Choosing the right home loan can be a major decision when investing in property. Which loan is the right one for you though? We’ll go through the different types of loans available below.
Variable rate loans
These are the most common type of home loan. Variable loans do what it says on the tin – your rate will vary based on the national interest rate fluctuations. This means that if interest rates go down, your repayment rate will drop too.
It’s important to remember that this works the other way too – if the interest rates go up, you will be paying more towards your loan.
Variable rate loans offer flexibility, with the ability to repay in advance of the minimum payments. This will reduce the term of the loan and build equity in your property. This is a great incentive for taking out a variable rate loan on your property.
Fixed rate loans
The opposite to variable rates, fixed rate loans have a set interest rate for a certain period of time. Most people who take out fixed rate loans will only fix it for the first few years. It gives them a period of stability and allows them to avoid paying higher rates for extended periods, if interest rates drop.
The challenge with fixed rate loans is trying to figure out when the rates are unlikely to fall any further; essentially locking in the lowest possible rate for your loan.
The main advantage of fixed rate loans is that if interest rates go down, you’ll be able to maintain lower payments whilst everyone else is up to their necks in the new higher rates.
People who locked into 8% fixed rate loans a few years ago, are now not too rapt as there are penalties to get out of a fixed rate.
Fixed rate loans can be perfect for certain situations however. For example a single mum with two children and divorce bills, might want to lock in at 4% for three years to help get things stable and back on track. It’s perfect for her as if it goes down a bit, she’ll still know what her payments are going to look like for a few years.
Split rate loans
Want to lock into an interest rate for some of you loan but not the rest? Well turns out you can do that if you fancy. Split rate loans essentially allow you to have part variable rate and part fixed rate loans.
Many people do this to avoid the fear of being stuck paying more than they need to if the interest rates fall.
Borrowers who fix a portion of their loan amount are likely to lessen the risk and keep their future payment options open. The rest of the loan will be at that variable interest rate. A split can be 50-50, 60-40 or whatever else you want it to be.
These loans are traditionally used when making investments. Interest-only loans allow you to pay off the interest alone, without paying off the actual loan itself.
The thought process behind this method of loaning money, comes in the form of the value of the property. Investors pay the minimum off their loan while waiting for the property to increase its value – then you can sell it off to cover the full loan amount.
Interest-only loans are being regulated quite heavily these days. Traditionally these loans are for investment purposes only because they maximise negative gearing allowances. Banks are however, being asked to look at these loans more closely nowadays.
In short, the regulating bodies for interest-only loans are worried that people will never pay off their mortgage after taking out their loan. Therefore the risk of taking out an interest-only loan is much higher right now.
Low doc loans
Not all buyers in Australia have the luxury of earning regular pay checks. This will have a significant impact on their earning capacity, and therefore their ability to borrow money.
Business owners, freelancers and other self-employed people often have difficulty providing proof of their income to banks, in order to secure a home loan. This makes it harder for banks to decide whether to invest in the person or not.
Low doc loans require far less documentation in order to borrow, but will normally mean that the interest rate is higher due to the increased risk. They may also require a larger deposit.
Rules governing this type of loan have also been tightened recently, increasing the total number of documents required to take one out. For certain self-employed applicants, these loans provide an alternative route into investment money.
It’s becoming ever harder though to take out this kind of loan. Around four years ago it was much easier; you could sign a form that stated you were able to make payments and that was it. Now there is a fair amount more to do before you can borrow.
Low doc loans can have interest rates anywhere from 1-1.5% higher than standard interest rates, with some banks offering as high as 8%.