Mortgage – Helpful Tips

1. Different Loan Types Explained

Standard Variable Rate Home Loan

The Standard Variable Rate loan is the most common type of home loan. The interest rate that applies to the loan is subject to change, depending on the official rates set by the Reserve Bank rate and the prevailing market conditions. If the rate is increased, so do the amount of your regular loan repayments. If the rate falls, your repayments will be accordingly reduced.

This type of loan is the most flexible and may include optional features such as the ability to make extra repayments, to split the loan, or to redraw extra repayments made.

Basic Variable Rate Home Loan

A Basic Variable Rate loan is usually a “no frills” version of the Standard Variable Loan, good for the budget conscious borrower. It generally offers a lower interest rate, but with less flexibility and fewer features than the Standard Variable roan. In some cases, there will also be more restrictions on this type of loan, with higher fees charged for greater flexibility. As with the Standard Variable Rate, the Basic Variable Rate is subject to official and market interest rate changes.

Fixed Rate Home Loan

The Fixed Rate Loan offers one key advantage over Variable Rate loan types: the certainty that your loan repayment amount each month will not change, whatever is happening in the market or to official rates. Fixed Rate loans are based on a set interest rate for a pre-determined period of time that might run from 6 months to 10 years. If the Reserve Bank changes official rates, for example, this will have no impact on your regular repayment under a Fixed Rate schedule.

This provides some level of security for borrowers but a Fixed Rate Loan is often the most inflexible of loan types. For example, additional repayments, made to reduce the term of the loan and interest payable on the balance of the loan, may result in additional charges being incurred. Redraw is generally not available on Fixed Rate loans.

Split Loan

The Split Loan offers a “best of both worlds” scenario between the Variable and Fixed Rate loans described above. If you are concerned about rising interest rates, but want to maintain the flexibility of making additional loan repayments without being charged extra costs, the Split Loan might be for you. Essentially, you split the total loan into two portions, making one portion a Fixed Rate loan, with the second portion a Variable Rate loan. The split ratio is typically up to you but 50:50 or 60:40 splits are the most common.

Introductory or Honeymoon Rate Home Loan

Introductory loans offer an interest rate that is lower than the standard variable rate for an initial period of time, usually the first year of the loan. This rate may be fixed or variable and once the Introductory period concludes, the interest rate usually reverts to the Standard Variable rate. The advantage of this rate is that it offers borrowers a chance to ease their way into the routine of repaying a home loan with the reduced rate. This “honeymoon” period also allows you to reduce the principal loan amount more quickly by making extra repayments at no penalty charge.

All In One Home Loan

The All-In-One Loan essentially combines your home loan account with your day-to-day transaction account. This allows you to directly credit your salary into the account and then withdraw funds as you need them, like a standard transaction account. The major benefit of this structure is that enables you to decrease the interest charged on the loan by keeping your salary, savings and other income in the account for as long as possible.

The interest rate on All-In-One loans may be slightly higher and you may also be charged a higher monthly fee. This type of loan suits reasonably disciplined borrowers or experienced investors who can regulate their spending so as to not allow the debt to expand or stagnate.

Line of Credit Home Loan

Line of Credit loans, also known as Home Equity loans, offer high levels of flexibility. You can think of it operating a little bit like a credit card, in that the lender assigns you a credit limit secured against your property, and when you need cash for bills or other spending, you simply draw against that limit. As you pay back the loan, the funds become available to you again. 

One of the biggest advantages of a Line of Credit is that you always have ready access to money, making it highly attractive to investors. However, Line of Credit usually will attract a higher rate of interest than a standard loan. As for All-in-One loans, a degree of discipline is necessary to make sure the debt does not escalate and never reduce.

Low Doc Loan

Low Doc Loans are useful for borrowers who are self employed and are unable to provide the conventional documentation required to prove their income level. There are many variations on these types of loans, some allowing customers to simply declare their income by completing the loan application or by signing an income statement.

The trade off for this level of flexibility in the application process is either more initial deposit money or a higher interest rate. Many Low Doc products give borrowers the option to switch back to a conventional variable rate product after a set period of time without the need to show full financial statements, provided that they have maintained a good credit history during the applicable period.

Non-conforming Home Loan

Non-conforming loans are designed for borrowers that don’t meet standard lender credit criteria. These people may include seasonal or contract workers, non-residents, small or no-deposit holders or even those with a poor credit or repayment history. In most cases, non-conforming loans will attract higher interest rates.

Bridging Home Loan

This is a short term loan that allows a buyer to complete the purchase of a property before selling their existing property. It is useful for borrowers who want to finance the building or purchase of a new home while still living in the old one. Given the higher risk to the lender associated with this kind of loan, the bridging loan may attract a higher interest rate.

