Which home loan is right for you? How can you tell when there are so many different lenders, loan types and features available?
It can be confusing, particularly if you are a first-time buyer. Fortunately, we’re here to help explain things, so let’s dive in.
Interest rates versus comparison rates
Interest rates are one of the factors that determine the cost of your mortgage and repayments. Even a small difference in interest rates can have a huge impact on how much interest you’ll pay over the course of the loan
However, rather than just going with the lowest interest rate, it’s important to consider the comparison rate when comparing loans.
The comparison rate is an indication of the true cost of a loan once the interest rate and fees are included. It’s usually expressed as a percentage, making it easier for you to compare the real cost of different loan products.
Loan types
Principal and interest
With a principal and interest loan, you’ll be paying off both the principal (the amount you borrowed) and the interest.
People buying their own home usually opt for this type of loan, as it helps you pay down your mortgage until you eventually own the property.
Interest-only
An interest-only loan allows you to pay the interest you owe on the loan for a fixed period – usually one to five years.
At the end of the fixed period, the loan usually reverts to a principal and interest loan. Some people choose to refinance to another interest-only period at that point.
People buying an investment property often start off with an interest-only loan because the interest is tax deductable. However, interest rates on these types of loans are usually higher. And because you’re not paying down the principal during the fixed period, you will likely end up paying more interest over the term of the loan.
Variable home loan
With a variable home loan, your interest rate will fluctuate. If rates go down, your repayments will decrease, but if they go up, so too may your repayments.
One positive is that often with these types of loans you can make extra repayments, thereby saving on interest and potentially paying off your loan sooner.
Fixed home loan
A fixed rate loan is where you lock in your interest rate for a period (usually one to five years). The key benefit is that you’ll know exactly how much your repayments will be and can budget accordingly.
However, there may be restrictions on paying extra repayments and if you want to end the fixed rate period early (if you sell, for example), you may be up for exit fees.
Split home loan
Want the best of both worlds? With a split loan, you can fix a portion of your loan and keep the rest variable.
This option allows you to budget for the fixed portion and lock in a competitive interest rate, while enjoying any interest rate drops on the variable component and being able to make extra repayments.
Loan features
There are all sorts of loan features that can potentially save you money in interest and shave time off your loan term.
An offset account, for example, allows you to offset any savings in a transaction account against the balance of your home loan.
A redraw facility gives you the flexibility to make extra repayments on your home loan and potentially save on interest, but still gives you access to the funds.
Redraw facilities and offset accounts work in a similar way – they both effectively allow you to reduce the balance of your home loan, which reduces the amount of interest you pay.
So, how do you know which is right for you, or whether you should choose a home loan with both a redraw facility and offset account built-in? To help you decide, here we explain some of the pros and cons of both.
Redraw facilities
With a redraw facility, you can deposit spare funds into your home loan account, but still draw the money back if needed. You can either make extra repayments above the minimum requirement or throw in a lump sum every now and then.
The pros:
- Make extra repayments to reduce the total balance of your loan and potentially pay it off sooner.
- Use it to save money without locking up your funds.
The cons:
- There may be restrictions on how much money can be withdrawn and when. There may not be same-day withdrawal, for example.
- Additional fees may be applicable.
Offset accounts
An offset account is a transaction account that’s linked to your home loan, but pretty much functions as a regular everyday account. Usually, you can deposit money into an offset, make withdrawals and buy things using a debit card linked to it as required.
The main perk of an offset account is that deposited funds are offset against your loan balance, saving you in interest.
Here’s an example of how an offset account works. Let’s say you have a $100,000 loan and $10,000 in your 100 per cent offset account. Instead of paying interest on your $100,000 loan, you will only pay interest on $90,000.
In some instances, lenders may offer a partial offset option, meaning only some of the balance of your offset account is taken into consideration.
The pros:
- Reduces the interest you pay (based on the balance of the account), while still giving you access to your money.
- Your money is working harder for you in an offset account by cutting down your interest.
The cons
- There may be additional charges for an offset account. However, the fees may be worth the interest savings and the added flexibility compared to redraw facilities.
Like to know more?
Deciding between a redraw facility and an offset account largely depends on how accessible you need your extra money to be and your personal circumstances.
In some cases, a combination of both may work – that is, the option to keep your spending money in an offset account and tuck funds you’re unlikely to need into a redraw facility. Speak to us to explore your options.