How do I know what home loan to choose?

Because there are hundreds of different loan products on the market, it is important to understand the different loans so that you can select a loan type that best suits your needs.

Introductory Loan

Also known as a discount variable loan or honeymoon rate loan.

With this loan type, the lender will offer you a discounted rate for a specified term, usually six months or twelve months. At the end of the term, the loan usually reverts to that lender’s Standard Variable Rate (SVR). The loan can be effectively used in the short-term (generally not suitable for loan terms longer than 2 years) and you need to be aware of any early repayment fees.

Advantages: usually has one of the lowest rates, by paying more off your loan in the introductory term the principal can be quickly reduced.

Disadvantages: can be a trap for borrowers who don’t pay off more during the introductory stage, the interest rate and repayments increase after the discount period.

Basic variable loan

This is a ‘no frills’ flexible product with competitive interest rates, and many lenders offer free internet transfers and no ongoing fees. There are usually fewer features than a standard variable loan (SVR). Because it’s a variable loan, the interest rate and therefore the repayments vary over the term of the loan.

Advantages: usually has a lower interest rate than the SVR loan, repayments are also usually lower, additional payments can be made without penalty.

Disadvantages: may not offer the full suite of features or flexibility of loan types like a Standard Variable Rate or a Professional Package.

Standard variable rate loan

The interest rate varies throughout the term of the loan. The term is generally about 30 years and borrowers have a broad range of features. But, to gain cost effectiveness, the loan should be used within a professional package in order to obtain a discounted interest rate, a rate comparable to the basic loan.

Advantages: When the interest rate falls, repayments fall, additional payments can be made without penalty.

Disadvantages: when the interest rate increases so will the loan repayments. The amount of the interest discount usually depends on the amount of the loan.

Line of credit loan

This type of loan is like a transaction account and a loan account in one, with the borrower having access to a pre-determined credit limit. The minimum repayment is the interest (no principal repayments are required). And, with some Lines of Credit (LOC), the interest does not have to be paid, it is added to the loan until the limit is reached and then repayments have to be made (this is called capitalizing the interest). Though this is the most flexible loan type it’s generally also the most expensive. Only very disciplined borrowers should consider this type of loan.

Advantages: utilize the funds you need using the equity in your home and pay this back when you can, often you don’t have to pay the interest until the credit limit is reached.

Disadvantages: you may never pay off any of the principal amount.

Fixed rate loan

Here the interest rate is fixed for a specific term, one to five years and seven, ten and fifteen years. At the end of the specific term, the interest rate generally reverts to the standard variable rate. Fixed rate loans protect you against interest rate changes for the specified term, so are best suited for people who want the security of knowing their repayments won’t change. Having a mix of part-variable and part-fixed is a suitable strategy to get the benefits from both fixed and variable loan types.

Advantages: if the variable rate increases or decreases, there is no change to the fixed rate during the fixed term, your repayments will not change.

Disadvantages: you will not benefit from any reduction in rate if the variable rate is reduced, extra repayments are limited and if you make more payments into the loan than are acceptable, you may incur a break fee. The break fee may be substantial.

Professional package

This package can offer good discounts and benefits if you qualify, though benefits vary between lenders. Generally the rate discount is between 0.50% and 0.70% depending on the loan amount. The discount is for the life of the loan. The key criteria are that your loan needs to be $150,000 or more and you need to earn in excess of $50,000 gross per annum. You don’t have to be a professional to qualify.

LoDoc

A LoDoc loan can be used if you’re self-employed or a contractor and cannot give the lender your full financials e.g. pay slips, tax returns. You still have to submit a completed application and state your full assets and liabilities. Generally you’ll need to have an ABN for two years and if your income is above the GST threshold, then you’ll usually have to be registered for GST. Some lenders require that you submit the last twelve months of BAS together with the last 3 months statements for your business account.  You’ll need to give an income declaration, stating your gross annual income. Some lenders no longer offer this type of product.

Advantages: simple income declaration, no evidence of income is generally required; there are a number of competitive LoDoc loans available.

Disadvantages: some lenders charge an interest rate premium for a LoDoc loan; generally the maximum amount you can borrow is to 80% of the property’s value.

Offset account

A 100% offset account is a transaction account linked to a loan account. No interest is paid to the offset account. Instead the balance of the offset account is deducted from the loan account before the interest on the home loan is calculated. Therefore less interest is charged to the loan. So, if you had a loan of $100,000 and had $15,000 in the off set account, interest on $85,000 (not $100,000) would be charged. This type of loan is most suitable for an owner-occupier debt so that the borrower’s spare cash can be used to reduce a non-deductible debt.

Advantages: Money in a savings account earns interest and is taxable. However, when the money is deposited in an offset loan account, the amount reduces the home loan amount and so reduces the amount of interest paid on the loan; the interest rate on the offset account is the same as that applied to the loan account and is generally at a much higher rate than could be earned on most savings accounts. The interest rate moves with your loan account rate ensuring maximum benefit with every dollar in the offset account.

Disadvantages: Most lenders charge an ongoing fee for you to have an offset account; you may need to keep a minimum balance in the account.

EFM (Equity Finance Mortgage)

An EFM is a no-monthly interest rate home loan that is used in combination with a traditional home loan to help make home ownership more affordable.

With an EFM, you are not charged monthly interest or fees during the term (25 years) of the loan on the EFM portion. Unlike an ordinary loan where interest is charged throughout the life of the loan and monthly repayments are required regardless of how much or how little the home increases in value, the cost of the EFM is linked to change in the value of the property.

When you decide to sell the property or pay out the EFM, you pay out the amount originally borrowed plus a share of any increase of the value of the property. Importantly, with an EFM, you will always have at least 60% of the capital growth that is realised on the property.

If the property’s value doesn’t increase, you just pay the original EFM amount with no interest whatsoever.

If, when you decide to sell the property and repay the EFM and the value of the property has fallen, the lender may share up to 20% of the borrower’s losses.

Advantages: An EFM can also be used to cut the costs of purchasing a new property; existing borrowers may want to refinance out of their current loan and reduce their repayments by up to 20% or more using an EFM; the EFM can be repaid at any time.

Disadvantages: an EFM is only available for owner occupier property; no Interest Only option is because as all repayments have to be Principal & Interest.

Because of its flexibility, an EFM is suitable it you’re:

  • A first home buyer
  • A borrower wanting to upgrade your home
  • A borrower suffering mortgage stress and want to reduce your current loan repayments
  • Separating from you partner and want to keep the family home rather than sell it