Explaining different types of home loans
There are different types of loans available for your home loan repayments, understanding the differences can help you select which is the most appropriate type of loan for your individual circumstances.
Your regular repayments are the same each week, fortnight or month, unless your interest rate changes.
Every repayment includes a combination of interest and principal. At first, your repayments are made up mostly of interest, but as the amount you still owe begins to decrease, your regular repayment will include less interest and more principal (the amount you borrowed). Most of your later mortgage repayments go towards paying back the principal.
With a table loan you can choose a fixed rate of interest or a floating interest rate. With most lenders you can select a term (how long you’ll take to repay the loan) of up to 30 years.
Pros and cons
- Table loans can help to keep you on track because they have regular repayments and a set date by which the loan will be paid off.
- They provide the certainty of knowing what your mortgage repayments will be (unless your mortgage rate changes, in which case repayment amounts can change).
- Fixed regular repayments might be difficult to make if you have an irregular income.
Offsetting loans, such as TotalMoney, can reduce the amount of interest you pay. They do this by letting you subtract, or offset, for the purposes of calculating interest, your TotalMoney everyday account balances from the amount you still owe on your loan. This type of mortgage has a floating (or variable) interest rate.
The total amount in your TotalMoney everyday accounts is subtracted off your mortgage before the interest is calculated, which means you only pay interest on the difference. For example, if you have a variable interest rate home loan of $100,000 and you offset $20,000 of it using your cheque and saving balances, you’ll only pay interest on $80,000 of your mortgage.
Pros and cons
- If you regularly have money in transaction or savings account you can save on interest and pay off your home loan faster and if you are fully offset you can pay no interest.
- As the rate is floating, it can go higher than fixed term rates and if the interest rate goes up, so will your repayments.
- You don't earn credit interest on your savings.
Reducing balance (non-table) loans
With a reducing balance (non-table) home loan your regular repayments of principal and interest are initially higher than other types of loans, but while your principal repayments remain constant your interest payments will steadily decrease.
With a reducing balance (non-table) home loan, you repay the same amount of principal each period and pay the interest as a separate payment. As the amount you owe gets less, so does the amount of interest you pay each time.
Pros and cons
- Over the life of your loan you’ll pay less interest than you would with a table loan.
- A reducing balance (non-table) home loan can be a good idea if your income is expected to decrease; for example, if you or your partner plan to stop working in a few years time.
- Higher initial repayments on a reducing balance (non-table) home loan make this type of loan more expensive in the short to medium term. It may be more affordable for you to make regular payments of the same amount under a table loan.
Revolving home loans
A revolving home loan, such as Rapid Repay, is sometimes called a "line of credit" or "revolving credit mortgage". It's like having a large overdraft. The idea is to help save on interest by keeping the daily balance of your loan as low as possible.
You can do this by direct crediting all your income into the account and then paying your bills and everyday expenses from the account as you need to. Revolving home loans have a floating (or variable) interest rate.
The interest is calculated on the daily balance of your account, so by keeping the loan as low as you can, for as long as you can, you should pay less interest. Some revolving home loans have a credit limit that steadily decreases to help you stay on track to the day you’ll be debt free.
Pros and cons
- If you're good at controlling your finances you can repay your home loan sooner. If your income is uneven, a revolving home loan may be best for you, because there are no fixed repayments but (depending on the product you select) your limit might reduce each month.
- You have the option of making lump-sum repayments and if you need the money again, you can redraw up to your limit at any time.
- You can help save on interest by putting spare money into this account instead of a savings account.
- You need self-control. If you keep borrowing up to your credit limit you'll end up paying interest on the full loan amount year after year.
- As these are also transaction accounts the usual bank fees can apply for things like deposits, withdrawals and setting up an automatic payment.
An interest-only mortgage can be ideal when you need a home loan, but don’t want to pay off the principal (the original amount you borrowed) just yet. They’re often used for property investment. Some people take an interest-only loan for a year or two and then switch to a table loan.
With this type of mortgage, you don’t repay any of the money you’ve borrowed (principal) until an agreed time — then you repay it all in one sum or you could request to switch to a table loan. In the meantime you make regular interest payments every week, fortnight or month.
Pros and cons
- Because you’re not repaying principal, you can free up cash for other purposes, such as renovations.
- You pay interest on the full amount you borrowed until an agreed time because you are not paying off any principal — then you still have to repay the loan amount (or you might for example request to switch to a table loan).