Every loan these days seems to come with its share of bells and whistles – but which ones really make a difference? Here’s a simple guide to work out what’s what.
Principal and interest loan with a variable rate
This is the most common type of loan, in which the interest rate is partly set according to the Reserve Bank of Australia’s benchmark lending rate (also called the ‘cash rate’). As the cash rate moves up and down your lender may adjust your loan’s interest rate, but any change is at the lender’s discretion and can be bigger or smaller than the RBA’s move. Rate changes can also be made by lenders outside of the RBA’s move, known as out of cycle rate changes.
The advantage is that standard variable loans generally offer the lowest rates available, and many also offer a selection of the features listed below.
- When rates drop, payments drop.
- Generally variable rate loans offer more flexibility.
- When the cash rate rises, payments can rise.
- Your rate can be put up by lenders at any time.
Suits borrowers who want to take advantage of some of the lowest rates on offer.
Stay away if you think rates are likely to rise in the near term.
Along with a variable home loan, this feature lets you funnel extra money into your loan, to speed up the rate at which the principal loan is repaid. A loan that allows extra payments could be your ticket to a far earlier mortgage-free life.
- Reduce the interest payable over the life of the loan.
- Loan can be paid out sooner.
- If your loan is for an investment property, you can’t claim tax benefits off additional payments.
- Rate may be higher than for a basic loan.
Suits people who dislike debt.
Stay away if you’d like to access your extra funds and there is no redraw access.
Many loans that allow extra payments will also allow that capital to be redrawn. This means you can benefit from putting more money into your loan but still access the funds if you need them down the track. To avoid complications, your lender won’t let you take out any more than the extra you’ve put in.
- If you have a financial emergency, you can redraw your excess funds.
- The money in your redraw will reduce the interest charged by lowering your outstanding principal loan balance.
- Easy access to funds means you may not save as much as you’d like.
- Some home loan products charge for redraw, or have a limited number of permitted redraws, so look for a loan with free, unlimited redraw if you plan to use it frequently, such as the Aussie Select basic variable loan.
Suits borrowers who want to be covered for contingencies and unexpected expenses.
Stay away if you’ll be tempted to redraw too often.
In these accounts your current balance is “offset” daily against your home loan, so that regular large deposits, like your pay packet, reduce your level of debt. So long as the account is never overdrawn, interest will be charged on an amount lower than the principal remaining so you pay less interest.
• Interest is calculated on reduced principal amount if transaction account is in credit.
• Additional funds paid into the offset account are generally easily accessible, like a normal savings account.
• Requires disciplined budgeting as penalties can apply if you overdraw.
• Rate may be higher than for a basic no-frills loan.
Suits borrowers who can stick to a budget.
Stay away if you can’t resist the temptation to spend.
Principal and interest loan with a fixed rate
Fixed rate loans allow certainty of payments for a defined period, usually up to five years although they can be extended. This option may be applied to an existing variable-rate loan if you’re willing to accept what is often a higher interest rate. This strategy may appeal if you’re confident that rates will rise higher than the negotiated rate within the loan’s term, or if you want certainty of what your repayments will be for budgeting reasons.
• If rates go up, payments won’t change.
• If rates go down, payments won’t change.
• Limits may apply to making additional payments.
• Substantial costs can apply if you want to break the fixed period.
Suits borrowers who don’t like uncertainty.
Stay away if you want to pay off your loan faster.
What home loan features do you favour? How have they helped you achieve your financial goals? Tell us in the comments below.