Mortgage features to consider
Principal and interest loans and interest-only loans
Most people take out a principal and interest home loan, where you make regular payments against the principal (the amount borrowed) as well as paying interest. This type of loan is designed to be repaid in full over the life of the loan.
A credit provider will usually offer a number of different principal and interest loans, with a range of features such as a redraw facility or an offset account. Generally the more features a loan has the higher the cost will be.
The loan is usually repaid over an agreed period of time, such as 25 or 30 years.
Ask one of the consultants at AMAFG to give you an indication on how much you can borrow or how much your repayments might be.
As the name suggests, your repayment amount will only cover the interest on this loan. The principal amount you borrowed will not reduce unless you choose to make extra repayments. Paying interest only may cost you more over the term of the loan because you’re paying interest on a principal that doesn’t reduce variable, fixed and split rate home loans
Lenders will usually offer several different interest rate options:
- Variable interest rate– The interest rate on your loan can go up or down, usually in line with a change to the official cash rate (but lenders may make changes independently of cash rate changes).
- Fixed interest rate– The interest rate on your loan will remain unchanged for the fixed period. This is usually 2-5 years, after which your loan will usually revert to a variable rate loan.
- Split loan– This is where part of your loan is variable and part is fixed.
Making extra payments
Paying a little bit extra will save you interest and get your loan paid off quicker. However, most fixed rate loans will limit the amount of extra payments you can make each year. There may also be penalties for paying out a fixed rate portion early.
Redraw, offset and line of credit
This is a savings or transaction account linked to your home loan. Your account balance is taken off the amount you owe on your home loan, reducing the amount of interest you pay.
For example, if you have a home loan of $100,000 and a balance of $20,000 in your offset account, you only pay interest on $80,000.
If the balance of your offset account is low, the additional costs may outweigh any benefits you get from having it. Be realistic when calculating the expected benefit an offset account may give you.
Having a redraw facility allows you to pay extra money into your loan that you can take out (or redraw) later if you need it.
The extra money you pay into the loan reduces your loan balance which reduces the interest you pay. Your loan balance will still reduce each month according to the terms of your loan.
Credit providers may impose conditions or a fee to redraw funds. You should check what conditions and charges apply to your loan.
Loans that allow you to have your whole pay credited to the loan account and pay bills or use EFTPOS to withdraw funds are operating with a redraw facility.
Line of credit loans
A line of credit is a loan where a credit limit is set and you can spend up to that credit limit.
Typically you would have your wages paid into the account and pay your bills and other expenses out of the account.
The limit on the line of credit is fixed and does not reduce as you repay the loan. This means you can always draw up to this limit. You will need to repay the loan in full eventually, usually by a specified date, which you will need to plan for.
This type of loan suits someone who is a disciplined and careful budgeter who may have irregular income.
Extra features can mean extra costs
Features like redraw, offset and line of credit can be useful but they may come at a cost. Loans with these features may have a higher interest rate or a product fee, so think carefully about which features you really need.
It is common for people to move house before they have finished paying off their mortgage. Loan portability is a feature that some lenders offer that allows you to transfer your existing loan from one property to another.
It helps the lender keep you as a customer and it saves you money on things like exit fees (banned on loans taken out after 1 July 2011), and application fees (although some lenders may charge you a fee for swapping over the secured property).
Loan portability also allows you to keep features of your loan such as the interest rate, online banking, ATM card and cheque book, as you will have the same lender and loan structure.
Portability is usually only a feature of variable rate loans. If you have a fixed rate loan you may incur break costs so check with your lender first.
To transfer your loan from one property to another, both your sale and purchase properties must settle on the same day, which can be quite difficult to arrange.
Each lender has different rules about loan portability so make sure you understand the portability rules of the loan you are considering. You should also check that there are not more competitive loans on the market from other lenders.
Ask one of the consultant at AMAFG to make sure you are getting the best deal.
