Home Loans: Evaluating the Different Types Currently Available
If you would like to discuss the different types of homes loans that are available in Australia today, please do not hesitate to call or e-mail us and one of our specialists will be happy to provide you with all the information you desire. In the meantime, we have put together a guide covering the main features of each type, along with their respective pros and cons.
Which Type of Mortgage is Right for You?
While we urge you to consult an experienced professional before deciding on a particular type of home loan, the information below should at least give you an idea of the types of mortgages on which you wish to focus when you contact us for the very first time. Whether a particular type of home loan is suitable for your needs will depend on your financial circumstances at the time you apply for the loan, your future plans, and, to a certain degree, your personal preferences.
Variable Rate Loans
The simplest type of mortgage available is a basic variable rate loan, with monthly repayments applied to both the principal and interest on the mortgage.
The interest charged on such loans will normally move up and down, shadowing the Official Cash Rate (OCR), which is reviewed by the Royal Bank of Australia (RBA) at its monthly meetings.
Standard variable rate loans work in a similar way to basic variable rate loans but offer additional benefits, such as the ability to pay off the principal more quickly in the event you have money to spare and a redraw facility, which basically enables you to withdraw any extra money you have repaid if you should need it for other purposes at a later date.
While standard variable rate mortgages are more flexible in these respects, they normally come with higher interest rates so you will have to decide whether you wish to pay a little extra for the additional functionality they have to offer or whether you would prefer to apply for the basic type of variable rate loan and pay slightly less interest.
- Lower repayments when the OCR falls.
- Ability to pay off loan more quickly with standard packages
- Higher repayments when the OCR rises
Fixed Rate Loans
If you are not keen on the idea of a home loan with repayments that could theoretically change on a month-by-month basis, you can apply for a fixed rate mortgage, which, as you may have guessed, has a fixed rate of interest.
However the rate is normally only fixed for a period of between 1-5 years, at the start of the loan, so you cannot use this type of mortgage to protect yourself from movements in the OCR that may occur in the distant future.
What you can use it for is to fix your repayments for a number of years, thereby making it somewhat easier to manage your finances initially. Once the fixed-rate term has come to an end, you can opt to fix it at the prevailing rate for another period of time or to convert your mortgage to a variable rate loan.
As with variable rate loans, the payments that you make on an ordinary fixed rate loan will be applied to both the principal amount outstanding and to the interest charges.
- Your repayments will not rise if the OCR rises
- Easier to manage your finances on a monthly basis
- Your repayments will not be reduced in the event that the OCR is lowered
- Limited opportunity to make extra payments
- Penalties for early settlement
For those who would like to start with the lowest possible repayments when they buy a new home, interest-only mortgages could be worth considering.
If you apply for an interest-only loan, you will only have to pay the interest due every month for a fixed period at the beginning of the loan, with nothing going toward reducing the principal. Once this period is over, your repayments will go toward both the principal and the interest, as with the previously discussed types of mortgages.
This type of home loan is popular with first-time buyers who have reason to believe that their fortunes will take a turn for the better in the near future but they should not be thought of as a way to buy a property that you cannot really afford.
- More manageable repayments to start with, which can make setting up home much easier for some
- Large increase in repayment amount once the interest-only period is over
- Ability to repay loan is calculated on higher payments, reducing the total amount you can borrow
Some lenders offer introductory home loans in Australia, which are mortgages with a special rate of interest for a fixed period of time, usually the first year.
These types of loans are popular with lenders because they can be a very effective tool in luring customers away from competitors. At the same time, they can be convenient for first-time buyers who may struggle to find the money to furnish and decorate their new home without a special introductory rate.
If you are shopping around for a normal principal and interest mortgage with the lowest possible initial repayments, introductory loans are sure to get your attention.
- Unusually low repayments for the first 12 months
- Ability to quickly reduce principal during the ‘honeymoon period’
- Your repayments will increase significantly after the initial period is over
For borrowers who cannot meet the documentation requirements for standard mortgages, a low-doc (or no-doc) loan could be a viable alternative.