2. Ways to repay your home loan more quickly

Home loan repayments can be a constant challenge or irritation to any home owner. While you will eventually have to pay back the whole of your mortgage amount, there are a few ways you can make it easier to keep up with your repayment obligations and actually paying off your home more quickly.

1. Offset accounts

By linking a deposit account to your home loan account, any funds you have in the deposit account work to offset the interest you are paying on your home loan. Over time, money in your offset account can and the home loan interest this saves, help to reduce the loan principal more quickly, allowing you to pay off your loan sooner and build up equity.

Let’s say you may have a home loan of $200,000 at 7.2% p.a. and an offset account with $30,000 in it. The offset account balance is set off against the home loan, meaning that interest is calculated against $170,000, rather than $200,000. Thus your repayments reduce more of the principal each time, allowing you to repay the loan over a shorter time period.

2. Honeymoon rates

Many lenders offer “honeymoon rates” as a marketing tool to attract borrowers to their products. Basically, the lender will grant a cheaper rate of interest for an initial period (usually 6-12 months) after which time the rate reverts to the standard variable rate of that institution.

This system appeals to borrowers who plan to attack the loan early by making extra payments in first months to help reduce principal. Honeymoon rates are tempting, but watch out for restrictions or exclusions on other aspects of the loan. Many lenders will limit the available features to offset the lower interest rate. This can result in limited flexibility or higher charges over the term of the loan.

3. Debt consolidation

If interest rates rise on your home loan, it’s guaranteed that credit card and personal loan rates will also climb. This can be crippling, as the interest rates on your credit cards and personal loans are usually much higher than the interest rate on your home loan. To alleviate these higher repayments, many lenders will allow you to consolidate or refinance all of your debt under the one roof of your home loan. 

This means that instead of paying up to 20% p.a. on your credit card or personal loan, you can transfer these debts to your home loan and pay them off at the current variable rates (generally around 7.25% to 7.5% p.a.).

4. Additional repayments

Whichever way you decide to go with your home loan, don't forget to consider the advantages gained through additional repayments.

Say you have a loan of $300,000 at 7.25% p.a. that requires a minimum repayment of $2,168 per month over 25 years. By contributing an extra $100 per month (that’ s just $25 a week), you will see the loan paid off 2 years, 9 months earlier with an interest saving of around $46,000. Even if you can’t pay extra, making weekly or fortnightly payments rather than monthly will also reduce the loan term and your interest costs.

Whether you make regular payments or irregular one-off payments whenever you have some spare money, the financial benefits can be considerable – and you’ll be debt free sooner.

3. Negative Gearing

Negative gearing can be a great way to get your foot in the door to the investment property market, but it pays to do your homework first so you’re not left with a massive loan you can’t afford to pay. It is important to seek advice from a qualified expert who can advise you on the taxation and financial implications. Mortgage brokers generally will not be able to give you such advice, so you’ll need to consult an accountant or a licensed financial planner. The following information should not be considered to be investment or financial advice.

Negative gearing is defined as borrowing to invest, where any income you receive from the investment is less than your borrowing costs and the costs of acquiring and maintaining the investment. These losses can then be used to reduce your taxable income and hence potentially reduce your tax bill – perhaps even qualify you for a tax refund.

Take this example. David saved a $50,000 deposit which he used to purchase a $500,000 investment property. He borrowed $450,000 to fund the remainder and covered all of the additional purchasing costs from his own pocket. He plans to keep the house for around 10 years, then sell it and repay the loan in full. The house is currently tenanted at $1400 per month but David’s loan repayments (interest only) are $3495 per month, leaving a shortfall of $2095 per month, which accumulates as $25,140 per year. At the end of each financial year, David’s taxable income (upon which his tax liability is calculated) can be nominally reduced by $25,140.

A popular wealth creation strategy, negative gearing lets everyday consumers invest in the property market through access to additional funds. The intention of all gearing for investment purposes is to access a larger pool of money, namely the investor’s own stake together with outside loan funds, than if only a smaller pool - the investor’s own stake by itself - had been used, says Nick Renton, author of Understanding Investment Property and Negative Gearing. This produces a much higher net return for the investor and a larger benefit from inflation.

Like any investment, there are uncontrollable factors that could impact on your plans, especially in suburbs that have experienced negative value growth in the last year or two. It’s also important to consider the possible impact of any interest rate rises or having an investment property untenanted for an extended period of time.

While negative gearing can be an effective way to make financial gains, Nick Renton cautions investors to thoroughly consider the pros and cons first. Apart from the possibility of making a loss instead of a profit, a borrower can also face the situation that he or she will not have the necessary cash resources to repay the loan on its due date, or at all, and that the lender will be unwilling in the circumstances to roll over the loan.

Big thanks to my friend John from HMC