How to choose the right loan?

The 3 Main Types of Loans

Lenders provide home loans to enable you to buy a house, unit, townhouse or house and land package, with a variety of different loan product features and options.

The maximum loan term available in Australia is 40 years from only a select few lenders however 30 years is the available term with most lenders and comprising 3 types of loan products as indicated below with several product variations of the three, i.e. Discount Loans, Introductory loans, Honeymoon loans, Professional Loans, 100% Off-set accounts, etc.:

• Variable Interest Rate Home Loans
• Fixed Interest Rate Home Loans
• Line of Credit / Equity Interest Rate Home Loans

Loan Repayment Options

The loan repayment options available are, weekly, fortnightly or monthly, depending on loan product and what suits your requirements. Lenders do offer interest paid in advance which are used by professionals to minimise taxable income and may not suit the majority of borrowers. 

The more often you make loan repayments, i.e. weekly, the lower the interest cost over the term of the facility and the sooner your loan will be repaid (although this will depend on the terms of your particular loan product and whether additional or lump sum repayments are also allowed).  If you plan to make loan payments in addition to your scheduled repayments, make sure you check that your loan facility allows for additional loan repayments, increased monthly repayments, or occasional lump sum repayments; and also check for any fees that may apply.  If you plan to pay off your home loan ahead of time, check that you can do so and check for any fees that may apply. For example, with fixed rate loans some lenders allow additional repayments at a maximum $10,000 amount per annum without incurring any break cost, therefore, if you plan to pay off your loan sooner you need to talk to a credit adviser to insure you are not locked into an incorrect loan facility.

Most funders offer the following six types of home loans:

• Basic Variable Rate Home Loans – a lower rate than the standard variable rate, but some features are not available or you need to pay to use them, such as redraw
• Honeymoon Rates Home Loans – discount introductory loan rates which, after a certain period (normally 6-12 months), revert back to a variable rate home loan
• Standard Variable Rate Home Loans – a higher rate than the basic variable rate, but with more features with either lower or no fees
• Fixed Interest Home Loans - which will usually revert back to a standard variable rate home loan after the nominated fixed term expires Fixed interest loans generally are less flexible (e.g. you can’t redraw any extra repayments you’ve made) and have charges for early repayment. Your loan repayments are determined by the amount borrowed, the term of your home loan, frequency of the repayment and the interest rate (although you will need to review the terms of your particular loan).
• Line Of Credit or Equity Loans– a loan where you borrow to a maximum ceiling amount and you can pay down and draw back up to that ceiling amount (think of it as a huge credit card facility, interest is only charged on what you borrow within the line of credit)
• Professional Rate Home Loans - usually provides you with a discount off the annual interest rate, and in return the lender charging an annual fee. The discount off the rate is based on your loan amount size, the larger the loan, the higher the discount however you need to be eligible for this facility criteria; 
   

Variable Rate Loans vs Fixed Rate Loans

There are pros and cons with each type of loan. With fixed interest loans you have a fixed interest rate over a set period term so you have some certainty about how much your loan repayments will be. A typical fixed interest loan will allow you to fix the interest rate for a term of one to five or ten years. If interest rates increase, you will be protected from these rises. However, if they decrease you will not enjoy the lower rates. Also, a fixed interest loan may not offer the same level of flexibility and extra features as a variable loan. There may also be extra break costs should you wish to payout the fixed interest loan before the fixed rate period expires.

Many variable loans offer a cheque book, a redraw facility, 100% Off-Set, and/or the ability to transfer your home loan to another property called Substitution of Security (which can also be done with most fixed interest loans) and to make extra lump sum loan repayments. With variable loans your loan repayments will rise and fall depending on current interest rates.

If you’re uncertain about whether you should take up a fixed interest home loan or go with a variable loan, you can ‘take a bet each way’ and split your loan so that a portion is fixed and the rest is variable. If you choose this option find out if there are any extra costs involved.

Loan Off-Set account and redraw facility

An Off-Set facility loan is linked to a savings account (for example, an account where your salary and other cash might be deposited). You also use this account to withdraw from when bills are payable. There may be some types of Off-Set accounts where you have to move your money into a transaction account before accessing that money. But for as long as the money sits in the account it is ‘Off Set’ against your loan (effectively acting as an additional payment towards reducing the debt owed on your loan) and this can reduce your interest costs over the term of your loan.

A redraw facility can operate in a similar way to an Off-Set account meaning you can apply payments to your loan, (which means the balance on which interest is charged is lower) but still be able to draw back any or all of any early payments made. However if you have a loan for an investment property it may be easier for taxation purposes to have an offset account. You should discuss the best option with your accountant or financial adviser.

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Non-conforming home loans

Non-conforming home loans are for people that don’t fit into a mainstream lender’s approval criteria. This normally includes people with a poor credit history.

With a non-conforming home loan, you will pay a higher interest rate. But once you establish a history of regular and on-time loan repayments over a two to three year period you can often refinance your loan with a mainstream lender and switch from a non-conforming home loan to a traditional home loan.

Reverse loans

Reverse loans allow you to borrow money against your home, without having to make regular payments. These loans are designed for older home owners (i.e. 60 to 65 years and over) to release the equity in their homes and gain access to extra cash. The amount of money borrowed through a reverse loan (the interest accrued over the term of the loan) is paid when the property is sold or when all borrowers cease to live in the property or pass away. It is very important to understand how a reverse loan will affect your financial position in the long term. You need to discuss these types of products with an experienced credit adviser at Neomoney.
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