First home buyers have a wide range of choices to make when choosing your loan. One of the choices relates to over 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.
Principal and Interest Loans
Principal and interest loans is the most common type of loan that First Home Buyers will usually take out. As the name suggests, a principal and interest facility means that your regular monthly/fortnightly/weekly repayments to the bank include a repayment for the principal component, representing a portion of the initial amount you borrowed, and a component for the interest being 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 will generally have lower monthly/fortnightly/weekly 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 does not reduce with each repayment you make whilst under an interest only facility. This type of loan structure is more suited to investors looking to purchase an investment property in order to keep the repayments low to maximise the cash flow from the investment property.
Fixed Versus Variable Loans
Choosing between a fixed or a variable loan is a personal choice which considers a number of factors which are specific to you. 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.
A fixed rate loan refers to a facility where the interest rate will remain the same during a period of time (i.e., 1 year, 2 years, 3 years, etc.). A fixed rate will mean that, despite what happens with interest rates in the general market, your interest rate does not move with the market and will remain the same during the fixed period. 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 your loan will revert back to a variable rate loan, where this will then move with the market depending on what the interest rates are doing at the time.
Following on from the above example, if on the other hand rates were to drop to 2.99% in the market during your fixed rate, then you will continue to be locked in at the 3.99%. Lenders do allow the ability to break a fixed rate, however this may come at a cost and is something that should be factored in when considering to break a fixed rate.
We have provided a few pros and cons to a fixed rate below:
Both parties are locked into this arrangement, in other 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.
- As rates are fixed, your repayments will not change. Therefore, this is a good option for those looking for consistency with their repayments and are looking to create a household budget.
- A good option to secure competitive interest rates for a certain period of time
- Protects you from rises in interest rates.
- If interest rates in the market decrease, you will continue to pay a higher rate until your fixed rate expires
- Fixed rates can limit your ability to make additional repayments to your mortgage depending on the lender
- Some of the loan features can be quite limited.
Variable loans are tied to a floating interest rate, which means the amount you pay each month can change depending on what happens in the market. Every first Tuesday of the month the Reserve Bank of Australia Board meets and makes decision about the cash rate. The cash rate can influence the interest rates that are offered by lenders to consumers.
Variable rates are popular with borrowers, particularly when rates are low and stagnant, as they provide flexibility with regards to additional repayments, and provide the capability to attach an offset account and redraw facility. Variable loans can also be switched to another lender with little cost, compared to fixed rate loans, which provide you flexibility to take advantage of competitive rates in the market.
Following on from the above example, if your rate on your variable loan was to be 3.99%, and interest rates in the market and with your particular lender were to increase to 4.99%, you would see your interest rate and repayments rise to reflect the change in the market. Conversely, if the rate in the market were to reduce to 2.99%, you would benefit from a lower interest rate and repayment on your facility.
We have summarized some pros and cons of a variable rate facility below:
- If interest rates decrease, you benefit from a lower interest rate on your loan and lower ongoing repayments
- Variable rates provide additional features, such as the ability to make additional repayments to your loan, the ability to attach an offset account, and the ability to have a redraw facility.
- Flexibility to make additional repayments to your loan without incurring any additional fees
- If rates were to increase in the market, you will incur higher interest charges, and higher monthly repayments.
- Harder to budget, as repayments change depending on what is happening in the market
- Some circumstances can see variable rates being higher than fixed ones
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.
- Get the best of both worlds – get access to features from both the 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.
- 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.
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.
So, Which One is Right for Me?
With so many different product types, it can be difficult to know which one is perfect for you; that’s where we come in!
Our finance specialist will be able to assess your situation and suggest which type of loan best suits your budget and lifestyle. Chat with us today and we will start your loan journey on the right foot!