An important consideration when looking for your new home or investment is not only what you can afford, but what are your options for repayments?
Looking for a home loan that meets your requirements is an often overlooked but essential part of your purchase strategy. Being prepared includes understanding your options and strategies to maximise the strength of your loan application.
Other than interest rates and loan length, there are various other options to choose from when it comes to your loan structure.
This can make it quite intimidating to understand which suits your circumstances best, especially for a first-time homebuyer.
We walk you through the different loan options, suitability, and availability based on your financial position and goals. Generally speaking, chatting to a mortgage broker early in your property search can help you understand your budget, options, and anything you can do to help strengthen your loan application.
Types of Home Loans
Below, we will outline some of the most common loan structures:
Principal and Interest Loans
This is the most common loan repayment structure. This loan type enables you to pay the principal and interest off regularly, typically as monthly payments to the bank.
The principal component of the loan refers to the borrowed amount. Interest is the additional fee at your interest rate that is part of your loan term. These are paid together in line with the repayment schedule (typically set as monthly repayments).
Simply put, each time you pay the principal, you are returning a part of the borrowed money. When you pay off the interest, you are paying the bank fee for lending you the funds.
Interest Only Loans
In this repayment structure, your loan repayments only comprise the amount of interest that the bank has charged you for that time. An interest-only loan often has smaller instalments because you are not paying down the principal amount as well.
With an interest-only loan, the principal amount you borrowed from the lender does not decrease with each payment you make, meaning when you sell your property, the entire amount you borrowed will need to be repaid. This strategy is typically used in a rising market, and the loan arrangement is better suited to investors wishing to buy an investment property. Interest may offset the tax from their rental income, whistling keeping the monthly payments low to maximise the cash flow from the property.
Not all lenders will offer this loan structure, and a favourable interest rate or loan term may not be available. We recommend you talk to your accountant or mortgage broker to understand the risks fully and use an interest-only loan as part of a clear investment strategy.
Fixed vs Variable Loans
Choosing between a fixed and variable loan is a personal decision and may be based on various criteria unique to you. Depending on your lender, features such as an offset account, additional repayments or the ability to redraw may only be available at a variable rate. However, a fixed rate will typically be a lower rate at the time of locking in your loan features.
This is why it is essential to consider what is important to you over the next few years and how your finances may change to make sure you have a loan structure suitable to your circumstances.
Fixed Rate Loans
In a fixed-rate loan, the interest rate stays the same for a set length of time. A fixed-rate means that, regardless of what occurs in the general market, your interest rate will not change and will remain the same for the duration of the fixed period.
For example, a fixed rate of 3% for three years means that even if rates go up and new loans are locked in at 8%, you will still pay 3% for the entire three years.
On the other hand, if market rates decrease to 2% per cent during your fixed-rate period, you are locked in at 3% for the entire 3-years.
When a fixed-term rate ends, your loan will return to a variable rate loan, which will change with the market based on current interest rates.
Lenders may enable you to break a fixed rate loan, but this can come with a penalty fee, which should be considered when deciding the feasibility and benefits of breaking from a fixed-rate loan.
Variable Rate loans
Variable loans have a fluctuating interest rate, which means that the amount you pay each month might fluctuate based on market conditions. The Reserve Bank of Australia Board meets every first Tuesday of the month to decide on the cash rate. The cash rate impacts the interest rates that lenders provide to their customers.
Variable rates allow flexibility with additional repayments and the possibility to attach an offset account and redraw capacity, especially when interest rates are low and static.
If your variable loan rate was 3% and your lender increased interest rates to 4%, your interest rate and repayments would increase to reflect the shift.
In contrast, if the lender lowers the rate to 2%, you will benefit from the lower interest rate and payback on your loan.
You may consider a variable rate if you believe the interest rate will decrease and a fixed rate if you expect the interest rates to increase or want more certainty in your repayment schedule.
It is important to note that even if the RBA lowers the cash rate, it is at the lenders’ discretion to pass the interest rate cut on.
Split Loan
Split Loans are seen as getting the best of both worlds and is a more conservative strategy. In this structure, you can opt to have a fixed-rate portion to lock in a fixed rate on a percentage of your loan. You can split this with the balance of your loan having a variable rate.
You may be able to take advantage of other features such as redraw facility, offset account or extra repayments without penalties on the variable portion of your loan. But have the certainty of fixed rates on the balance of your loan.
Individuals typically take this approach to balance their risk. Based on your unique circumstances, a mortgage broker can explain the benefits and risks of this sort of loan structuring.
Honeymoon Rates
Honeymoon rates are what is typically referred to as a special offer or introductory rate for new loans. Such an offer could be a very low-interest rate for a short period or other additional features. Once the ‘honeymoon period’ ends, honeymoon loans return to a higher rate, so make sure you understand the full fee schedule when your introductory period is over, so you are not surprised by an unexpected fee hike.
These are just a few of the most common loan structures. It is important to keep in mind that the most suitable options will vary with your budget and lifestyle.
Our experienced team can talk you through your options and tailor loan options based on your circumstances and budget. Book an appointment today.
Disclaimer:
Terms are subject to approved persons only. This information is true and correct as of 28/11/2021. All of the content above is general in nature and may not suit your personal needs, situation objective & goals.
