Not all that long ago, home loans were simple. If you wanted one, you’d walk into a branch or call your broker and you would get one. If you wanted one for investment purposes, there was no difference in price. The only real price differences between products was if you wanted an equity loan (which nobody really needs anymore).
These days there’s a myriad of loan types on offer from lenders (not just banks). This week we explore most of what is on offer.
Owner Occupied Home Loans: These loans are just a standard loan with a weekly, fortnightly or monthly repayment and a thirty year term (sometimes the term can vary depending on the age of the applicant). These are the cheapest products on the market as all banks want a share of this pie. Pricing depends on your risk profile and what kind of lender will lend you the funds. Generally, if you qualify for a bank loan you should be able to achieve 3.85% (comparison rate 3.86%) currently. These loans can also have an offset and redraw facility.
Investment Loans (for residential property): Generally the same as an owner occupied with the exception of price. These loans are generally 0.20-0.50% more expensive but that should be taken as a guide only as we’ve seen some being offered at almost the Owner Occupied Home Loan rates (probably because the lender had capacity under their regulatory cap for this product).
Equity Loans or Line of Credit: These are generally loans up to a pre-approved limit that you can draw down and repay at will. The same can be achieved with a standard home loan (at a much cheaper rate) with redraw and offset facilities. The other major issue with a line of credit is that there are no fixed repayments. So if you have a $1M home and you draw $300k, with an ordinary home loan you have to make monthly repayments. With a line of credit the lender can continue to charge you interest and debit your account each month. You don’t even have to make interest repayments until you reach your credit limit – so if your limit is $800k, theoretically you can spend $500k without anyone pulling you up. Of course, once you get yourself in trouble and are unable to service the loan thereafter the lender is entitled to sell your home and recover their debt. That makes this a very dangerous type of home loan. Whilst we deem these loans to be completely unnecessary, we do get borrowers calling and insisting that they require these loans. Just this week we received a call from a client that had been referred to us. When we tried to advise him on other types of loans he became insistent that a line of credit was what he needed. When we later provided pricing at around 4.20% he tried to argue that he had another broker quoting 3.79%. We advised him to take it. So we double checked and sure enough, he had received a quote for a standard owner occupied home loan with a second tier borrower (nothing wrong with second tier borrowers – we think they’re brilliant). This is not what he had asked for from us. So he wasn’t comparing like for like.
Reverse Mortgage: This is a type of equity loan. There are no repayments as all interest is capitalised. It’s generally for older people that are unable to afford their lifestyles. We will recommend these loans only in exceptional circumstances. When the homeowners have reached a particular milestone – usually death or they move from the house into an aged care facility – the lender recovers their debt by the sale of the house. There are many risks arising from this type of loan and they may be different in each circumstance. I suggest that before taking out such a loan potential borrowers read about the risks here.
Low Doc Loans: These loans are usually preferred by small business owners or those with an imperfect credit history. We are selective which clients we recommend these loans to as they are more expensive than standard home loans (often by 1% or more). They also charge a significant up-front fee. Low-Doc lenders usually lend a lower LVR (maximum of 80%) to mitigate the higher risk. Generally, to apply an accountant must confirm what your income is and that you are able to afford the loans.
Fixed Rate: Currently, the interest rates on fixed rate loans are very attractive (lower than a variable rate loan at around 3.75% (comparison rate: 4.62%) for 2 or 3 years on an Owner Occupied loan) Be sure that the broker/lender carefully explains your obligations should you wish to break a fixed rate loan. It can be an expensive exercise.
Variable rate loans: Again, your broker/lender should explain with these loans the risk is that interest rates rise and your repayments increase. You should be comfortable with a rate a couple of percent higher than what you will initially get.
Split loan: This is where part of your loan is variable and part is fixed. Usually the variable portion allows you to make extra repayments on top of your monthly repayments so that you’re able to reduce the loan quicker. Depending on your view of the world these it can be argued that these loans either halve your exposure to the vagaries if interest rate rises or falls or double them.
So confusion reigns. However, the wide range of products have been developed over time to cater for certain borrowers. Knowing which loan is right for you is the trick. Talk to a broker and have them explain the differences to you and then ensure that they spend time assessing your requirements with what you can afford and which type of loan suits you the best – we’re legally obliged to do that as a minimum.
Better still call us.