Loan types and features

It is easy to be daunted by all the various products on offer these days and by all the different advertised interest rates touted by the many lenders looking to entice you in.

Many people seem to choose a home loan for all the wrong reasons, primarily because they have opted for the apparent best advertised rate on the day, without an understanding of the limitations of the product or possibly because they are unaware of all the other options offered by other lenders who haven’t advertised.

We have simplified the task of understanding your choice by graphing an overview of the industry. Take 5 minutes to read this through and then call one of our consultants to discuss any questions you might have.

Remember, to determine the right loan, you must deal with more than just rates and fees. You must first qualify for that particular loan based on equity or savings and income. Secondly, the loan must have the features you need and thirdly, the lender must be able to deliver the level of service you require.

Types of Loans

This loan was designed initially by marketing merchants, allowing them to quote and advertise an artificially introduction low rate in order to achieve sales. The loan gives you a cheaper rate for normally 12 months and then reverts to the standard variable rate for the rest of the term of the loan. Penalties normally apply should you wish to break the term of the loan within the first 3 years.

This is generally not a good long-term choice. The loan does have benefits however for those who have a definite short-term cash flow problem and may be a very good option when the lenders choose to offer “specials” that can be converted to a discounted standard variable rate after the introductory period.

A traditional style loan, the most common in Australia, with repayments calculated as principal and interest generally over a 30-year term.

All variable rate loans may overtime vary the rate that you are charged, by either going up or down over the period of the loan. These tend to be the most flexible type of loans with features such as extra repayments, offset accounts, redraw facilities and repayment holidays. No penalties apply for cancelling or paying out the loan.

Historically, this variable rate loan was initially introduced by the banks as a no-features, no-frills discounted rate in order to combat the entrance of the non-bank mortgage managers who were, at the time, offering lower rates. Over time and with increased market competition this loan has evolved to include some extra features such as extra repayments and redraw facilities. These loans certainly have their place, particularly suiting the rate shopper or those on a tight budget with little extra cash for extra loan repayments.

Some lenders offer discounts either to professionals or to those applying for larger loans. It has become a very popular style of borrowing since the loan has all the features of a standard variable loan along with good discount that increases with the size of the home loan. Annual fees of approximately $300.00 to $400.00 apply which entice the borrower to a set of benefits for the package, including a discount off the normal rate, no application fees and other banking discounts.

Fixed rate loans allow the borrower to lock in the interest rate for a pre-determined term from 1-10 years, ensuring that loan repayments will not change over that term. This is particularly useful for those on a tight budget and those with large borrowings who need the security of a fixed repayment without having to feel at risk of interest rate hikes. It is also very useful for investors who are looking to secure their cash flows.

The disadvantage of fixed rates is that they tend to be inflexible. Extra repayments are usually very limited, redraw is not allowed and penalties for early payout can be quite stiff.

However, some lenders do allow both extra repayments and redraw on fixed rates so if that is what will suit you, make sure to ask your broker which lender offers such features.

Traditionally an overdraft facility, these loans were brought into the consumer arena for financial planners designing quick, non-tax deductible, debt reduction for their high-income earning clients.

A line of credit is essentially a giant credit card where funds can be drawn up to a pre-determined approved limit. Any funds paid into the loan can be drawn out again up to the limit. Used properly, this style of loan can significantly reduce interest costs.

This loan is suited firstly to cautious spenders and controlled budgeters who have fairly significant excess monthly savings, looking to pay their loan off sooner. Secondly, the loan is commonly used by investors for flexible access to unutilised equity in their own home in order to make further property or share market investing. An excellent tool for wealth creation through the use of a global limits across your lending portfolios.

Some lenders will allow you to apply a ‘global’ limit to all your secured property loan with that one lender. This feature is used extensively by financial planners who set their clients up with an equity loan to purchase shares on a regular basis. This loan is ‘tied together’ with the owner occupied loan which, when it reduces, will release equity to the investment share loan for the further purchasing of shares.

These are normally principal and interest loans which are also used as transaction accounts. All income is paid directly into the home loan and living expenses are withdrawn from the loan, similar to a line-of-credit in operation except that the loan is reducing or amortizing. This loan is suited to borrowers who don’t have 20% deposit funds and yet have fairly high disposable income.

It is possible to combine different loan types from one lender. The usual scenario is to have 50% of the loan variable to allow flexible repayments with potential for redraw, the other 50% fixed in order to reduce the risk of rising or fluctuating interest rates. However, any combination is possible. Investors may wish to separate tax-deductible debt from non-tax deductible debt via the use of a combination loan. Entry costs on combination loans differ significantly, so please check with our brokers.

Interest only loans require no principal payments. The maximum term allowed is usually 5 years with either a variable or a fixed rate option. These loans are useful for investments where the interest charged is deductible and the investor is not looking to reduce the loan balance as it is preferable and tax effective to reduce other non-tax deductable debt first.

