Which Home Loan Is For You?
A typical home will cost a lot more than the amount handed over at settlement, with the final price paid ultimately depending on the interest rate charged by the chosen lender - and as a result, choosing the right home loan is often just as important as choosing the right property.
When deciding, it is important to note that the right home loan isn’t always the one with the lowest interest rate. Each loan type offers a different set of features and benefits, and it’s up to you to decide whether these outweigh the higher interest rates banks charge to offer them.
This is why you must take your time mulling over the options, as a poor decision could lead you towards mortgage stress, or result in you paying thousands more for your home than you otherwise would have paid.
Here’s a quick guide to the ten loan types you’re likely to come across.
Variable rate loans
The most common type of home loan is a variable-rate loan, and as its name implies, the interest rate varies over time.
This means that your rate and repayments will drop if there’s a dip in external interest rates, but will rise if there’s a spike in these rates. As a result, homeowners with a variable-rate loan often find it harder to plan for the future than those on more stable loan types.
However, unpredictable interest rates are only part of the picture. Unlike other loan types, variable-rate loans allow homeowners to make additional repayments free of charge. And many also offer access to an offset account and a redraw facility, which allows borrowers to access these additional repayments at a later stage.
And so prospective buyers must weigh the threat of potential interest rate increases against the increased flexibility afforded by a variable-rate loan’s extra features.
Fixed rate loans
At the other end of the spectrum are fixed-rate loans, which allow borrowers to “fix” the interest rate at a certain level for an agreed upon period of time.
Fixed interest rates mean fixed monthly repayments, and so borrowers with a fixed-rate loan often find it easier to organise their budget and plan for the future than those with variable-rate loans.
The downside is fixed-rate loans prevent borrowers from enjoying the benefits of rate drops, and most come with limited flexibility and restrictions on additional repayments, which make it much harder for borrowers to pay off their home loan sooner.
Generally speaking, fixed-rate loans are a good idea when rates are low and expected to increase in the future. But prospective borrowers should also take into account their current financial situation when deciding which loan is right for them.
Split rate loans
Not everyone who locks in a fixed interest rate wants to fix their entire loan amount, as most want to avoid paying more than they need to if interest rates fall.
Instead, many borrowers will fix a portion of their loan amount to lessen their risk whilst retaining some flexibility over their future repayments. The rest of their loan will remain on a variable interest rate.
Interest only loans
Traditionally only offered to investors, interest-only loans are mortgages that allow the borrower to only pay off the loan’s interest and ignore the principal for a set period.
Some of the thinking behind interest-only loans is that investors can pay the minimum off their loan while waiting for the property to increase in value, at which point they will be able to sell it to cover the original loan amount and bank a profit. Temporarily switching to an interest-only loan can also be a good way to reduce mortgage stress – though banks are cautious when approaching this idea.
Investors and owner-occupiers are treated differently in the home loan department.
For starters, most loans to investors require a higher loan-to-value ratio (LVR), meaning these loans generally come with higher interest rates. Then there’s the fact that the Australian Prudential Regulation Authority currently imposes more restrictions on lending to investors than lending to owner-occupiers. This, however, is subject to change (see our previous article HERE )
One of the benefits of property investment, though, is that investors can deduct these additional borrowing expenses from their taxable income. It’s one of the many ways investors can reduce their tax bill.
Low doc loans
Not all borrowers have the luxury of regular paychecks and a clearly defined earning capacity. Business owners, freelancers or other self-employed people often have difficulty proving to a bank or lender that they will be able to repay their home loan. Enter the low doc home loan.
As you can probably guess from the name, low doc loans allow people to apply for a home loan without providing the standard amount of paperwork, in return for paying a higher interest rate and larger deposit. White says the rules governing low doc loans have also been tightened recently, increasing the amount of documentation required.
Low deposit loans
Low deposit loans allow aspiring homeowners to get a foot on the property ladder much sooner than they would have otherwise been able to. But they come at a cost.
Lenders require borrowers with a deposit that’s less than 20% of the property value to pay for lenders mortgage insurance, to protect the lender in the event that the borrower defaults on their loan. This is technically a one-off payment, though lenders will generally offer to finance LMI into your home loan, so that it’s added to your monthly mortgage repayments.
How it works is a friend or family member who owns a home takes on some of the risk of your loan by putting forward equity in their property as security. The bank lets you borrow and repay the money, and if you default on your loan, the lender will recover the debt from the equity your guarantor provided.
The guarantor can choose to offer as little or as much equity as they like. Often, borrowers use a guarantor just to avoid paying LMI. For this to work, a guarantor would need to offer enough equity for the combined value of the equity they put forward and the borrower’s deposit to exceed 20% of the property value.
Lines of credit loans
Line of credit loans essentially allow you to swap the equity you’ve built up in your home for cash. As they are a complete reversal of the usual home loan set-up – i.e. paying mortgage repayments in return for equity in your home – they are often referred to as reverse mortgages, and most are interest-only loans with no set date for the balance to be repaid by.
They’re useful for people who have built up equity in their home and need a temporary cash flow boost, as they offer fantastic accessibility and flexibility and present a cheaper form of credit than other loan types and credit cards.
However, home loans that offer the feature often have higher interest rates and administrative charges, so it’s important to sift through the fine print before signing up.
Full feature home loans
Flexibility is essential for some borrowers, and that’s exactly what these features offer you. As always, though, there’s a price to pay – generally in the form of higher interest rates and administrative charges. And so it’s important to weigh up the benefits of the added flexibility against these extra costs – and to seek advice from a licensed financial advisor if you’re unsure what’s best for you.
Offset account: This facility offsets your account balance against the balance of your home loan to reduce your monthly interest repayments. It can save you thousands of dollars and help you pay off a loan much sooner, but the numbers don’t always stack up.
Additional repayments: The less money you owe, the less interest you pay. And so taking out a loan that allows you to make additional repayments can help you pay off your loan much sooner.
Redraw facility: This feature allows borrowers to access any repayments they have made on their home loan that exceed the minimum required repayments. It’s helpful for freelancers or project-based workers with unstable incomes.
Home loan top ups: A home loan top up allows you to borrow more money against the equity you’ve accrued in your home. For example, let’s say you originally borrowed $640,000 to buy a $800,000 house, and that a few years later, you had paid off $100,000 and the value of your home had increased in that time to $900,000. Given a lender will generally only allow you to increase your home loan to 80% of the property value, you would likely be able to increase the value of your home loan from $540,000 to $720,000, giving you $180,000 to draw out in cash. Bear in mind, though, that increasing the size of your loan increases the size of your repayments.
Who can you ask for help?
As with most things in property, the key to choosing the right home loan is to base your decision on an honest appraisal of your current finances and future goals. But often that’s easier said than done.
If you’re struggling to determine which path is right for you, seek professional advice from a financial advisor, an accountant, or a mortgage broker.
Boasting strong connections with lenders, mortgage brokers are particularly well placed to find you a good deal, and should be able to help you with the paperwork, too.
Would you like to know more about loans and which might suit you? Send me a message HERE, and I can send through some information to assist you.
The above information has been sourced from Realestate.com.au. To read the full article CLICK HERE.
This information is of a general nature and does not constitute professional advice. You should always seek professional advice in relation to your particular circumstances.