What type of home loan is right for you?

Finding your home is time consuming, stressful and overwhelming at times, and you want to get it right. So that means spending lots of time on weekends inspecting properties, negotiating with agents, making multiple offers and potentially bidding at multiple auctions.

What doesn’t need to be stressful and overwhelming is finding the right loan.  70% of Australians utilise the services of a mortgage broker to do the leg work and minimise the stress at no cost to themselves. 

The more you understand about the types of loans and features available, the less stressful the decision making becomes.  To help you arm yourself with knowledge, I’ve outlined the different types of home loans available.

Understanding the types of home loans available

Almost all home loans work on a ‘principal plus interest’ basis. That means, over the term of the loan, you repay the principal (the amount of money you borrow) as well as interest (the price you pay to borrow the money) charged on the outstanding balance. But there are a lot of other options to consider when deciding which loan is right for you.

Fixed rate loans

Fixed rates are locked in for an amount of time that is prearranged between you and your lender, with the most popular fixed rate terms being 2 or 3 years. Your repayments will remain the same, irrespective of how market rates move during the fixed term, which can make it easier to budget for your loan repayments.

You can apply for a fixed-rate loan before you find the property you want to buy. You can also opt-in for a ‘rate lock’ which locks in the fixed rate for the time of the pre-approval for between 60 and 90 days, while you search for your new home. There is normally a fee associated with locking in your rate, however even if rates do go up between when you have a loan pre-approved, then settling the loan and moving in, you have guaranteed the fixed rate.

Note that with fixed rate loans, should you decide to break the loan, either by refinancing or selling your house, you will be up for significant break costs.

Variable rate loans

Unlike a fixed rate loan, the interest rate on a variable loan will move up and down in line with market interest rates. As a result, your loan repayments can vary widely during the term of your loan, and it’s worth allowing for the possibility of future rate rises before committing to a variable rate loan. Variable rate loans generally have no break costs if you decide to refinance or sell beyond the legal costs involved when selling up and se􀇠ling a loan.

Split loans

A split loan divides your loan into fixed and variable rate portions. This gives you certainty of repayments on the fixed rate part of the loan while still being able to enjoy the savings of possible future rate falls on the variable part of your loan.

Interest only

These are a type of loan that allows you to only pay the interest each month and not any principal. As a result, the monthly repayments are less than a principal and interest loan. However, you will never pay the principal down for the term of the interest only period and you will build no equity in the property beyond any capital growth that may have occurred. Lenders will only do set periods of interest only, usually up to 10 years as they will eventually want the principal to be repaid.

Interest only loans may be useful for short periods of time, you might switch to one income when you start a family, or making renovations and you need to rent elsewhere. When you apply for interest only loans the lender will take into account the reduced time you will be repaying the principal, which, given it is a shorter period of time, means your monthly repayments will be higher when you switch back and may affect your borrowing capacity.

Interest only loans are often used by investors to maximise their tax benefits or to reduce their repayments on their investment property and pay more o􀇛 their primary residence.

Line of Credit

A line of credit loan combines the home loan with an everyday transaction account from which you can draw cash up to a pre-approved limit. A line of credit loan requires an interest only repayment as a minimum, each month, if the credit limit has been reached. The reduction of the loan balance is entirely up to you as there are generally no set repayments. Each month, the loan balance is reduced by the amount of cash coming in and increased by the amount paid for drawings, direct debits or cash withdrawals.

Low-doc/Alt-doc loans

Low-doc loans are useful if you are unable to provide conventional income documentation or for people who may have complicated financial structures (e.g. self-employed). They allow you to minimise the time and effort of collating tax records, bank statements and other documents in order to obtain finance. Low-doc loans may attract a higher interest rate

Bridging loan

While this is not a type of loan you will use to purchase your first home, you may use it when you purchase your next one. A bridging loan works as a short-term loan that finances the purchase of a new property while you are selling your existing property. Bridging loan can also provide finance to build a new home while you live in your current home. You will normally have 6 months to sell the existing property; or 12 months if a new property is being constructed.

When you take out a bridging loan, the lender usually takes over the mortgage on your existing property as well as financing the purchase of the new property. The total amount borrowed is called the Peak Debt, and includes the balance of the loan on your existing home, the contract purchase price of the new home and any purchase costs such as stamp duty, legal fees and lenders fees.

The minimum repayments on a bridging loan will generally be calculated on an interest-only basis, and in many cases this interest may be capitalised until the existing home is sold – that is, accrued and added to the Peak Debt.

Once you sell your first property, the net proceeds of the sale (sale price minus any sale costs such as selling agent's fees) are used to reduce the Peak Debt. The remaining debt then becomes the End Debt, which is repaid as a standard mortgage product from this point onward.

That was a brief overview of the different types of loans available.  As to which one is right for you, well, that depends on your goals and your individual circumstances.

If you want to find out which loan is right for you, complete our 5 minute form here: https://bit.ly/43VqyrH
Call on: 0418 552 938
Email at: peter.jefferson@mortgagechoice.com.au, or
Book a time to chat: https://bit.ly/43WsXma

If you’re a first home buyer, I’ve also created a useful guide to help you understand other key aspects of buying your first home.