What Interest Rate is Best for You?
- Your loan decision should be based on a loan product suited to your individual needs not on the interest rate.
- Ensure that an increase in interest rates is factored into your loan and repayments so you are not left short.
It’s not all about the rate. A discounted interest rate can sometimes prove to be more costly than a loan facility with a slightly higher rate that is better suited to you and your needs.
Interest Rates on Home Loans
There are two types of interest rates that apply to home loans – variable and fixed. You can choose whether you’d like a variable or fixed interest rate, or a combination of both, depending on the type of loan product you decide on.
Variable Interest Rates
As the name implies, variable loan rates will fluctuate as the market and the official cash rate does. Therefore if the official cash rate rises, your loan interest rate rises and so does your repayments on the loan, and vice versa. Loans with variable interest rates tend to offer more flexibility in payment options.
Fixed Interest Rates
This type of interest rate allows you to fix the interest rate you borrow at for a certain period of time within the overall loan term. Fixed terms tend to be from one to three years however some lenders may offer 10-15 year terms. With a fixed interest rate you have the certainty of a set monthly repayment as you are not affected by changes in the official cash rate. This is positive when the official cash rate rises as your repayments would not increase, however you cannot reap the benefits of a reduced repayment if the official cash rate falls. With a fixed interest rate your loan provider is taking the risk on the market, which is based on their assumptions about future interest rate movements.
Typically suits someone who is working to a tight budget, is sensitive to interest rate movements and is not planning on making large lump sum repayments
Guide to the Types of Home Loans
Mortgage managers, banks, credit unions, brokers, insurance groups all offer a seemingly endless choice of loan options – introductory rates, standard variable rates, fixed rates, redraw facilities, lines of credit loans and interest only loans, the list goes on. But with choice comes confusion.
How do you determine whether a home loan is suitable for you?
- Set your financial goals, determine your budget and work out the term of the loan (i.e. how long you will be paying it off). You may do this yourself or with your financial advisor or accountant.
- Ensure the organisation or person you choose to obtain your loan from is a member of the Mortgage and Finance Association of Australia (MFAA). The MFAA Member logo means you are working with a professional who is bound by and subject to a strict industry code of practice.
- Research the types of loans available so you can explore all options available to you with your mortgage provider.
Basic Home Loan
This loan is considered a no-frills loan and often offers a very low variable interest rate with little or no regular fees. Be aware they usually don’t offer additional extras or flexibility in paying off extra on the loan or varying your repayments.
These loans are directed towards people who don’t foresee a dramatic change in personal circumstances and who may not need to adapt the loan in accordance with any lifestyle changes, or people who are happy to pay a set amount each month for the duration of the loan.
Typically suits someone making minimum repayments with a low bank account balance month to month.
Introductory Rate or ‘Honeymoon’ Loan
This loan is attractive as it offers lower interest rates than the standard fixed or variable rates for the initial (honeymoon) period of the loan (i.e. six to 12 months) before rolling over to the standard rates. The length of the honeymoon depends on the lender, as too does the rate you pay once the honeymoon is over. This loan usually allows flexibility by allowing you to pay extra off the loan. Be aware of any caps on additional repayments in the initial period, of any exit fees at any time of the loan (usually high if you change immediately after the honeymoon), and what your repayments will be after the loan rolls over to the standard interest rate.
These loans may be appropriate for people who want to minimise their initial repayments (whilst perhaps doing renovations) or to those who wish to make a large dent in their loan through extra repayments while benefiting from the lower rate of interest.
Redraw Facility
This allows you to put additional funds into the loan in order to bring down the principal amount and reduce interest charges, plus it provides the option to redraw the additional funds you put in at any time. Simply put, rather than earning (taxable) interest from your savings, putting your savings into the loan saves you money on your interest charges and helps you pay off your loan faster. Meanwhile, you are still saving for the future. The benefit of this type of loan is the interest charged is normally cheaper than the standard variable rate and it doesn’t incur regular fees. Be aware there may be an activation fee to obtain a redraw facility, there may be a fee for each time you redraw, and it may have a minimum redraw amount.
These loans are suited to low to medium income earners who can put away that little extra each month.
Line of Credit/Equity Line
This is a pre-approved limit of money you can borrow either in its entirety or in bits at a time. The popularity of these loans is due to its flexibility and ability to reduce mortgages quickly. However, they usually require the borrower to offer their house as security for the loan. A line of credit can be set to a negotiated time (normally 1-5 years) or be classed as revolving (longer terms) and you only have to pay interest on the money you use (or ‘draw down’). Interest rates are variable and due to the level of flexibility are often higher than the standard variable rate. Some lines of credit will allow you to capitalise the interest until you reach your credit limit i.e. use your line of credit to pay off the interest on your line of credit. Most of these loans have a monthly, half yearly or annual fee attached.
These loans are suited to people who are financially responsible and already have property and wish to use their property or equity in their property for renovations, investments or personal use.
100% Offset Account
Money is paid into an account which is linked to the loan – this account is called an Offset Account. Income is deposited into the Offset Account and you use the Offset Account for all your EFTPOS, cheque, internet banking, credit transactions. Whatever is in the Offset Account then comes directly off the loan, or ‘offsets’ the loan amount for interest. Effectively you are not earning interest on your savings, but are benefiting as what would be interest on savings is calculated on a reduction on your loan. These loans are directed at medium to high income earners, and to disciplined spenders as the more money kept in the offset account the faster you pay-off your loan.
Partial offset account and an interest offset account are also available.
Typically suits someone who has a high bank account balance month to month, is saving for other purposes, and considering future tax consequences.
Split Loans
This is a loan where the overall money borrowed is split into different segments where each segment has a different loan structure i.e. part fixed, part varied. These loans are directed at people who seek to minimize risk and hedge their bets against interest rate changes while maintaining a good degree of flexibility however subject to the proposed structure of the split loans taxation issues may arise in some circumstances.
Interest Only Loan
This loan allows you to structure your payments where you are only paying off the interest accrued on the amount borrowed – the repayments are a lot less than those for a principal and interest loan. They are usually taken over a normal term (i.e. 30 years) with the interest only option being 1-5 years, and renegotiated after 1-5 years.
Tip: These loans are suitable if the investor is relying on a capital gain in the short-medium term.
Construction Loans
These loans are tailored to building a home when you don’t need the entire amount from the start – you only pay interest on what you’ve spent over the stages of construction.
Bridging Loans
These loans are for when the sale of an existing property takes place after the settlement of a new property – when you want to buy a new investment property before selling the old one, where the funds from selling the existing investment are paid straight into the loan for the new investment property.
