Loan types explained

9th May 2016

So, you’re looking for a home loan. Fantastic! The only trouble is, the term ‘home loan’ can refer to a number of different products- fixed, variable, construction, and so on. It’s great that we have ample choice when it comes to our mortgage, but what exactly is the difference?!

To help you understand, we have provided an A-Z listing of the most common loan types, along with a brief explanation of each!

Construction

This option is only available to those who are building or renovating. A construction loan allows you to break the loan amount into ‘progress draws’. For example, if your first invoice is $30,000, your lender will allow you to draw out this amount, and leave the remainder untouched. This means you are only paying interest on the amount you need at each stage, which will save you a lot of cash over time. After construction is complete, your loan will likely be converted to one of the below options.

Fixed

Arguably the most common loan type, a fixed loan means your repayments are locked in at a pre-determined interest rate for an agreed term. You do not need to worry about interest rate fluctuations, so your repayments are literally a case of ‘set and forget’- perfect for those who like to stick to a budget. On the flipside, if you have fixed your loan and interest rates decrease, you could end up paying more than you have to. You also have less flexibility with a fixed loan, as you would likely be hit with break costs were your circumstances to change before the fixed term finishes.

Introductory Rate

Aimed at first home buyers, an introductory loan offers ‘bargain’ interest rates for a short period of time. This can be a great way to soften the blow when you are taking on your first mortgage, as it will ease you into the financial commitment. But be warned- caution must be taken with these types of loans; after the honeymoon period, lenders may increase the rate beyond the norm. It is important to find out what the revert rate will be, before locking yourself into this seemingly attractive option.

Line of Credit

A line of credit, often referred to as a home equity loan, is a flexible transactional mortgage than you can draw down on and then pay back with interest. This loan is obtained by unlocking the equity in your existing home loan.

Low-Doc

Generally aimed at the self-employed who may have difficulty gathering the necessary documentation for approval, Low-Doc loans do not require traditional proof of income. Instead you would sign a declaration to confirm you can afford the loan, known as ‘self-certification’.

Split

A split loan allows you to utilise the benefits of both a fixed loan, and a variable loan (see below). You lock a portion of your money in at a set interest rate, and allow the remainder to fluctuate with the market. This is like balancing out the potential risks, as each loan negates the detriments of the other.

Variable

The other most common loan type, a variable loan means your repayments go up and down as the market interest rate changes. This option can be great as you can take advantage of the low interest rates, and you also have the ability to pay your loan down as quickly as you like- generally without additional costs. The downside of a variable loan is that it is hard to predict what your repayments are going to be, thus making it extremely difficult to budget. You may also experience lenders hiking their interest rates outside of RBA rises, which is a common and sanctioned practise within the banking industry.


So there you have it, the most common loan types explained. Bear in mind, lenders can occasionally throw some curveballs in the mix. They may advertise a product that seems like one of the above, but is actually a complete mishmash with unexpected break costs and the like. Always be sure to read the fine print- or better yet- ask your local broker to do it for you!

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