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:
- Principal — the amount of money you borrow.
- 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 are some of the most common types of loans you’ll find, and their pros and cons.
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 how market interest rates move.
- You can budget with some certainty.
The drawbacks of fixed home loans:
- The rate is usually a little higher than for a variable loan.
- Your interest rate won’t drop even if market rates do.
- There can be penalties (known as 'break costs') for ending the loan before the fixed term ends.
- Redraws and extra payments are restricted or not available.
This is currently the most popular type of loan in Australia. As the name suggests, the interest rate will vary —depending on lender pricing — throughout the term of the loan.
The good features of variable home loans:
- If lender 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 use redraw to access extra repayments if you need to.
The drawbacks of variable home loans:
- The interest rate and your repayments might go up.
- Some basic variable loans may have better rates but less flexibility.
This loan can give you the best of both worlds. It blends repayment flexibility with some interest rate security by combining fixed and variable rate portions in one loan.
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 drawbacks of split loans:
- Interest rates and repayments can still go up and affect the variable rate portion of the loan.
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 usual documents available to access finance.
The drawbacks 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 the repayments are made on time.
Line of credit loans
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 drawbacks of line of credit loans:
- You need to have some discipline to ensure you pay off the principal as well as the interest.
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.