First home buyers have a wide range of choices to make when choosing their loan types. One of the choices relates to what time you choose to repay your housing loans in Australia. This is influenced by home loan types being principal and interest or interest only. Another choice will be with respect to the types of home loans being fixed-rate mortgages, variable or a combination of both.
The Different Types Of Home Loans
Here are the different types of loans and by continuing to read, you can find the one that best suits your needs;
1. Principal and Interest Loans
A principal and interest loan is one of the most common types of loans for homes 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 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.
2. Interest Only Loans
Interest-only types of 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.
3. Fixed Versus Variable Loans
Choosing between a fixed or variable home loan is a personal choice that considers several factors specific to you. Whilst there is no set answer to this question, a good mortgage broker can guide you through how variable or fixed home loans can specifically affect you.
4. Fixed Loans
The fixed-rate mortgages refer 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 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 mortgages, 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 breaking a fixed rate.
Pros And Cons To A Fixed Rate
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.
PROS
- As rates are fixed, your repayments for these types of home loans will not change. Therefore, this is a good option for those looking for consistency with their repayments and who are looking to create a household budget.
- The fixed-rate types of mortgages are a good option to secure competitive interest rates for a certain period of time
- Defends you from an increase in the interest rates.
CONS
- 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 fixed rate mortgages depending on the lender
- You get access to limited loan features with these mortgage types
5. Variable Loans
Variable loans are secured with a floating interest rate, which means you will see the difference in the amount you pay each month depending on what happens in the market. Every first Tuesday of the month the Reserve Bank of Australia Board meets and makes a decision about the cash rate.
For the variable home loan type, 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 with the 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.
Pros And Cons Of A Variable Home Loan Rate
PROS
- 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
CONS
- 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
6. Split Loan
A split loan gives you freedom. 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 And Cons Of Split Loan
PROS
- You get to divide your loan into different parts with variable or fixed home loans.
- In case of an increase in a variable rate, the loan falls back on a fixed interest.
- Pay off the variable rate loan amount faster through the additional repayment option.
CONS
- There is a limit set to the number of additional repayments.
- To get the best out of the interest rate of fixed or variable home loan types, you have to correctly set the split ratio.
- There is a possibility that your repayments may slightly rise if there is a difference in the official variable rate.
7. Honeymoon Loans
Honeymoon loans offer a low-interest rate initially for a period of about 12 months. The introductory rate may increase after a fixed period. Honeymoon loans have been introduced to support first-home buyers in setting a strong foot for the foundation of buying a home. These loans eventually revert to a standard interest rate once the ‘honeymoon period’ is over.
8. 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 types of loans best suit your budget and lifestyle. Chat with us today and we will get you started with your loan journey with no hassles.
