Choosing the right type of loan

There are hundreds of different loans out there in the mortgage marketplace but fundamentally they are all based on two things:

1. Principal—the amount of money you borrow.
2. Interest—the amount you pay to borrow the money. It’s calculated on the outstanding principal.

The differences you’ll come across are the type of loan and the type of features that come with the loan. Here’s some of the most common types of loans you’ll find, and their pros and cons.

Fixed loans

Interest rates and repayments are fixed for a set period usually between 3 to 5 years.

The good features of fixed home loans:

• Repayments won’t change for a fixed period, no matter what the Reserve Bank does.
• You can budget with some certainty.

The bad features of fixed home loans:

• The rate is usually a little higher than a variable loan.
• Your interest rate won’t drop even if the official rates do.
• There are usually penalties for ending the loan before the term ends.
• Redraws and extra payments are restricted or not available.

Variable loans

This is the most popular type of loan in Australia. Like the name says, the interest rate will vary —depending on the Reserve Bank and lender pricing — throughout the term of the loan.

The good features of variable home loans:

• If official interest rates drop, so can your repayments.
• Rates are usually lower than fixed rates.
• You can pay off the loan faster if you choose to make extra repayments.
• You can redraw extra repayments if you need to.

The bad features of variable home loans:

• The interest rate and your repayments might go up.
• Some basic variable loans may have better rates but less flexibility.

Split loans

This loan can give you the best of both worlds. It blends repayment flexibility with some interest rate security. When you split a loan you fix one part and let the other part range with market fluctuations.

The good features of split loans:

• You can access variable loan features like redraws and extra payments but have a little bit more certainty around your long-term budget.
• Most lenders will let you set the portions to how it suits you.

The bad features of split loans:

• Interest rates and repayments can still go up.

Low-doc loans

This one is mostly for self-employed home-buyers that don’t have all the financial documents normally required to get a loan. A low-doc loan can be either fixed or variable.

The good features of low-doc loans:

• It allows eligible home-buyers without all the documents to access finance.

The bad features of low-doc loans:

• The rate is generally higher than a standard variable or fixed loan, but this is usually reduced after a few years if repayments are on time.

Line of credit

With a line of credit loan you can draw from a fixed amount at any time to pay for whatever you want: your home, shares, renovations, even a holiday. It’s kind of like a credit card with a big limit but your home still acts as security for the loan.

The good features of line of credit loans:

• You only pay interest on the funds you use.
• You can access the funds like you would a normal savings account or credit card via ATMs and EFTPOS machines.

The bad features of line of credit loans:

• You need to have some discipline to ensure you pay off the principal as well as the interest.

Equity release

This type of loan is also known as a reverse mortgage. It’s generally available to people over 60 who want to access the equity that’s built up in their property.

The good features of equity release loans:

• You don’t have to make any repayments as the interest charges and fees that accrue each month only need to be paid when the property is sold or the title is transferred.

Continue to information to help you understand loan features.