Potential homeowners in Australia have enjoyed a decade of low and declining interest rates. The Reserve Bank of Australia after the global financial crisis of 2008 have bought down interest rates to record low levels, which was favourable for home loan borrowers.
Recently we have observed signs that major Banks are starting to tighten and increase interest rates which would translate to higher borrowing costs for future homeowners. With this in mind, below are several available loan options for borrowers and a breakdown of pros and cons of each one. When it comes to home loans, there are three main types:
1. Fixed Interest Rate Loan
- A borrower seeks to lock in the interest rate for the period of 1-7 years thus removing the anxiety in case that interest rates rise in the future.
- Fixed interest rate loan is also a good option for people who want to be able to calculate their monthly budgets more accurately and predictably.
- The downside of fixed interest loan is that a borrower would not be able to pocket in the difference should interest rates decline in the future. If a borrower wishes to switch loans during the fixed period some providers charge an exit fee for trying to refinance during the that period.
- Another thing to have in mind is that some flexible features such as a 100 percent offset account and the ability to redraw part of the money that you have already repaid are generally not included in this type of contract.
2. Variable Interest Rate Loan
- Interest rates in this type of loan are determined by lender and could change at any time, as the rates move in sync with official cash rate charged by the Reserve Bank of Australia.
- If the rates decline a borrower will benefit as he would now be paying less for his monthly payment, but the opposite would happen should the rates increase.
- Variable loans also provide additional flexibility to a borrower due to the ability to pay a loan faster through options like extra repayments, a redraw facility and an offset account.
3. Split Home Loan
A home loan arrangement where a borrower can have both fixed and variable interest rates on a loan at the same time. The loan is split into portions with allocation percentage entirely chosen by borrower. Split home loans have the potential to take the best of both worlds and combine it to a single product.
Below is the example from one of our previous clients: The client was considering taking a loan for an owner-occupied property in Box Hill area and an investment property in Glen Iris.
After several meetings, and taking into consideration client’s wishes and all other relevant information we decided to proceed with the following structure:
- Fixed interest rate loan for $870,000 and a period of 5 years was selected for the investment property
- For a $420,000 owner occupied residence loan, the preferred option was a split loan type set up in these terms: $320,000 was a fixed interest rate, 3-year loan and the remaining $100,000 was a variable interest rate loan. This allowed our client to make additional repayments for variable loan part and still have access to redraw while ensuring he was reducing his home loan through extra repayments.
Assumptions: Client had no intention of selling either property for at least 10 years, he was happy to pay the minimum interest only in the investment property but wanted to accelerate his repayments on his home loan and he had a surplus of $20,000 p.a. he could put into the loan as additional repayments.
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The case study is illustrative only and is not an estimate of the investment returns you will receive or fees and costs you will incur.
General Advice Disclosure: This document contains information that is general in nature. It does not take into account the objectives, financial situation or needs of any particular person. You need to consider your financial situation and needs before making any decisions based on this information. If you decide to purchase or vary a financial product, your financial adviser, AMP Financial Planning and other companies within the AMP Group may receive fees and other benefits. The fees will be a dollar amount and/or a percentage of either the premium you pay or the value of your investment. Please contact us if you want more information.