What are the Different Types of Loans?
Whatever flexibility you want/need in a mortgage, chances are it's out there. But remember, these features don't come for free. You can expect to pay for extra features with slightly higher loan account fees, therefore it is wise to choose these extras only you will actually use them.
Loans that require regular periodic payments of principal and interest over a loan term:
? Basic Variable Rate Loan: The interest rate rises and falls with market changes. Generally inflexible, but often the least expensive type of loan if you don't plan on making adjustments to the loan. There might be penalties for early repayment.
? Standard Variable Rate Loan: As above, but with extra features and flexibility. Usually slightly more costly than the 'basic' loan, but might allow you to make more frequent repayments to save interest. You may be able to pay out your loan early without penalty, or use an 'offset' account (see below) to reduce interest. May also allow limited redraws. (see below) SVRs are generally a couple of percentage points or so higher than base. As the Reserve Bank moves its rate up and down so lenders move their SVRs. But beware, lenders aren't required to pass on the full move, so even if the Reserve Bank cuts rates by 0.5%, your lender might only change its rate by say 0.35%.
? Fixed rate loan: The interest rate is fixed by the contract and cannot change, regardless of market fluctuations. The interest rate may be fixed for a set period, most commonly 3 or 5 years, after which you can choose to renegotiate another fixed rate term or revert to a variable rate for the remaining period of your loan term. Offers security when interest rates are rising and gives you the ability to budget accurately as your repayments don't change in the fixed rate term. Not as flexible as a variable rate loan as your ability to make extra or lump sum repayments is limited. You can incur large fees for extra repayments or breaking a fixed term loan.
? Split loans: Combination of fixed and variable that fix interest on only part of the loan: Interest on the fixed interest portion is fixed for a set period, typically up to five years. Some loans revert to standard variable rate automatically at the end of that term. Others leave scope for re-negotiation. Offers you the flexibility of a variable rate loan along with the security of a fixed rate loan.
? Can cost more in account and establishment fees as you have two loan accounts instead of one.
? "Honeymoon" loans: These loans offer low 'introductory' interest rates for a short period, typically 1 to 2 years, before reverting to higher standard variable interest rate. Can help when you are coping with the initial costs of purchasing and moving. Be careful to budget for increased repayments. Many buyers have lost their homes because they made the mistake of budgeting based on lower initial repayments, and could not manage the higher repayments.
Other Loan types include:
? Interest only loans: Usually short term, up to 5 years. Interest may be fixed or variable. You pay regular periodic payments to cover the interest, but you don't have to repay the principal until the interest only period expires. Usually considerably more expensive overall, because reducing the principal reduces the interest cost. Used frequently for investment properties as the owners select the minimum repayment possible and ?buy time? for the investment property to increase in value. Helps when short-term cash flow is tight. You can secure a property without agreeing to large monthly payments. And remember that if you can't pay it on the due date, the lender might not be obliged to extend or renew your loan agreement.
? Bridging loans: Short-term loans, often used if you want to buy a new home, but the sale of your current home hasn't completed, or you have other assets you need to sell to fund your purchase. Helpful short-term, especially if you fall in love with that dream home and want to secure it. These loans are generally more expensive, and if you are unable to sell your existing asset for the expected price or within a reasonable time, you could end up in serious trouble. Plan carefully!
? Vendor finance: Loans, or deferred payment agreements offered by the seller of the property. Usually short-term, or for only a portion of the price. Often offered by vendors who are struggling to sell their property at the asking price, or for properties that banks are reluctant to finance (e.g. tiny studio apartments, or farms). Can be very attractive if the terms are right, but make sure you understand why the vendor has resorted to this strategy to close a sale, and consider potential risks carefully.
? Line of Credit: A Line of Credit is like a giant credit card facility secured against your property. The lender agrees to you drawing loan funds as needed, up to an agreed limit. The interest is charged to the account regularly. You can add to the balance of the account and spend money from it, provided you don't exceed the agreed limit. Depending on the terms, you may be required to pay a minimum amount each month or have the interest expense capitalised (using available funds to cover the interest repayments). Often comes with a cheque book and credit or debit card, for convenience. Can save a lot of interest by allowing you to pay all of your income into the account (thus reducing the balance considerably), then pay your bills from it as they fall due. It can also put cash at your disposal for unplanned large purchases, without you incurring interest costs on any unused funds. Be aware that if the lender doesn't renew the agreement at the end of a term, you may have to refinance in a hurry! These loans are great for good money managers and a disaster for those who can't budget. Be honest with yourself when entering this type of agreement!
(comments need to be approved before they will be displayed)