This type of loan is worth investigating if you are self-employed and may have difficulty proving that you enjoy a certain level of income or if you simply wish to invest in property without jumping through dozens of administrative hoops to raise the finance you need.
One thing to bear in mind when considering low-doc loans is that you should never use them as a way to obtain finance to fund property purchases that you cannot really afford to make as you are sure to run into difficulties sooner or later if you do.
On the other hand, if you have more than enough money to service a loan of a certain size but are unable to provide adequate proof to qualify for a standard mortgage in Australia, a low-doc home loan could be the most practical path to home ownership currently open to you.
- Accountants declaration of income
- Some lenders can use 12 months of Business Activity Statements (BAS).
- Some lenders can use 12 months of Trading Statements.
- Same loan features available as a normal loan.
- Some Lenders interest rates may be higher than a comparable standard mortgage.
- Some Lenders require a higher deposit amount.
- You may have to pay Lenders Mortgage Insurance (LMI)
For existing homeowners with equity in their house or apartment, line-of-credit mortgages may provide a handy way to use this equity to raise cash to invest in a second property or to make other types of purchases.
This type of home loan usually consists of an agreed line of credit, hence the name, which is made available in the form of a separate loan account. The credit balance of this account, i.e. the outstanding debt, will increase as cash is withdrawn to fund investments or purchases, and decrease as money is paid back in.
If you have been paying off a mortgage on your home for a number of years and have a substantial amount of equity built up in it, this type of home loan offers a relatively simple way to raise money for investments and purchases, and should not involve a lengthy application & approval process.
However, if you are not meticulous about making repayments on the outstanding loan amount, you could end up paying a lot of money in interest when using this type of mortgage.
- Ability to utilise home equity without selling up and moving
- Lower rate of interest than personal loans or credit cards
- Higher rate of interest than ordinary mortgages
- Possibility of letting your spending get out of hand
- Potential to end up with less equity in your property
Split Rate Loans
For those who are not sure whether a fixed or variable rate home loan in Australia is the best option, there is another alternative: the split rate loan.
With this type of mortgage, a fixed rate of interest is charged for part of the outstanding debt and a variable rate for the rest. The way the outstanding amount is split can be agreed between you and the lender.
If you think that the OCR could go either up or down in the future and you would like to limit any possible resulting increase in your monthly mortgage payments without losing the opportunity to gain some benefit from a decrease, a split rate home loan could be just what you are looking for.
Split rate loans are not the right choice for everybody of course: as with all mortgage products, they have their advantages and their disadvantages.
- Allows a certain degree of control over future monthly payments, with the fixed rate portion
- Ability to make extra payments on the variable portion of the loan if desired
- Repayments will still rise somewhat if the OCR rises
- You will not gain the full benefit of any future reductions in the OCR
Non-conforming mortgages, or home loans, are a group of loan products offered by certain banks and other financial institutions to borrowers with a less than perfect credit history.
If for example, you have a poor credit rating that makes it difficult for you to qualify for any of the mortgage products covered so far in this guide, a non-conforming loan could be an option that is worth exploring.
However, although some lenders will overlook poor credit ratings, they will still expect to see proof that your current financial situation is healthy and that you will be able to make the repayments.
While this type of loan may be a good choice for those with a patchy credit history, there may be better options if you think that your credit rating is good enough to convince lenders to offer you one of the other types of home loans that we have discussed above.
- Available to borrowers with a poor credit rating
- More costly than other mortgages owing to the higher risk of defaults that the lenders take
In addition to the various types of home loans that are available to help you purchase a property in Australia, there is a slightly different type of financial product that you may or may not require when you are moving home, known in the banking industry as a bridging loan.
These are a special type of loan, designed to bridge the gap in your finances should you end up completing on a new property before you have managed to sell your existing home.
Without extra finance, you could find it very difficult to keep up the payments on two mortgages at the same time and consequently miss the opportunity to buy a property that you really want: a bridging loan is meant to be used over a short period of time – normally from 6 to 12 months – to give you a little more time to sell your home.
- Enables you to buy a new property before selling your existing home
- Possibility of having to accept lower asking price if you cannot sell your current home