Winning the lotto or inheriting a fortune aside, most of us will need to borrow money to make homeownership a reality.
There are hundreds of different loans available from hundreds of lenders but they are all based on two things:
1. Principal – the amount of money you borrow
2. Interest – how much you pay to borrow the money (calculated on the outstanding principal)
With these fundamentals in mind there are only three main types of home loan.
Types of home loans
1. Variable rate loans
You pay a different or ‘variable’ interest rate every month, which is set based on movements in the official cash rate (determined by the Reserve Bank of Australia) and other market conditions. Your starting rate is generally lower than in other (fixed) loans as your repayments can move up and down as interest rates vary. One possible advantage of these loans is being able to pay off your loan sooner by making extra payments (typically there is no extra charge for this). But you also need to make sure your finances can cope with higher rates if they go up quickly.
2. Fixed loans
You agree a set interest rate for a set period, usually between one and five years, so you know how much you will need to repay from month to month and you’re protected from increases in market interest rates. On the flipside, you don’t benefit from any reductions in interest rates. Some fixed rate loans allow extra payments up to a set amount and some also offer redraw so you can withdraw money already repaid on the loan up to a specified amount.
3. Split loans
This is where you fix one part of your home loan, while the rest is subject to the variable rate. This can allow you to have interest rate security with repayment flexibility. Most lenders will let you set the fixed/variable portions in the way that suits you.
Once you choose the type of loan that suits your circumstances, you can examine the loan categories in more detail. This is where your choices expand!
Off home loan or 100% offset account
This loan links your savings or transaction to your home loan. The money in your savings or transaction account is deducted from (or offset against) the value of the home loan for the when interest is calculated, saving you partial interest charges. For example if you have $50,000 in the offset account and your loan is $600,000, then you only pay interest on $550,000.
Basic or 'no frills' home loans
These variable rate loans usually come with a lower interest rate but have fewer features than a standard variable home loan, such as no credit card or redraw facility. Conditions can also be restrictive, for example, limiting your ability to make additional payments or imposing penalties for repaying early.
These loans are generally short-term and designed for those selling their home and buying another. If there is a mortgage on either property, the loan will cover the ‘gap’ between the mortgage on the new property and the proceeds from the sale of the existing property.
Construction home loan
Specifically for borrowers building a new home, who are able to pay the builder in stages, this loan requires you to make repayments on the portion of the loan you have used. Once construction is complete, the loan reverts to the standard variable type of loan you have chosen.
Introductory or honeymoon rate
Usually one year in length only, these loans offer a low rate (fixed, variable or capped), which generally reverts to the lender’s standard variable rate after that time.
You repay only the interest on the principal during the term of the loan, so your loan amount remains the same. At the end of the interest-only period (usually one to five years), you must start making principal and interest payments.
Line of credit or equity line of credit
This allows you to redraw repayments made on the fixed amount loan at any time, so you can use the equity in your home to finance other things such as renovations or investments in shares or funds. You generally need to have a substantial deposit or good equity in your home to secure the loan. There are no set repayments or set loan term.
Low-doc or no-doc loans
Designed for investors or self-employed people who don’t have the financial documentation providing proof of income, normally required to secure a loan. They can be fixed or variable loans and the interest rate is usually higher than other loan types.
No deposit loans
This allows you to borrow 100% of the home purchase price and sometimes more (107% to pay for extras such as stamp duty). The loan has stricter lending criteria than other loan types and is only available on certain types of properties. You'll also have to pay mortgage insurance.
Non-conforming loans are available to people who don't meet a bank's strict lending criteria including self-employed people who are unable to verify their income; over 55s who may not be eligible for a long-term loan; those wanting to borrow more than 90% of the property's value; people with a bad credit history; seasonal or casual workers and/or new migrants with no borrowing record. These loans usually carry higher interest rates and charges.
Designed for retirees, this loan allows older people to use the equity in their home to fund other activities or investments. The loan is repaid when the borrower sells the property, moves out or passes away.
Package or all-in-one loan
Usually offered to certain professionals or to those with good relationships with financial institutions, such as doctors, these loans combine a home loan with other financial products like a credit card or insurances. You may be asked to pay an annual package fee but receive a fee waiver on some or all bundled products (including insurances), plus higher interest rates on term deposits and a discounted home loan interest rate.
The above is general information only. Please seek professional financial advice to assist with your personal circumstances.