When it comes to choosing the right loan for you, a low interest rate is not the only thing to consider. There is a range of loan features that make managing your loan easier and sometimes the benefit of a particular feature is essential for your personal circumstances.
We’ll talk to you about the types of loan features that may or may not be essential for you. To begin with, below is an overview of the main types of loans.
First, let’s cover off key terms that you will hear repeatedly:
Principal: this is the amount of money you borrow
Interest: this is the cost of borrowing – an interest fee charged on the outstanding principal/what you still owe the bank
Term: the time you have to pay off your loan.
TYPES OF LOANS
VARIABLE RATE LOANS
The interest rate you pay over the life of your loan is subject to change – as determined by your lender. As the interest rate changes, your repayments will also vary (up and down) over the life of your home loan.
PRINCIPAL & INTEREST
A Principal and Interest Loan is one where when repaying your loan you are making repayments on both the interest and the principal loan amount.
INTEREST ONLY LOAN
A loan when you make repayments, it is only for the amount of interest you owe, you are not paying back any of the principal amount borrowed. You can generally only have an IO loan with the same lender for a period of up to five years, and the interest rate is typically higher than a P&I loan. Once the IO period ends, your repayments will likely be higher as there is now less time remaining on your loan term to repay the principal portion of your home loan
FIXED RATE LOAN
Your home loan interest rate is fixed (will not change) for a specified period – usually one to five years. With a fixed rate, you always know your repayment amount which can help with budgeting, and you are protected from rates rises. However, the downside is that you miss out on the savings if variable rates decrease, and it can be hard to make additional repayments without penalty.
SPLIT LOANS
This is when you fix one part of your loan and the other part has the variable rate. This can give you the best of both worlds – some protection from rising rates though still with the ability to benefit from any rate cuts. Some split loans are used when you have 2 purposes for the money borrowed i.e. part investments part for your own home.
LINE OF CREDIT
This type of home loan allows you to draw from a fixed amount at any time, to fund items of your choice like shares, renovations, education expenses or a holiday. You need strong financial discipline to ensure you don’t continue to use your home loan to fund a lifestyle you can’t afford.
OFFSET LOANS
An offset home loan has a savings or transaction account linked to your home loan. This linked account is called the ‘offset’ account.
The balance of your offset account saves you interest on your home loan.
This is because the balance of your offset account is deducted from your home loan principal when monthly interest is calculated. For example, if you have $20,000 in the offset account and your home loan principal is $350,000, you will only pay interest on a principal amount of $330,000 while the money sits in your offset account. The bigger the balance of the offset account, the bigger the savings on your home loan interest.
