Loans Demystified
There are a lot of different kinds of loan products available and it can be confusing trying to sort through them. It’s important to be informed and understand how a particular loan will work for you, so here are some simple descriptions of the various types of loans you are likely to encounter.
- Standard Variable Rate Loans
- Basic Variable Rate Loans
- Introductory / honeymoon rate loans
- Fixed rate loans
- All-in-one loans
- Lines of credit
- Low documentation loans
- Non conforming loans
- No deposit loans
- Bridging loans
- Professional packages
Standard Variable Rate Loans
This loan is called a standard variable rate loan because it is based on the official Reserve Bank cash rate* and varies over time. Your payments will increase or decrease depending on the movement of the Reserve Bank rate. This is one of the most popular home loans as it usually offers a variety of features such as the option to make additional repayments without penalty, to split your loan, or to redraw funds from the mortgage.
*The Reserve Bank of Australia set the official cash interest rate monthly. This determines how much interest financial institutions pay to use the Reserve Bank’s money. The financial institutions pass interest rate increases or decreases on to their
customers by raising or lowering their standard variable rate.
Basic Variable Rate Loans
This kind of loan is also sometimes called a “no frills” loan. It usually offers a lower interest rate than the standard variable rate, but the trade off is that it also offers fewer features and can be less flexible. You may have to pay additional fees for services like early repayment, or withdrawals, or you may not be able to do them at all.
Introductory/Honeymoon Rate Loans
Honeymoon Rate loans offer a reduced interest rate for a set period – often a year, and then revert back usually to the standard variable rate in effect at the time. They can be either fixed or variable during the honeymoon period. Sometimes
these loans may have an early repayment penalty attached to them to deter you from refinancing elsewhere at the end of the honeymoon period.
Fixed Rate Loans
Fixed rate loans are for a set period of time ranging from as short as 6 months to as long as 10 years. Like their name suggests, the interest rate is fixed for the period of the loan. This offers the certainty of knowing exactly what your payments will be throughout the duration of the loan. Although it also means that if interest rates fall during the loan period, your repayments may be higher than if you had taken out a variable rate loan. Many borrowers split their mortgage between a fixed and variable rate loan to receive the benefits of both products. Fixed rate loans generally limit the amount of extra repayments you can make each year, and often charge an exit fee if you pay the loan out before completion of the fixed term.
All-in-one Loans
Also known as salary accounts, all-in-one loans combine the features of a transactional account and your home loan. Your salary or other income is paid directly into the account and you access your money in the usual way through EFTPOS, ATM, a linked credit card or cheque book as you need. The goal is to keep your funds sitting in the account as long as possible. Home loan interest rates are calculated daily and any additional funds you have in the account will reduce your balance and cut your interest payments. Interest rates for this type of loan may be slightly higher and the entry fee and ongoing fees also tend to be higher than for some other loan products. This type of loan only works for disciplined savers who will ensure that they do not withdraw more money than is going in.
Lines of Credit
This type of loan is also called a revolving line of credit, or an equity line. It works a bit like your credit card, the lender allows you to withdraw funds (which are secured against your property) up to a set limit at any time, generally by writing a cheque or using a special debit card. You make repayments either in full or on a monthly basis. A line of credit is often used to carry out renovations, invest in shares or pay bills. It is attractive because you always have ready access to money. A line of credit loan may have a slightly higher interest rate than loans with a traditional reducing balance. This kind of loan requires discipline to ensure that you stay within your financial limits.
Low Documentation Loans
Low doc loans are generally designed for self-employed individuals and small business owners who have income or assets but find it difficult to supply the income documentation required for a traditional home loan. Some lenders require applicants to complete an income statement, while others may not require any declaration about income, assets or liabilities (a No Doc loan). The less information you are required to provide, the higher the interest rate you can expect to pay or the greater the deposit you will need to have. Low doc loans can be fixed, variable or even a line of credit.
Non-Conforming Loans
Non-conforming loans are intended for borrowers who have trouble qualifying for traditional bank loans. This might include borrowers with irregular income, those lacking a deposit, non-residents, new arrivals in Australia, or someone with a poor credit history. In most cases, non-conforming loans will have a higher rate of interest.
No Deposit Loans
No deposit loans, as the name would suggest, are for individuals who do not have a deposit saved to put towards their purchase. They work well if you have a good cash flow but not much equity. There are three main types of no deposit loans:
- 100% finance for the purchase price of the property ? the buyer pays the purchase costs (stamp duty, legal fees, etc) from their own savings.
- 100% finance for the purchase price of the property ? the buyer pays the purchase costs (stamp duty, legal fees, etc) from grants, such as the first home buyers grant, and/or gifts.
- More than 100% of the purchase price of the property is financed so that the purchase costs (stamp duty, legal fees, etc) are also covered by the loan.
These types of loans tend to have higher interest rates and fees attached to them, and the lender may have stricter qualification criteria. Some lenders require a savings history of at least 6 months.
Bridging Loans
A bridging loan is a short term loan which allows you to purchase a house before you have sold your existing one. You can also use it to build a new house while you are living in the old. The loan is secured by your existing property and the new one. Generally you have twelve months to repay the loan. Although it is a quick solution to allow you to move ahead and purchase the property you have found, bridging loans often come with higher interest rates.
Professional Packages
In order to attract the borrowers they consider most desirable, many lenders offer professional package loans which have discounted interest rates. In the past, professional packages were for individuals in specific professions like medicine, engineering or law. Today professional package loans are targeted towards applicants with a high income or large loan. They are referred to as packages because they usually offer a range of benefits like an offset account, free credit card and, of course, a reduced interest rate. Interest rates can be 0.5% lower than the lender’s standard variable rate or 0.25% lower than their fixed rate, but may be even greater for a large loan.
