Searching for the right home loan
There are a bewildering variety of home loans available, and it can be confusing to figure out which type of home loan is the best for your circumstances. However, when you know the pros and cons of each type of loan, you can make a decision that will fit best with your financial situation.
Fixed rate home loan
A fixed home loan offers an interest rate that is fixed for a set period of time – usually 1, 3 or 5 or 10 years. The key benefit is the ability to budget, knowing exactly how much your repayments will cost each time.
However, a fixed loan doesn’t have the same flexibility as other loans – you will encounter restrictions if you want to make additional repayments, such as fees or capping to a low amount. You might also be disappointed if interest rates drop dramatically and you are still paying the same fixed rate.
This is a good option if you want to make steady regular payments and you intend to stay in your current home throughout the term of the loan. It is not such a good option for someone who wants to move to another property in the foreseeable future, or who wants to cut down on the term of their loan.
Variable rate home loan
The graph above shows the Historical F05 Indicator Lending Rates for home loans, which appear to me to be about 1.8 to 2.5% higher than the Reserve Bank of Australia’s official cash interest rate. However, recently the banks and other lenders have increased their rates independently of the official cash rate. Data source: http://www.loansense.com.au/historical-rates.html
A variable home loan is far more versatile, with the option of making extra payments at no extra cost, enabling you to pay the loan off sooner. Your loan might also offer unlimited redraws, so you can access money in an emergency. Another positive feature is the offset account, a transaction account linked to your mortgage account which reduces your interest payable.
This is a good option if you want to invest the maximum into your mortgage, with the freedom to redraw in an emergency. However, as the interest rates will vary from payment to payment, it is not such a good option if you struggle to budget for unpredictable changes in the loan repayments.
Split loan
The split loan offers the advantages of both fixed and variable loans. You can split your loan into any proportion you wish – 50/50 or 80/20. One of the benefits of the split loan is that payments will gradually decrease, as the steady fixed rate payments lower the amount of the loan so that the variable payment is proportionally lower at times when interest rates rise.
Interest only loan
With an interest only loan, you pay only the interest on the loan for the initial term, usually from one to five years. Your monthly repayments are considerably lower, although this is because you are not reducing the principal of the loan. At the end of the interest only term, your repayments will rise as you must start paying both interest and principal.
This can end up being an extremely expensive option if you are not sure what you are doing. However, investors tend to choose interest only loans, as they can take advantage of low repayments over a set period before they resell the investment property.
Low Doc Loan
The low doc loan has lower requirements for proof of income and credit rating, yet they also require a higher deposit and charge higher interest rates. For someone with an unstable credit history or employment background, the low doc loan will be difficult to pay off. While this option can be popular with self-employed people, who don’t have the same level of documentation to prove their income, the excessively high-interest rate generally makes it a bad long term choice. If this is your only option for a loan, your best alternative might be to wait until you can be approved for a different type of loan.
If you need help figuring out the best home loan option for your circumstances, contact us today.
Richard Khuong
Director, Simple Easy Finance Pty Ltd
Property & Finance Strategist
E: [email protected]
