Types of Home Loans
We will look at various types of home loans available in the market. A mortgage broker will go through these loans and depending on your structure guide you with what will be best for you.
Please note – Some banks may not be able to offer certain types of loans.
Fixed interest rate loan
This is a rate of interest that stays the same for a certain period of time – generally between 1 to 10 years. It’s different to a variable rate, which may go up or down over time. When this fixed term ends, the bank allows a 60-day period for you to make changes to the loan interest term. You can either move to a new available rate or switch to a floating interest rate.
A fixed interest rate loan can help you figure out how much will each of your repayments be over the term. It can help you secure a competitive rate as most banks will have specials on fixed rates to compete with other banks. Generally, fixed rates are lower than floating rates and locking in a lower rate will help you save money over the term.
Since interest component is fixed over the loan term, any breakage of fixed interest loan means you must pay break fee which could be the balance of interest to be paid over the remaining term. The break fee may also be higher if your fixed term loan is longer. There is also a chance of missing out if floating interest rates drop as you have to keep paying at the fixed rate that was set.
Floating rate loan
Floating interest rates changes quite frequently and is also known as variable interest rate. Your interest rate may go up or down over time, which is determined by the lender you have chosen. This means your repayments can change over the life.
With a floating rate you have the freedom to change to a fixed rate term anytime when interest rates drop low. You also have the flexibility to make any extra repayments anytime without paying penalty charges and can pay off your loan faster. Making these extra repayments may also lead to reduced overall interest rate – meaning the more repayments the lower the interest rate may be.
However, floating rates have consistently shown to be higher than fixed rates. So, if the interest rate increases, your repayments will go up as well and which means you end up paying more.
The money in your savings and everyday accounts is offset against your loan balance. Generally, interest is applied on the total amount of your loan. But with offsetting the interest is calculated based on the loan balance and your savings in the account. You will need to link your savings account and your mortgage, and the more the savings the less the interest.
For example, if your home loan amount is 400,000 and your linked savings account has 50,000, you will only need to pay interest on 350,000.
It allows you to pay off your loan faster as you only pay interest on the balance. The interest is calculated everyday and the depends on your savings, so the more you save the less interest you pay. You also have the freedom to pay extra repayments with out penalty. Some banks also allow parts of your home loan to be put as offset loan and enjoy the benefits of other rates as well.
It may not be the ideal option if you tend to spend your earnings frequently as the savings need to be left untouched to ensure lower interest rates.
Reducing or straight-line loan repay the same amount of principal with each repayment, but a reducing amount of interest each time. The principal fraction of your regular payment stays the same throughout the entire term of your mortgage while the interest portion will decrease. Your normal repayment amount is high in the beginning of the term but will steadily decrease overtime. Reducing loans are very rare in New Zealand.
Revolving credit loan
The main idea behind a revolving credit mortgage is to reduce your daily mortgage balance so you can save on interest. This is done by transferring/crediting all your income into the account and paying all your daily expenses and bills from that account as needed. The interest is calculated daily based on the balance of your account. To pay less interest, you will need to ensure the loan amount remains as low as possible for as long as you can.
The advantage with this type of loan is that some banks have a credit limit which constantly decreases to help you stay on track to be debt free one day. This is an excellent option if you are good at managing your finances and have an unsteady income as there are no fixed repayments and allows you to contribute lump-sum amounts towards the loan.
Interest only loan
Interest only loan is self-explanatory. You will have a period in which you will repay the interest charges only – you will not pay back any of the principal. This period is typically up to five years. This type of loan is popular among investors as they often hold on to the property for a short term.
The borrowed amount of the loan does not decrease until the end of term. Once the interest only period has ended, the loan usually will revert to principal and interest repayments – meaning your repayments will increase. This is not an ideal mortgage option if you are wanting to be debt free soon as possible.
With a table loan, the amount you must repay remains the same each time unless there are changes in the interest rate. The beginning payments mainly consist of interest. Overtime as the total amount you owe decreases, the repayments are made up more and more of your principal and less of the interest.
Table loan can either be on a fixed or floating interest rate with a term of up to 30 years. The advantage of a table loan is you know when your loan is going to be fully paid which will help you stay on track. It may not be suitable for people with irregular income.