Types of home loans
Basic or "no frills" loans
What are they? A variable rate loan with a relatively low interest rate. There are usually no extra "bells and whistles" which are likely to add to the price.
You're paying a relatively low rate which may mean you can pay off the loan faster. If rates fall, so will your minimum repayments. But if you keep paying the higher amount you'll get rid of the loan faster.
They often don't have the features and flexibility of other loans. Check that the loan conditions are not overly restrictive, warns Cannex's sector manager for mortgages Henry Senlitonga. "Check for the ability to make additional repayments and repay the loan early without penalty," he says. If rates rise, so will your repayments. Make sure you can still afford to pay the loan if they do.
Who they suit:
They can be ideal for first home buyers because of the low rate.
Standard variable rate loans
What are they? These are the most popular type of loan in Australia and offered by most lenders. It's a variable rate loan, like a basic home loan, but offers a few more features and flexibility so the rate is slightly higher.
If rates fall, so will your minimum repayments. However, if this happens, it's a good idea to keep repaying at the old level and pay off the loan faster. They have a lot more flexibility than basic loans. Most come with the features discussed earlier such as redraw; the option to split between fixed and variable; allowing you to make extra repayments without penalty; and portability.
If interest rates go up, so will your loan repayments.
Who they suit:
Most people, from home buyers to those refinancing and anyone who wants flexibility.
What are they? The interest rate is set for a particular term — usually one to five years so your repayments are set for that period. At the end of the term you can lock in another fixed rate, switch to variable or go for a split loan.
You have the security of knowing exactly what your repayments will be and can budget accordingly.
If rates fall, you'll miss out. Fixed loans also often have limited features and lack the flexibility of variable loans. Make sure you find out about any exit fees and whether you're allowed to make extra repayments.
Who they suit:
Ideal for borrowers who like to know exactly what their repayments will be or those who worry about rates rising.
Equity line of credit loans
What are they? These loans let you use the equity in your home to finance other things such as renovations or to invest in other assets such as shares or funds. You generally need to have a large deposit or good equity in your home to be able to take advantage of this.
The extra funds are there when needed without having to apply for a separate loan or get special approval. If you're buying shares, unlike a margin loan there're no margin calls. There are also no set repayments.
They are sometimes more expensive than standard products, so check whether you'll really benefit. If you're not disciplined, you could only pay interest and not reduce the principal or even eat into the equity you've built. You could end up with a mortgage for the rest of your life!
Who they suit:
They are only appropriate for those who are disciplined and have strong budgeting skills. They suit people who are thinking about renovating or investing.
Packaged home loans
What are they? Packaged home loans are offered by banks to people in a particular profession or those borrowing over a certain amount — sometimes it's over $150,000 but more commonly over $250,000. They were originally introduced to cater to high income earners but have now become more widely available to certain professional groups, those who need to borrow a higher amount or those who have a good relationship with the bank. Features include rate discounts, reduced ongoing fees, fee-free credit cards and transaction accounts.
You get discounted rate not only on the home loan but benefits on other products as well, depending on the institution.
Be aware that the yearly fees for these packages are often around $350+ and the benefit of the reduced interest might be much less. So make sure you get value for money.
You're also tied to the one institution for a range of services which can be limiting.
Who they suit:
These are great for people who need to borrow large sums or are a member of a particular professional group, says Senlitonga. It's also ideal for those who need a whole suite of products.
What are they? Non-conforming lenders will lend money to people who don't meet the banks' strict lending criteria including:
Self-employed people likely to have difficulty verifying their last three years of income.
Older borrowers (over 55) for whom a 25-year loan may not be appropriate because they are close to retirement.
Those who wish to borrow more than 90 percent of the property's value.
People with a bad credit history, for example those with a history of late repayments, loan default or possibly even bankruptcy.
Seasonal or casual workers who have infrequent or variable income.
New migrants with no borrowing record.
The rates are much lower than they were in the past for these types of loans. Non-conforming loans are fully featured, so you don't miss out on any of the extras. They're a great way to build your credit rating.
The rates are usually at least one percent higher than a traditional loan. The rates depend on your level of credit impairment. You might be up for a hefty deferred establishment fee if you pay out the loan — particularly if refinancing in the first three years.
Who they suit:
Small business owners, older people and those with a bad credit history.
100% Offset "Loans":
Strictly, it is the account that is attached to the mortgage that is set up as a 100% offset facility. This is linked to your mortgage and is a great way of being able to reduce your mortgage quicker by reducing the interest calculated on it. It should be noted that this type of structure is only suited to borrowers who have either, a good cash flow going through their account and/or a reasonable lumps sum of money sitting in that account.
Basically it links a savings account with your mortgage account, the balance in the savings account offsets a similar amount in the mortgage account when interest is calculated on a daily basis - so the more money you have in your savings account the more interest you save on.
