amount borrowed. The principal balance of your home loan does not reduce during this period.
The interest only period is usualy 1-5 years of a 30 year term home loan. After this period you have three options:
- Renegotiate an continue paying interest only for another 1-5 years (a new application may be required).
- Start paying the nominated principal and interest (this will be substantially higher due to the fact that your loan term is now 25 years after 5 years of interest only).
- Refinance and start again!
If you refinance you can again choose the interest only option, or start paying principal and interest over a new 30 year term.
An interest only home loan is suitable if you are relying on a capital gain, or are wanting to keep repayments as low as possible to allow for additional funds to go towards other expenses or investments.
A redraw facility offers you the opportunity to redraw or take back any additional repayments you have made on your home loan.
Be aware of ‘redraw fees’ and the minimum redraw amounts set by the lender.
Many people take advantage of this facility by putting their savings into their home loan, saving interest and helping to pay their home loan off faster rather than earning interest (taxable) in a savings account.
ALL IN ONE
This type of home loan works as an account where all income is deposited, and all expenses are taken out of. If managed correctly it has the ability to reduce the principal owing on your home loan and therefore the interest charges.
It also has the benefit of being a one-stop shop for all of your finances where your loan, cheque, and savings accounts are combined into one. These can be interest only (line of credit) or traditional principal and interest term home loans. It is important to check out fees such as ATM, cheque and eftpos.
An offset facility is similar to the ‘all in one’ account, however the home loan account and transaction account are separate, not combined.
All income is deposited into the offset accont and you can use the offset account for ATM, eftpos, cheque, and internet transactions or in some cases transfer money from the offset account into a transaction account when required.
You are not paid interest on the money in the offset account, but the balance in the offset account is ‘offset’ against that owing on your home loan. Any ‘notional’ interest earned at the same rate as the linked loan.
Over time this can help you pay off your home loan sooner and build up equity.
There are two types of offset accounts – 100% offset and partial offset. An offset can be termed ‘partial’ in two ways. The offset may only apply after your account reaches a minimum balance or be at a reduced rate.
As an example, if the principal owing on your home loan is $100,000 and you have $5,000 in your 100% offset account – the principal is reduced by the $5,000 offset to $95,000. Interest only accumulates on the $95,000. Repayments continue to be made on the entire $100,000 principal and applicable interest. While savings in the offset account are actively working to reduce the loan, and repayments are working more effectively to reduce both the principal and interest it attracts.
It is again important to check all fees and charges associated with an offset facility.