These loans allow a borrower to bridge the time gap between the sale of their home and the purchase of another. Particularly useful if the purchase property has to settle prior to the sale of the existing home. Lenders qualify your maximum borrowings based on the final debt after sale, whilst taking into account interest charges that will occur on the whole debt for six to twelve months. This can be an expensive form of financing and it is imperative you talk to one of our brokers to confirm suitability.

A loan that has been approved to a certain limit for a certain borrower, draw down of the loan or settlement being subject to the borrower locating a suitable property as security for the loan. This is an excellent start to property purchasing, allowing borrowers confidence in their bid for contract acceptance. It gives confidence to the seller’s agent who would be more ‘inclined’ to accept an offer from a purchaser who can demonstrate the lenders intention to offer finance.

These loans are used by investors traditionally at the end of the financial year. The product offers a discounted fixed rate loan that allows the customer to pay all of their interest for the next financial year in advance. It is a tax effective strategy of property investment.

These loans are ideally suited to self-employed borrowers who either have not had their required tax returns completed or have complicated trust structures and multiple entities.

“Low Doc” means “low documentation” ie minimising the paperwork required to support the application for a loan.

“No Doc” means even less paperwork, ie simply complete an application form with a supporting letter from your accountant.

This style of equity lending has become popular for its simplicity. It suits both the borrower and the lender. The advantage for the borrower is that once you have acquired equity in a property, you now have an opportunity of securing finance without having to provide reams of paperwork as evidence of your income.

Its simplicity makes it a winner. These loans are however restricted to the self-employed. Lenders may apply restrictions on LVR, location of the security property and size of the loan. They are normally slightly more expensive than traditional loans due to the higher risk profile. The lower the LVR however, the greater the chance of reducing the interest rate charged.

There are a number of lenders who specialise in providing loans to individuals who have a poor credit history, ie a history of defaults, judgments or bankruptcy. Their intention is to provide credit to individuals who would otherwise not be able to borrow, the objective being to get the borrower back on track so that in a couple of years the borrower is able to re-enter the mainstream mortgage market. The interest rates levied are dependent upon the applicant’s credit rating and are higher than normal bank interest rates.


Loan Features

A loan with a redraw facility allows access to advance payments or extra payments made to the loan account. This feature allows extra payments to the loan, helping to reduce interest costs, whilst still having access to the funds in the future. A fee may be charged when the funds are redrawn and some lenders have minimum redraw limits.

Tip: Always try and apply for an extra $5000 – $20,000 which you can pay straight back into the loan after settlement. These funds will then be available for redraw.

A loan with a normal transactional account linked to it with any funds deposited into that account, offsetting the balance on the home loan and thereby reducing the interest charged on the mortgage. For example, if your home loan balance is $150 000.00 and you have $10 000.00 in your offset account, you will only be charged interest on $140 000.00.

These style loan features suit most borrowers but especially those with good disposable income and frugal spending habits. All monies earned be it salary, rent or investment income can be deposited directly into the offset account to immediately reduce the interest being charged on the home loan. It is also possible to delay expense withdrawals from this account by utilising a credit card for monthly bills, thus enhancing the benefit of an offset account.

Mortgage offsetting is a tax effective tool because the account itself earns no taxable interest thereby legally minimising taxable income. Please refer to your financial planner or accountant before making tax related decisions.

Most loans have this feature however in limited and differing options. If a loan is variable you generally may pay any amount into it without incurring penalties. If the loan is fixed, the major lenders will limit the extra repayment to approximately $10 000 pa. Some lenders do allow unlimited extra repayments and redraw on fixed rate loans, however potentially large penalties apply if you pay out the loan during the fixed rate term.

Typically, lenders will allow you to reduce or avoid making payments for up to 6 months if your circumstances change due to maternity leave or the temporary loss of income due to illness. This is however dependent on the particular lenders, the term of your loan and on your commitment with the lenders.

This feature allows you to have multiple loan accounts. Particularly useful for friends who partner up to purchase property together. With multiple loan accounts they can each be responsible for their own loan repayments.

You can also split your loan into various proportions so that you can have different fixed rates on different portions or have part fixed and part variable.

Another reason to split your loan is if you are using one security property to secure both tax deductable debt and non-tax deductable debt. The tax deductable portion could be an interest only, variable or fixed rate loan with its own separate loan statements that will make it easy accounting at tax time for both your accountant and the ATO. That loan would need to have an investment purpose such as shares or property.

A great feature to have if you could simply move from one home into another on the same day. On that day the bank substitutes our property for the other as security for the loan, with no change to the loan.

The negative, of course, is that this rarely happens because of the timing of sale and purchase. It is also an appropriate time for the purchaser to re-educate themselves on the other market offerings by talking to their mortgage broker to secure a better loan.

This feature allows you to have your salary paid directly into your home loan. If you do not have a 100% offset account than this can be an efficient way to run the home budget. Living expenses are then withdrawn from the home loan.

If you have the ability to salary sacrifice into your home loan, then you will need this feature so that your employer can transfer funds directly into your loan account.

 

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