Types of home loans
With thousands of different home loans on offer you’d be forgiven for thinking that it’s all too complicated to decipher. But fear not! Loans are fundamentally all based on two key things:
- Principal – the amount of money you borrow; and
- Interest – how much you pay to borrow the money, which is calculated on the outstanding principal.
When choosing a home loan you have a choice between Principal and Interest (P&I) or Interest Only (IO) repayments. P&I loans mean when repaying your loan you are making repayments on both the interest and the principal loan amount. These types of loans generally have a lower interest rate than IO loans. IO loans mean you are only making repayments on the interest portion, and not paying back any of the principal amount borrowed. You can generally only have an IO loan with the same lender for a period of up to five years, and the interest rate is typically higher than a P&I loan. Once the IO period ends, your repayments will likely jump higher as there is now less time remaining on your loan term to repay the principal portion of your home loan.
From here, there is a wide variety of home loan features and structures to choose from, and it’s worth knowing what’s involved to make an informed decision. We break down what they are and what they mean so you can decide which one is right for you.
Variable rate loans
This is a popular type of home loan in Australia. The interest rate you pay may vary in line with movements in market interest rates, so you can expect the repayments to vary (up and down) over the life of your home loan.
With this type of home loan the rate you pay – and the home loan repayments, are fixed for a set period, usually between one and five years. This makes it easier to budget for repayments and you are protected from increases in market interest rates. The downside is that if rates fall, you could end up paying more than necessary.
Many lenders will let you fix one part of your home loan, while the remaining portion has a variable rate. This can give you the best of both worlds – some protection from rising rates though still with the ability to benefit from any rate cuts.
Now, within the categories of variable, fixed and split home loans, there are other types of home loans to choose from. They are:
Basic versus standard
‘Basic’ home loans are variable rate, no-frills home loans that often come with a cheaper interest rate though less features than a ‘standard’ home loan. The definition of ‘basic’ varies widely between lenders so it’s worth checking carefully which features are available with any home loan.
The important thing is to choose a home loan that only has features you are likely to use now or in the near future, so you don’t pay a higher interest rate than necessary.
An offset home loan involves a savings or transaction account that is linked to your home loan. Instead of being paid interest on the linked account like you would in a savings account or term deposit, the balance of the offset is deducted from your home loan when monthly interest is calculated. For instance if you have $20,000 in the offset account and the value of the home loan is $350,000, you will only pay interest on a home loan value of $330,000 while the money sits in your offset account. In essence, the higher the balance of the offset account, the bigger the savings on home loan interest.
A package home loan, sometimes called an ‘ongoing discount’ home loan, combines a home loan with other financial products – usually a transaction account and/or credit card.
You can generally expect fee waivers on some or all of the bundled products plus a discount on the home loan interest rate that usually lasts for the life of the home loan. On the downside, you may be asked to pay an annual package fee. This makes it important to weigh up whether the fee savings and rate discount are worth more than the annual package fee.
Line of credit
This type of home loan allows you to draw from a fixed amount at any time, to pay for whatever you want – which could be shares, renovations, or even a holiday.
It’s like having a credit card with a big limit, but your home still acts as security for the home loan. You only pay interest on the funds you use, but you need strong financial discipline to ensure you pay off the principal as well as the interest.
These are home loans designed for self-employed people who don’t have all the financial documents providing proof of income normally required to secure a home loan. A low-doc loan can be either fixed or variable though the interest rate is generally higher than for a normal variable or fixed home loan. The rate may be reduced after a few years with a good repayment history.
Navigating a path through the mortgage maze can seem confusing – especially with so much choice available. But, you won’t get lost with your Aussie Broker by your side.We will help you understand all the home loan jargon and find the loan that’s right for you.
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- Chapter One : Getting started
- Chapter Two : Your Dream Home
- Chapter Three : Money Matters
- Chapter Four : Ways to Purchase
- Chapter Five : Understanding Interest Rates
- Chapter Six : Understanding Home Loans
- Chapter Seven : Lending Sources
- Chapter Eight : Getting Your loan
- Chapter Nine : Choosing a Home
- Chapter Ten : Steps to Settlement