100% offset facilities can be set up on most principle and interest loan types but very few allow this set up on fixed loans without some penalties.
Example: A home mortgage for $320,000 (principle) with a linked offset savings account with a balance of $10,000
Interest calculated daily on the mortgage account will be:
$320,000 - $10,000 = $310,000
The monthly repayment will not change as it has been determined by the interest rate and term, however the interest saved will help the repayments work more effectively to reduce both the principle and interest it attracts. This is because a greater proportion of you monthly payment will go towards the principle.
Look at the potential savings!!
For example - with a $300,000.00 mortgage at say 6.8% interest, and, after time, $10,000.00 in your offset account you will reduce a 30 year loan by:
Save 2 years 11 months and save $58,908.00 in interest.
If your account held $20,000.00 then:
Save 5 years 4 months and save $106,349.00 in interest.
This is all by doing nothing except leaving your money in your offset account.
Loans to think twice about
There are many loans in the market place. Some cost more than others. Some loans may have further implications to consider. Here is a list of loans we recommend you evaluate carefully before signing.
Non-conforming or low document loans/mortgages
Non-conforming loans are for those who don't qualify for a conventional home loan because of a poor credit history. Low document (or lo-doc) loans are for the self-employed who can't provide records for their income over a long period. Both of these loans attract higher interest rates and charges because of the increased risk institutions face. It is important to understand all conditions attached to these loans and very carefully assess your ongoing abilities to meet repayments.
Low-deposit or no-deposit home loans
Some lenders offer low-deposit or no-deposit loans. These can carry special conditions, such as higher interest rates and additional fees, insurance and security. It's important to weigh up the advantages and disadvantages of getting a low/no-deposit home loan and having to pay a higher interest rate than that of other loans.
Some financial institutions may offer long-term mortgages of up to 40-50 years. This type of option may sound tempting if you're struggling to break into the property market because your monthly repayments would be reduced. While the longer-term loans can help first home buyers get a foothold in the housing market, you could end up spending the first 10 or 15 years paying off just the interest you owe.
The longer the loan term the more interest you pay to the finance company. You should also check how high the exit fees are if you decide to switch lenders or refinance and if you will be penalised for paying the loan off earlier.
Wrap loans and vendor finance
If you are a first home buyer, don't let the dream of your own home influence you to sign a contract you might regret. Vendor finance, a wrap loan or rent/buy scheme is an agreement where the owner of a property (the seller often called a 'wrapper') offers finance to the purchaser. Even though instalments are made regularly in these loans, the seller usually retains title to the property until payment of the final instalment. Vendor financing arrangements may seem like an easy solution, especially if you are having trouble obtaining finance elsewhere, but they have the potential to deprive you of your hard-earned savings and leave you with nothing.
The interest rate is usually about 2 per cent to 2.5 per cent higher than the standard home loan, and there may also be a premium over the purchase price of the property payable to the seller.
Purchasers should also be careful to check they are paying the true market value of the property and whether the seller's legal fees, insurance or property maintenance fees have been included in the price.
Because the purchaser is not the owner, they have limited rights. If the vendor or 'wrapper' has borrowed to finance the property and they default on that loan, the purchaser still loses possession and any possibility of ownership or refund of any monies paid even though the purchaser is not in default to the vendor. Approach vendor finance contracts with extreme caution.
The consequences if you default can be very harsh. If you fall behind on repayments - even one repayment - you risk losing the property. This means you risk losing your house, any repayments already paid, and affecting your credit rating.
A reverse mortgage allows you to borrow money against your home, without having to make regular repayments. They are often promoted as a means of giving older homeowners access to extra cash.
Unlike a normal loan, you don't have to make any repayments until you sell, move out of the home or die. The total amount you owe must then be paid back to the bank, usually from the sale of the house.
Your debt will be considerably higher than the original amount you borrowed, as each year the fees and interest accumulates and is added to the loan.
While historical data and trends indicate that your property is likely to continue increasing in value for the life of your loan, this is not a certainty. Nor are you likely to be able to predict how long you will live in your home. There is a possibility that the loan could eventually equal or exceed its value. If this happens, the lender may then ask you to commence repayment.
Before signing a contract or a reverse mortgage, carefully weigh up the advantages and disadvantages of this type of loan. It is important you understand how it will affect your choices and your financial position in the long-term. Australian Securities and Investments Commission (ASIC) provide a reverse mortgage calculator which can help you understand these loans better, and prepare you for this decision.
An alternative for older homeowners is Centrelink's Pension Loan Scheme aimed at people who are ineligible for the pension under the income or asset test. This loan is similar to a reverse mortgage but with lower interest rates. However, you may not be able to borrow as much money as from other lenders.