Home Loan Options
When it comes to deciding on the best home loan for your lifestyle and finances, one of the most important considerations is your choice of interest rate option. That is... fixed, capped, floating or a combination of these? Firstly, what do each of these terms mean?
Fixed rate home loan
A fixed rate home loan is a mortgage in which the interest rate does not change during the term of the loan, which anywhere from six months to five years. At the end of the term, a fixed interest loan automatically moves to a floating rate, unless you negotiate another fixed term. Advantages include knowing exactly how much each repayment will be over the term, the ability to lock into lower rates if market interest rates are rising, and the fact that rates are often lower than floating rates. Disadvantages include the fact that you cannot normally make lump sum payments, without paying a penalty. And, if you decide on a long term, there is a risk that floating rates may drop below your fixed rate.
Capped rate home loan
A capped rate home loan is a variation of the fixed rate home loan, with the assurance that the interest rate cannot rise, but will decrease if floating rates drop below the capped rate.
Floating rate home loan
With a floating rate home loan (also known as a variable home loan), your payments may go up or down, depending on what's happening with the interest rates. Advantages include being able to increase your repayments or make lump sum repayments without being penalised. Disadvantages include the fact that floating rates are often higher than fixed rates, and you will experience a tightening on your budget, if rates (and thus repayments) go up. It is, however, possible to split a home loan with a combination of fixed and floating rates. This allows you to make extra repayments without penalties on the floating portion, while you get lower rates on the fixed portion. Deciding which interest rate option is best for you depends on your priorities. For example, if your overriding goal is to shorten the term of your home loan, then a floating rate loan would be best as it enables you to can make extra repayments at no cost. If, on the other hand, you need the security of fixed repayments, then a fixed interest rate home loan is the one for you (this option may be especially useful for long-term residential investors who perhaps need to match their repayments to their rental income). Other considerations when deciding on the best home loan for your circumstances is deciding whether to take out a table loan, revolving credit loan or interest-only loan.
A table loan is the most common type of home loan. You choose a term (up to 30 years with most lenders), with most of your early repayments going towards interest and only later payments going towards paying off the principal amount you borrowed.
Revolving credit loan
A revolving credit loan works like a large overdraft. Your salary or wage goes straight into the account and bills are paid out of the account when they are due. By keeping the loan as low as possible at any time, you pay less interest because interest is calculated daily. You can, however, make lump sum repayments and even re-draw money up to your limit. Some revolving credit mortgages gradually reduce the credit limit to help you pay off the home loan. With interest-only loans, you don't repay the money you've borrowed (except for interest) until an agreed time... or a year or two down the track, before switching to a table loan. If you're not sure which interest rate option or type of home loan is best for your circumstances, lifestyle or financial situation, seek advice from your mortgage broker or lender.