How Different Mortgage Types Work

Fixed Interest Rate Loans

With a fixed rate home loan the interest rate you pay is fixed for a period of six months to five years. At the end of the term, you can choose to re-fix again for a new term or move to a floating rate.

Advantages:

·      You know exactly how much each repayment will be over the term.

·      Lenders often compete with fixed rate specials.

·      You can lock in lower rates if market interest rates are rising.

Disadvantages:

·      Fixed rates often have limits on how much you can raise repayments or make extra payments without paying charges.

·      If you take a long term, there is a risk floating rates may drop below your fixed rate.

·      If you choose to sell your property and/or break a fixed loan you may be charged a ‘break fee’.

·      Capped rates are a variation where the interest rate can’t rise above a certain point, but will drop if floating rates drop below the capped rate.

Floating Rate (or Variable Rate)

Lenders of floating rate loans will lift or lower the interest rate as interest rates in the wider market change, normally linked to the Official Cash Rate (OCR). This means your repayments may go up or down.

Advantages:

·      You have more flexibility to make changes without penalty, such as paying off the loan early or changing the loan term.

·      It’s easier to consolidate other, more expensive debt into floating rate loans by borrowing more.

Disadvantages:

·      Floating rates have historically been higher than fixed rates.

·      When rates go up the repayments also go up, putting a squeeze on your budget.

Mixed Rate – Fixed & Floating

You can split a loan between fixed and floating rates. This lets you make extra repayments without charge on the floating rate portion. Splitting a loan can give you a balance between the certainty of a fixed rate and the flexibility of a floating rate. How much of your loan you have in each portion depends on which of these is more important to you.

Revolving Credit Loan

Revolving credit loans work like a giant overdraft. 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 possible at any time, you pay less interest because lenders calculate interest daily.

You can make lump-sum repayments and redraw money up to your limit. Some revolving credit mortgages gradually reduce the credit limit to help you pay off the mortgage.

Application fees on revolving credit home loans can be up to $500. There can be a fee for the day-to-day banking transactions you do through the account.

 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:

·      It needs discipline! It can be tempting to always spend up to the credit limit and stay in debt longer. 

Interest-Only

We pay the interest-only part of our repayments, not the principal, so the payments are lower. Some borrowers take an interest-only loan for a year or two and then switch to a table loan. The normal table loan application fees apply.

Advantages:

·      We have more cash for other things, such as renovations.

Disadvantages:

·      Ultimately it costs us more. We will still owe the full amount that we borrowed until the interest-only period ends and we start paying back the loan.