Home loan structures and interest rates dummy guide
We know all too well just how confusing it can be trying to make sense of the different types of home loan structures and interest rates. So, we have created a quick dummy guide with the pros and cons to help you to make sense of it all. This is a very brief overview to help simplify the topic; you can read more on our website or give us a call on 1300 359 245 and chat directly with one of our loan experts obligation free for a more in-depth discussion.
Types of interest rates
Variable rate loans are subject to fluctuation based on market conditions. The Reserve bank of Australia dictate the movement in the rates however it is then up to the bank to pass on the rate change to you, the consumer based on the Reserve Bank of Australia findings. Variable rate loans (depending on the specific lender and product) usually also allow for an offset facility to be linked to allow you to further save on interest without effecting your monthly scheduled repayment.
Pros – There are no penalties for making unlimited extra repayments under a variable loan. Should your lender announce a decrease in the rate, your repayments will be amended to reflect the new lower rate.
Cons – The lender will schedule a minimum monthly repayment based on your overall loan amount and the rate that is current on the day of your loan settlement however, should your bank advise of a rate increase, your scheduled repayment will increase in-line with the new increased rate. It can therefore make it harder to budget over a longer period of time.
Fixed rate loans allow you to lock in the current market rate for a specific period and your loan is then unaffected within this period by any fluctuations in rate.
Pros – The rate will not move for the set term of the fixed rate agreement. You will know that your monthly repayment for the fixed rate period term will remain the same, making budgeting easier.
Cons – The rate will also not move should your bank announce a decrease in the rates. You are limited to or sometimes unable to make any additional repayments making repaying your loan sooner, harder. If you wish to make changes to the loan (i.e. pay out or refinance) under a fixed term, penalties for breaking a fixed rate agreement can be hefty: they can range from $100 to $20,000+ based on the bank’s terms & conditions. Facilities such as Offset Accounts usually are not an option with fixed rate terms.
You can however request for your loan to be a combination of the 2 rates (a portion fixed and a portion variable) which could assist with budgeting as well as maximise any remaining savings.
Home loan repayment types
Principal and Interest repayments
Principle and interest repayment (P&I) home loan structures allow you to pay off your principal loan amount along with the required interest repayment.
Pros – A loan with P&I repayments will ensure that your loan is repaid within the agreed loan term just by making the minimum required repayment. Additional repayments can be made to reduce your loan balance which will allow you to pay off your loan early. This is ideal for owner-occupied lending. Interest rates for Principle and Interest loans are usually lower than Interest Only facilities.
Cons – Higher amount payable vs Interest Only repayments, less flexibility to change your payments.
Interest Only (I/O) home loan structures, as the name suggests, allows you to make interest only repayments and not pay down the principal loan amount. The initial interest only period can be between 1 and 5 years.
Pros – Reduces your minimum repayment as no principle is being repaid. Interest Only repayments are primarily used for investment properties, to possibly free up some cashflow for further investments or to maximise tax benefits. Interest only repayments can be useful on owner occupied properties as well under the right circumstances (however most lenders will only allow this for a short period).
Cons – Interest rates are higher with most lenders (generally an average increase of 0.25% on top of the P&I rate). Interest only products do not pay off any the principal lending, which means that the loan balance is not being paid down unless you pay above the minimum and the remaining loan term to repay the principle portion is reduced by the selected interest only repayment term. This repayment type is usually not recommended for Owner Occupied Lending unless a lending strategy is being employed.
We are here to assist you in developing and implementing the right home loan structure and interest rate suited to your individual needs. We want you to get the best possible result, so hopefully this has helped to clear a few things up, otherwise please get in touch if we may be of any further assistance.
1300 359 245