Loan Types

When selecting a home loan, choosing the right one can be quite daunting. Here is a loans guide which provides a handy ‘pros and cons’ overview of each of the main loan types.

Fixed Rate Home Loans

With a fixed rate loan, you pay the same interest rate for a certain number of years (usually 1-5 years). Even if the Reserve Bank increases the official interest rate, your rate remains the same.

Pros

  • It’s low risk. Even if the Reserve Bank puts official rates up, your rate stays the same.
  • It’s predictable. You know exactly how much you’ll be spending on your mortgage, each month, so budgeting for other expenses is far easier

Cons

  • It doesn’t drop. If the Reserve Bank lowers official rates, your rate remains the same. So it’s possible you’ll end up paying more than you would on a variable rate.
  • Cancellation penalties. There are usually penalties for ending the loan before the fixed rate period ends.
  • It’s inflexible. You usually can’t use it as a redraw facility or make extra payments



Variable Rate Home Loans

With a variable rate loan, your interest rate goes up and down, based on the Reserve Bank’s official interest rate and your lender’s pricing.

Pros

  • It can drop. If the Reserve Bank lowers official rates, your rate will usually drop with it. So you may end up paying less, over time, than you expected.
  • You can make extra payments. Because the loan is flexible, you can make extra payments if you want, and pay your loan off sooner.
  • You may have access to a redraw facility. If you make extra payments, you can take the extra out at any time, so you always have a bit of a buffer.

Cons

  • Your repayments may go up. If the Reserve Bank puts official rates up, your rate and your repayments go up too.
  • It’s harder to budget. Because your repayments may vary each month, budgeting is a little more difficult.
  • Great rates = less flexibility. Some of the more basic variable interest rate loans have excellent rates, but offer less flexibility.



Split Home Loans

With a split rate loan, you get the best of both worlds. You can make part of your home loan fixed rate, and part variable rate, and you get to choose how much you want to allocate to each part.

Pros

  • It’s flexible. Because part of your loan is on a variable rate, you can make extra payments and use the variable portion as a redraw facility.
  • You can decide the split. Most lenders, these days, allow you to choose how much of your loan will be on a variable rate, and how much on a fixed rate.
  • It can drop… a bit. If the Reserve Bank lowers official rates, the repayments on the variable portion of your loan will drop too. Obviously the amount you save depends on what percentage of your loan is on a variable rate.
  • The fixed portion doesn’t go up. You’re effectively hedging your bets. Your repayments on the fixed portion remain steady, even if official rates go up.

Cons

  • There’s still a bit of risk. Because some of your loan is on a variable rate, if the Reserve Bank puts official rates up, your repayments for that portion of the loan go up too.
  • Double the fees. Because you have two loans (one fixed, one variable), you may pay fees on both.



Low Doc Home Loans

With a low doc home loan, you don’t need all the documentation usually required for proof of income.

Pros

  • Great if you’re self-employed. You can get a home loan if you’re self-employed, and your income varies from year to year, or you’ve only just gone into business.
  • Flexibility. You can get fixed rate, variable rate and line of credit low doc home loans.

Cons

  • Higher interest rate. Initially, the interest rate on a low doc home loan is generally higher than that of a standard variable or fixed rate home loan. After you’ve made your repayments on time for a few years, the interest rate is normally reduced.



Line of Credit Home Loans

With a line of credit home loan, you can access the equity in your home and use it for things like renovations, investments or other personal purchases. It’s a bit like having a credit card with a big limit, but your home acts as security for the loan.

Pros

  • You only pay interest on what you use. Although you have access to all the equity in your home, you only pay interest on the funds you draw down.
  • ATM/EFTPOS access. You can draw down money from your line of credit just as you would a normal savings account, using ATMs and EFTPOS machines.

Cons

  • You have to be disciplined. You need to make sure you pay off the principle as well as the interest, so that your loan reduces over time.



Construction Home Loans

A construction loan is an interest only loan on the value of your land, which increases in stages as your home gets built, then usually converts to principle and interest on completion.

Pros

  • Interest only while you build. For the duration of the construction period, you pay interest only on the loan with most lenders, making the repayments a bit cheaper for you.

Cons

  • You may have to pay rent or your current mortgage. If you don't have friends or family you can stay with while your new home is being built, you will have to factor in these costs.



Bridging Finance

With a home to home loan or bridging finance, you can buy or build a new home before selling your old one, without paying two mortgages at once. Instead, you use the equity in your existing home to finance your new one.

Pros

  • Buy or build before you sell. You can buy with confidence, even if you haven’t sold your current home.
  • No need to rent. You can stay in your existing home until your new home is ready to move into.
  • Rising market values. If the housing market improves during the months you’re holding onto your existing property, its value could go up substantially.
     

Cons

  • Falling market values. If the housing market declines during the few months while you’re holding onto your existing property, its value could go down somewhat.
  • Capitalised interest. The interest you would normally have to pay on the second property gets capitalised (added to the total sum of your loan), but you need to offset this against your moving and renting costs if building.



Guarantor Home Loans

Guarantor loans are a type of mortgage where an immediate family member will use the equity they have in their property as additional security or a safeguard against your loan. Guarantor loans are very popular with first home buyers who are struggling to save a deposit or unable to get a loan by themselves, but they certainly aren’t limited to this group.  If you’re looking to buy a property and have a friend or family member who is willing to go guarantor, there are a number of reasons why you should choose this type of loan.

Pros

  • No deposit required. If your guarantor has enough equity in their property, you won’t have to pay a deposit on your home. This means you can borrow 100% of the purchase price of your new home.
  • Pay no mortgage insurance. With another property put up as security, the lender considers your loan low risk, and therefore will not require you to have mortgage insurance. This will save you thousands of dollars if you don’t have a deposit.
  • You can remove the guarantee at a later date. Once you have enough equity in your home you can remove the guarantee, so your guarantor no longer has any responsibility for your property.

Cons

  • The person who goes guarantor is liable. You have to be doubly sure you won’t default on your loan, because if you do, the person who did you the favour of going guarantor will be liable for your debt.