Mortgage types

There are a large number of different mortgage options on the market - all suited to different lifestyles and circumstances. It can be confusing understanding all the features of the different products and knowing which one to choose.

Principal and Interest Mortgages

With a principal and interest mortgage your minimum monthly repayments cover both capital and interest on the loan, therefore with each payment made; your mortgage balance owing is reducing.

Interest Only Mortgages

With an interest only mortgage, your minimum monthly payments to the lender cover only the interest on the loan. At the end of the interest only period, the loan reverts to a principal and interest mortgage.




Note

Note: You can still make principal payments on an interest only mortgage during the interest only period, provided it is a variable rate.

Example: If capital gain is your objective, you’ll more than likely want to look at borrowing on an interest only basis. This means that you can minimize the cost of owning your investment property and receive the full benefit of tax deductions.

Interest rate options

Once you've decided on whether you are going to make payments on the capital or not, you need to turn your mind to interest rate options. There are many different ways of calculating the interest due - all of which have their advantages and disadvantages, depending on your circumstances.

Standard Variable Rate

The simplest form of loan is one which sets its interest rate according to the lender's standard variable rate (floating). With a loan like this, your interest payments are likely to rise or fall every time there is a change in the Official Cash Rate, as determined by the Reserve Bank.

Advantages

  • You can make additional repayments as often as you like
  • You are able to build your equity at a faster rate
  • You can pay your loan off faster

Disadvantages

  • Rates are often difficult to forecast
  • Rates are subject to change
  • Unable to redraw back funds if additional payments have been made.

Revolving Credit

Revolving credit is a variable loan and works like an overdraft and becomes a transactional account. Your pay goes straight into the account and bills are paid out of the account when they’re due. By keeping the loan as low as you can at any time, you pay less interest because lenders calculate interest daily.

You can make lump sum repayments and re-draw money up to your limit. Some revolving credit mortgages gradually reduce the credit limit to help you pay off the mortgage. Some Lenders may charge a fee for this facility.

Advantages

  • If you're well organised, you can pay off your mortgage faster. This also suits people with uneven income as there are no fixed repayments.
  • Putting surplus funds into this account rather than a separate savings account will give bigger interest savings and also avoids the tax on the savings account interest.

Disadvantages

  • You need discipline. It can be tempting to always spend up to your credit limit and stay in debt longer.

Fixed Rate

A fixed rate loan charges a set rate of interest for a predetermined period, and then usually reverts to the lender's standard variable rate. Fixed rate loans shield home owners from potential changes in the Official Cash Rate (OCR), as determined by the Reserve Bank.

Advantages

  • Your payments are set for a period of time
  • Fixed rates are generally lower than variable rates
  • You are not impacted by any increase in rates

Disadvantages

  • Often charged a penalty for making additional payments
  • If rates fall, you remain locked into the higher rate until expiry date. Break costs can be expensive.
  • Cannot access redraw (additional repayments)

Redraw Facility

A redraw facility works the same way as a revolving credit facility, except your transaction account is separated from your mortgage. This type of loan has the same advantages as the standard variable rate with the advantage of being able to redraw funds if additional payments have been made.