Types of Home Loans and Mortgages

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I thought we should start the new year with a list of the types of home loans/mortgages

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 6 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.

Fixed Rate Loans

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 5 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 5 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.

Important Note: Line of credit loans are not suitable for all people, 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 loan.

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 its 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.

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