Don’t let names of mortgage products confuse you. By knowing the main types of loans, you can narrow your search and avoid the pitfalls.
Low interest rates support and energise the housing market more than any other factor. In May, the Reserve Bank cut the official cash rate to 2.75 per cent, the lowest level in more than 50 years, so it’s little wonder that more investors and home buyers are signing up for cheap finance.
But it’s important to work out what kind of loan suits your needs and to then compare various lenders’ deals for that loan product. It can seem as if there’s a confusing smorgasbord of emotively named mortgages out there (think: ”Breakfree” and ”Rocket Repay”), but there are essentially six types of home loans to choose from.
In today’s low-interest-rate environment, fixed-rate loans are priced well below variable-rate loans. With a fixed product, the interest rate is fixed for a length of time that you specify, usually for one year to five years. Three-year terms are the most popular. Tread carefully, though. Most fixed loans limit the amount of extra repayments you can make, and you’ll pay ”break” fees to exit a loan early. Still, fixing part or all of your borrowings can make sense, particularly when fixed interest rates fall below 5 per cent as they have in recent months.
The interest rate for basic variable loans is typically 0.5 per cent below the standard variable rate. The no-frills basic loan also often provides a redraw facility, but you need to fully understand the borrowing conditions. The catch-22 of basic variable loans is that many do not permit interest-only repayments. You have to make principal and interest repayments, which reduces flexibility and does not suit the repayment and planning needs of many investors.
This is a bargain-basement product designed to rope you in. You get a discounted interest rate for the first 12 months, after which you pay the standard variable rate. Honeymoon loans work well for many home buyers, but they can create difficulties for investors. You rarely achieve low continuing costs, but merely tap into cheaper finance for one year. Although lenders have been banned by the federal government from charging mortgage exit fees, you may still have to pay a break fee to get out of a discount loan.
Because the interest rate on a standard variable product tends to be higher than the rate on a basic variable loan, you need to carefully evaluate what additional discounts are being offered. Lenders wheel and deal. High-income earners who qualify for a professional package loan can expect to be offered a continuing discount of 0.7 per cent to 1 per cent off the going standard variable rate.
With an offset transaction account, you deposit your income into the account and the daily balance is offset against the amount owing on your home loan. If you have a loan of $600,000 and a balance of $30,000 in an offset account, you’ll pay interest on $570,000. It’s a smart way to reduce taxable income, pay down loans and still have access to your funds. Offset accounts arguably work best for owner-occupiers. Using an offset will reduce the amount of tax-deductible debt on an investment loan.
Line of credit
A line of credit (LOC) can be more expensive than other loans, but they are highly flexible products. There is no pre-set loan term and the minimum repayment is for the interest only. You can withdraw funds from an LOC transaction account by using a credit card or BPAY, so it can be a fantastic tool for investors who are renovating and making frequent transactions. Compare lenders’ products to get the best deal.