When considering a home loan, there are various loan types to choose from, such as variable interest rate loan (standard and basic), fixed interest rate loan and Line of Credit (equity loan). See below for detailed descriptions for each type of home loan.
A fixed rate loan
A fixed rate loan is a loan that has a fixed interest rate and therefore fixed loan repayments. The time period of these loans can vary, but you can usually “lock in” your repayments for between 1-5 years. Although the fixed rate period may be 3 years, the total length of the loan itself may be 25 or 30 years. At the end of the fixed loan period you can decide whether to fix the loan again for another period of time at the current market rates or convert the loan to a variable interest rate for the remaining time left of the loan.
Pros:
- Repayments do not rise if the official interest rate rises
- Provides peace of mind for borrowers concerned about rate rises
- Allows more precise budgeting
Cons:
- Repayments do not fall if rates fall
- Allows only limited additional payments
- Penalises early payout of the loan
Interest-only home loans
You repay only the interest on the principal during the term of the loan; therefore, repayments are lower than with a standard principal and interest loan. At the end of the interest only period - usually one to five years - you must start making Principal and Interest Repayments over the remaining term of the loan.
Pros:
- Lower repayments initially so you have more money to renovate/improve the property.
- Cuts the cost of buying a residential investment property in the short-term, which could allow you to make greater contributions to your principal place of residence.
Cons:
- There will be sudden increase in repayments at the end of the Interest Only period and the loan converts to Principal and Interest repayments.
- Lenders will assess your ability to repay the loan only on the principal and interest repayments. This can reduce your borrowing power, as these repayments will be higher than a loan on Principal and Interest for the full term.
Variable (principal and interest) loans
The rate charged on a variable loan moves up or down in accordance with movements in interest rates, as set by the Reserve Bank. Basic variable loans generally have fewer loan features than a standard variable loan. Basic variable loans are suitable if you are looking to pay off a consistent amount over the full term of the loan, but are not suitable if you are looking to pay off your mortgage quickly.
Pros:
- Repayments fall when official interest rates fall
- Standard variable loans offer flexibility and additional features, such as the ability to make additional payments, such as a redraw facility (take out any extra money that you have put in), low introductory or honeymoon rates
- Allows careful borrowers to pay off the mortgage quickly by not having any penalty for advance payouts
Cons:
- Higher interest rate is higher for standard variable loans than basic loans because they usually offer additional features
- Repayments rise when official interest rates rise
Split rate (principal and interest) loans
A split rate loan is a loan that has one portion of the loan fixed and one portion variable. You can select how much to allocate to each.
Pros:
- Provides some peace of mind for borrowers concerned about rate rises
- Provides more certainty in budgeting than full variable loans
- Can make additional payments on variable portion
Cons:
- Allows limited additional payments only
- Repayments will rise with rate rises
Introductory loan
The interest rate is usually low to attract borrowers. Also known as a honeymoon rate, this rate generally lasts only for around 12 months before it rises. Rates can be fixed or capped. Most revert to the standard rates at the end of the honeymoon period.
Pros:
- Usually the lowest available rates
- When payments are made at the introductory rate, the principal can be reduced quickly
- Some lenders provide an offset account against these loans
Cons:
- Payments usually increase after the introductory period