Bridging loans, loans for building andrenovating
Bridging loans may be used to manage the transition between buying and selling properties. These are used by people who buy a new home before selling their existing home or who are building a new home.
There are typically two types of bridging loans. After assessing the level of equity available in your existing home, the lender may:
- Offer a single loan taking both properties as security– They will then give you a bridging period (6-12 months) in which to sell your existing property. Generally you will only have to make interest payments during this period. Once the first home is sold, the proceeds are put towards your overall debt and the balance (end debt) will either revert to principal and interest repayments or you will have to enter into a new loan.
- Offer a separate loan for the property being purchased– You will not need to make repayments on this loan during the bridging period. Interest will accrue on the new loan and you will still need to make your normal repayments on your existing home loan. When your existing home is sold and the original home loan is paid out, the outstanding debt on the new property will need to be renegotiated.
Think carefully before taking out a bridging loan. If you don’t sell your existing home within the bridging period, you may have to accept a price lower than you expected, leaving you with a larger end debt to repay.
Loans for building (construction loans)
If you are building a new home, you may need a ‘construction loan’. With this type of loan you withdraw funds in stages, as you receive bills from trades people and suppliers. You’ll only pay interest on the funds you’ve used.
Most lenders offer their construction loans at a variable interest rate. Once the construction is finished, the loan will revert to principal and interest repayments.
Approval for a construction loan often requires plans, permits and a fixed-price building contract.
If you’re an owner builder you may be able to apply for a construction loan without a fixed-priced contract, but the lender requirements may be stricter and the loan amount less.
You can get more information on building a home from your state’s fair trading or consumer protection agency.
Loans for renovating
Basic renovations and home improvements can usually be funded through your home loan. If you only require a small amount for your project, you may be able to redraw additional funds from your current home loan.
With vendor finance the owner (vendor) of a property may offer to provide finance to you as the purchaser.
There are different types of vendor finance. You may pay a higher interest rate than you would for a standard home loan, for example, a vendor loan may be 2-2.5% higher than a bank’s standard variable home loan rate. You may also pay a premium to the vendor over and above the purchase price of the property.
Your rights can vary a lot depending on the vendor finance scheme you sign up to. In some cases you may not have protection offered by the National Credit Act, such as financial hardship provisions. You may also not have access to external dispute resolution if things go wrong.
Under an instalment sales contract or a rent to buy scheme, you may not legally own the property until the final instalment is paid to the vendor. If the vendor has borrowed money to buy the property and they default on their loan, you may lose any possibility of ownership, even though it is not you who is in default. If this happens, your only recourse may be to take legal action against the vendor.
If you are considering vendor finance, you should get independent legal advice.
An instalment sales contract is where you agree to purchase property from the seller through a series of instalments. This type of arrangement is very similar to a bank loan in that you will make principal and interest repayments over a long period of time.
Here are some other features of instalment sales:
- The seller is responsible for all rates, insurance and taxes but will usually require you to reimburse any rates or insurance
- You are responsible for all repairs and maintenance
- You will have an equitable interest in the property
- You can usually refinance with a traditional lender at any time
- If you default on your repayments, the contract could be terminated and you could lose your deposit and any repayments already paid
Rent to buy schemes
Rent to buy or rent to own schemes usually include a standard residential tenancy agreement and an option to purchase the property. Other features of rent to buy or rent to own schemes include:
- The seller is responsible for all rates and taxes
- The seller is responsible for all repairs and maintenance but may encourage you to carry out renovations by offering a sweat equity credit. This is a reduction in the purchase price to compensate you for the work (sweat) you have put into the property
- You will have an equitable interest in the property
- Payments are fixed for the duration of the rental contract
- If you miss any payments, the contract could be terminated and you could lose any deposit credits already paid and forfeit your option to purchase the property
Before you get involved in a rent to buy scheme, contact your state’s consumer affairs or fair trading agency to better understand your rights and obligations.
There are many things to consider before you sign up for a loan.