There are a few different types of home loans available in Australia, and the one that works best for you will depend on your individual circumstances. It’s important to understand the pros and cons of each type of home loan so that you’re choosing the right one for you.
Don’t worry if words like ‘fixed’, ‘variable’ and ‘interest only’ leave you with a headache – we have the simple overview of the main types of home loans to help you understand the basics.
What Is Interest Again?All loans will incur interest, so here’s a quick refresher on the concept. Interest is essentially the fee you pay to borrow the money from a lender, and it’s calculated as a percentage point of the amount you have borrowed. It is paid periodically while you repay the loan balance. Because it’s a percentage of the total money owing, the amount of interest you pay gets smaller the more you pay off your loan.
Fixed-Rate Home LoanFixed-rate loans allow you to lock in the interest rate at the time of settlement on your new home. So whatever the interest rate is at that time, you will continue to pay that rate for the lifetime of your loan. When interest rates are very low, it can be beneficial to lock in that low rate and know exactly how much your repayments will be. The potential pitfall is that interest rates may fall further in the future, and you’ll be stuck paying the higher rate.
Variable Home LoanA variable loan is the opposite to a fixed rate one. The interest you pay on your loan fluctuates according to interest rates, which are a reflection of the economic climate. The interest rate offered by your home loan provider depends on a number of factors, including the official rate set by the Reserve Bank of Australia. This type of loan can help you repay your home loan sooner by taking advantage of falling interest rates. However, it is a riskier option, as you can’t predict if rates will go up in the future.
Split Rate LoansWhy not have both? A split rate loan gives you the best of both worlds, with part of the home loan fixed and part at a variable rate. This can provide more certainty for the future than a completely variable loan, while still allowing you to take advantage of future falling interest rates. However, the same conditions apply to the part of your loan that is fixed, so you’d be paying a higher amount on this if interest rates fall.
Interest Only LoanMost home loans are ‘principal and interest loans’ – meaning that when you are making repayments, you are reducing the amount you have borrowed (the principal) and also paying interest. However, there is an option to have a loan where your principal stays untouched and you only pay the interest amount.
This means your repayments are less. So what’s the catch? Interest only loans can’t last forever – at some stage you will need to start chipping away at that full principal amount. Generally, interest only loans are only available for a set period (typically one to five years). It does mean you’ll have more money in your pocket initially – handy if you’re doing renovations or money is a bit tight – but when that period ends there will be a substantial increase in your repayments.