Loan Types

Variable Rate Loans (Basic & Standard)

These two loan types are effectively the same in the way they work.  The only differences are in the interest rate charged, and the features available.  A standard variable loan will usually have a full range of features, whilst a basic variable loan will have a more restricted range.

A summary of the usual differences is set out below.  Please note that this is a general guide, and that differences between lenders may arise with specific products.

 

 Discount Variable Rate Loans or Introductory offers

Many Lenders have developed a variant of their Standard Variable loan product, by offering new customers a reduced or discounted rate of interest for a set time.

These discount periods can range from six months to 24 months, after which the interest rate reverts to the Standard Variable Rate.  In order for the Lender to ensure that they recoup the cost of the discount and to discourage borrowers from continually changing from introductory products of various lenders, most have introduced penalties should the borrower repay the facility within a specific time.

 

Be careful of low Intro or Honeymoon Interest rate loans, once the loan reverts to the Standard Variable Rate product it may be higher than a normal discount rate loan on offer.  Also check the exit costs of these products, as most of the establishing fees are Zero entry fees to entice you into the product and sting you when you exit.

 

Fixed Rate

A Fixed Rate Loan is a loan where the interest rate is guaranteed to remain the same during an initial term, regardless of what may occur in the market with variable rate loans.

Traditionally lenders have offered terms of between 1 – 5 years for fixed rates, however some Lenders may offered terms of up to 10 years.

Fixed Rate term loans normally require the loan to be renegotiated at the conclusion of the fixed term, thus a five year fixed term loan would normally be required to be repaid in full at the end of year 5.  However, most Lenders have the ability to arrange for the facility to revert to the Standard Variable Rate after the Fixed Rate term has expired.  Thus, a loan facility can be established for a 25 or 30 year loan term with the first five years, fixed at a specific interest rate.

Fixed rate loans are popular with borrowers that want to take a conservative approach to borrowing, as they guarantee that the loan repayment will be the same for the Fixed Rate period.  Many property investors have also found the Fixed Rate loans attractive products due to the product offering the comfort of guaranteed repayments.

Borrowers who take fixed rate loans need to understand that they are committing to a contract with the lending institution for the fixed rate term, and that should the contract be broken or the term changed, the Lender may charge the borrower substantial fees to cover the costs of breaking the contract.

These ‘break costs’ and can be very expensive.  The break costs are determined by many factors, such as the term remaining, the current interest rate environment and the amount of the outstanding balance.  They cannot be estimated when the contract is taken out.

In addition to the potentially prohibitive break costs, many Lenders also restrict the amount of extra repayments that can be made on the loan during the fixed rate period.

The restrictions vary from lender to lender, and if you are thinking of taking a fixed rate loan, these restrictions may be a very important factor to consider.

 

 Line of Credit ~ Home Equity Loans

Also known as Come and Go facilities, Equity Loans or Revolving Lines of credit, these loans offer similar benefits and operating features as the common bank overdraft.

A line of credit loan allows the borrower to establish a credit or facility limit, and then draw from and pay down the loan without restriction.  The borrower has the ability to use the entire limit at any time and does not have to comply with an amortised repayment schedule.

Most Lenders who offer these loans require that the monthly interest charge be the minimum payment required to maintain the account.  That means that the borrower can determine, how much if any, principal repayment they wish to make.

The credit or facility limit is normally determined by two factors:

• borrowers ability to repay, and
• level of equity in the property being offered as security.

These facilities have the benefits of allowing the borrower to utilise as much or as little of the credit facility for whatever time frame they require, while still only being charged interest for the outstanding balance.  The facilities even allow for the balance to move from a credit balance to a debit balance.  Most Lenders will also allow for the borrower to operate their loan account as their transaction accounts, as an ‘all in one’ account.

 

Line of credit loans are not suitable for people without discipline, as the facility allows for the original limit to be reused.  Without proper discipline, it is possible to never pay down the loan at all with this kind of facility.

 

Reverse Mortgages

Recent changes in the demographic of the population in Australia have seen an increase in Asset Rich and Cash Poor elderly Australians.  It is expected that this segment of the market will continue to increase as the ‘Baby Boomers’ start reaching retirement age.

A reverse mortgage allows the borrower to borrow funds for any purpose or for day to day living expenses, secured against the equity in their property.

The main difference to this product to standard home loans is that the lender does not require the borrower to make any principal or interest repayments during the loan term.  The debt instead capitalises.  The debt is traditionally repaid once the property securing the loan is sold.

Due to the nature of the facility, with interest capitalised until the full payment of the debt, lenders restrict the amount that they will advance against the value of the property.  Usually lenders will only lend up to 20% of the value of the property, depending upon the age of the borrower.

The borrower has the option of repaying the facility through normal means, however it’s not a requirement of a loan, allowing the consumer to maintain their current standard of living.

An additional requirement of these facilities is that the consumer will be required to obtain independent legal and financial advice, as the nature of the facility diminishes the borrower’s equity in the property.

 

Loan Features & Other Terms

Interest Only Payments

Most Lenders will offer borrowers the ability to make interest only payments on their loan for a set period.  That means that the monthly repayment has no principal reduction component, and the outstanding loan balance will remain unchanged during the term of the interest only period.

Generally the terms offered by the Lenders are between 1 –5 years but some lenders may offer up to 10 years. After the initial interest only period, the loan will revert to the normal amortised repayments over the remaining term of the loan.

For example, a loan with a 30 year term may have a five year interest only term, followed by a 25 year principal and interest term.

 

Loan Portability

Loan Portability allows the borrower the option of using their existing loan arrangements, but changing the property that secures it.  For example, a borrower may sell their current home, and purchase a new home, and simply transfer the existing loan to the new home.

 

Offset Account

A lenders savings OffSet account runs in conjunction or parallel with a residential loan. Some lender may refer to an OffSet account as an ‘All In One Account’. The interest earned on the OffSet account is applied to reduce the interest paid on the loan. The OffSet is normally set up to have income credited or deposited into the OffSet account for all transactions to be paid from the account, i.e. EFTPOS, internet banking, cheque's and credit transactions. With an OffSet you are not earning interest on your savings, however are benefiting as if interest on saving was calculated on a reduction against the loan. There are two types of OffSet accounts, a 100% OffSet and a partial OffSet. A 100% OffSet is where the interest rates earned and paid are the same. A partial offset account is where the interest earned on the offset account is only a portion of the rate paid on the home loan.

For example, if a borrower had a loan with a balance of $500,000, and an offset account with a balance of $100,000, then interest is calculated on the net balance of $400,000.

As mortgage offset accounts are regulated by the Financial Services Reform Act, providing advice on these accounts to consumers may only be done by a holder of an Australian Financial Services License (AFSL).

If a consumer requires a mortgage offset account, the lender who offers the product will provide the consumer with a Product Disclosure Statement which contains all relevant information.

 

Redraw

Loan redraw feature allows a borrower to withdraw any additional funds that they have paid of their loan facility over and above the normal minimum repayment.

For example, if a borrower has been paying an additional $500 per month of their loan, after 12 months, the borrower would be able to redraw $6,000.

The redrawn funds can be used for any purpose. Lenders may charge a fee to redraw extra payments, with costs typically varying from nil to $50 per redraw.

 

Split Accounts or Combination Loans

Most lenders allow borrowers to split their loan into a number of different products.  For example, a borrower may elect to take a combination of a Fixed and Variable Rate loans in order to minimise the potential effect of an interest rate rise, while still maintaining the flexibility of a Variable Rate loan.

 

 

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