First home buyers have a wide range of choices to make when choosing your loan. One of the choices relates to what time your loan will be repaid. This is influenced by a loan being Principal and Interest or Interest Only. Another choice will be with respect to the loan type being, fixed, variable or a combination of both.
Different Types Of Loans
Principal And Interest Loans
Principal and Interest loans are the most common type of loan used by First Home Buyers. As the name suggests Principal and Interest loans mean that your regular repayments to the bank include a repayment for the principal amount borrowed and a component for the interest charged by the lender.
Repaying a component of the borrowed amount each time you make a repayment, results in the full amount of your loan being paid out within a set number of years.
Interest Only Loans
Interest Only Loans have lower repayments as your loan repayments only include the amount of interest that the bank has charged you for that period. This means that the principal amount you borrowed with the lender always remains the same. This type of loan is more commonly associated with an investment property where an investor prefers to keep the loan repayments as low as possible and use the cash flow to purchase other investments.
Fixed Versus Variable Loans
Choosing between a fixed or a variable loan is a personal choice that considers a number of factors that are specific to you as a lender. Whilst there is no set answer to this question, a good Mortgage Broker can guide you through how fixed or variable loans can affect you specifically.
Fixed Loans
This type of loan has an interest rate, which the lender will fix for an agreed period. Irrespective of any change in the lending rates in the general market, once you fix a rate, it will remain fixed until the term finishes. For example, a fixed rate of 3.99% fixed for 3 years means that even if the bank rate goes up to 8%, you will still pay 3.99% for the full 3 years. Once a fixed-term rate expires, then you will be charged the market variable rate by the bank.
Both parties are locked into this arrangement, another words if the variable rate in the market goes down to 2.99% during the 3-year fixed term, you will continue to be charged 3.99% by your lender. A fixed interest rate agreement can be broken; however the lender will charge a reasonable fee to allow this.
Pros
- Good option for those looking for consistency with payments.
- Can live to a household budget as loan repayments will be the same.
- Protects you from rises in interest rates.
Cons
- If interest rates decrease, you will be tied to the higher rate that you signed up for.
- Generally, you can only make a small number of additional repayments to your loan.
- Some of the loan features can be quite limited.
Variable Loan
Variable Loans are tied to a floating interest rate, which means the amount you pay each month can change. Every first Tuesday of the month the Reserve Bank of Australia Board meets and makes decision about the cash rate. The cash rate effects the variable rate offered by lenders.
Variable rates are popular with borrowers, particularly when rates are low and stagnant, as they provide flexibility and an offset account facility that help reduce the debt. Variable loans can also be switched to another lender with little cost, compared to fixed loans, allowing you the flexibility to take advantage of a better rate in the market. In rising interest rate markets, Variable loans will reflect the ongoing changes set by the Reserve Bank of Australia. In choosing a variable rate, you should estimate your repayment cost, based on potential rate increases to ensure that your loan is affordable in the advent of several rate increases.
Pros
- Interest rates can fluctuate to a low level, leaving you to pay less than you would on a fixed rate.
- Higher degree of flexibility and features, such as additional repayments and redraw facilities.
- Allows you to pay off your loan faster with additional repayments.
Cons
- Your repayments can increase if interest rates rise.
- Less certainty and control over your finances, as repayments can change
- General variable interest rates can be higher than fixed ones.
Split Loan
A Split Loan offers you the best of both worlds. You can choose to have a component of your loan on a fixed rate and a component of your loan on a variable rate. This type of approach is generally used by individuals to manage risk. A good mortgage broker can explain the benefit of this type of loan structure based on your specific circumstances.
Pros
- Get the best of both worlds – features from both variable and fixed rate loans.
- Can fall back on a fixed interest rate if your variable rate rises.
- You can pay off the variable rate fast through additional repayments.
Cons
- The number of additional repayments can be limited.
- You need to get the split ratio correct so that you fully benefit from having both types of interest rates.
- Your repayments can still increase slightly if variable rates rise.
Low Doc Loan
Low Document Loans are best suited for individuals that are self-employed, work on a casual or contract basis, or do not have the necessary financial documentation to complement their home loan application. Low Doc Loans suits people who have an income and assets, however, are unable to provide the financial statements, or current tax returns required for typical loans.
Applying for a Low Doc Loan is different as the borrower will lack the normal documents needed. As part of your application, you will be asked to provide either a letter from your accountant, a bank statement showing your business income, or copies of your BAS (business activity Statement), as evidence of reliable income.
Low doc loans are generally tied with a higher interest rate than other types of loans and require some collaboration between your accountant and the lender.
Honeymoon Loans
Honeymoon Loans are usually associated with a special offer or introductory rate which is generally tied to a very low interest rate for a fixed period (about 12 months) to help first home buyers get their footing.
Honeymoon loans revert to a higher rate once the ‘honeymoon period’ is over.
