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Get familiar with home loan types

Fixed rate loan, or variable rate loan with offset feature? What are they and which is best for you?
In Australia, there are various types of home loans available, each with its own advantages and disadvantages to consider before making your final decision on structuring your home loan. Understanding these options will enable you to make a well-informed choice that supports your financial goals. The following are among the most common types of loans offered by banks and lenders:
FIXED INTEREST RATE LOAN:
A Fixed Loan is a type of loan where the interest rate offered is locked in for a specified period. For instance, you might be offered a fixed interest rate of 6.45% per annum over a 3-year period. Opting for this option means your loan repayments are fixed for 3 years, and you will only be charged interest at the rate of 6.45% per annum throughout this period. While short-term interest-only fixed rate loans are available, most fixed rate loans require both principal and interest repayments.

  • Advantage

    • Locking in a rate can be highly advantageous when interest rates are on the rise. By fixing your interest rate, you secure a set rate that applies to your loan for the entire duration of the fixed term, regardless of any increases in market interest rates during that time.
    • This ensures that your repayments remain stable and predictable throughout the fixed rate period, providing you with certainty and peace of mind regarding your loan obligations. It shields you from potential fluctuations in interest rates that could otherwise impact your monthly payments if you had a variable rate loan.

  • Disadvantage

    • When interest rates are decreasing, choosing a fixed rate means you are committed to paying the rate that you locked in, even if new borrowers can secure lower rates. Additionally, if you wish to make extra loan repayments while on a fixed rate, you may incur additional fees.
    • Many lenders permit you to repay up to 10k of the principal balance annually without penalty, but exceeding this limit could result in charges. Therefore, if you anticipate making occasional additional repayments, it might not be beneficial to fix your entire home loan or any part of it.
VARIABLE INTEREST RATE LOAN
A Variable Rate Loan, also known as a Floating Rate Loan, is subject to interest rate fluctuations that can move both up and down in response to market changes. Unlike a fixed rate loan where the interest rate is locked in for a specified period, a variable rate loan offers flexibility but with potential changes in repayments.For example, you might secure a floating rate of 6.00% per annum on a $100,000 home loan, but this rate can vary at any time during the loan term. As interest rates fluctuate, so do your repayments, which are calculated based on the prevailing interest rate. Typically, changes in variable loan rates correlate with movements in the Official Cash Rate set by the central bank.

  • Upside

    • If interest rates are declining, you will benefit from the lower interest rates. And if you keep repayments the same during this period, you could potentially pay off your loan faster.
    • A variable rate loan provides you with the flexibility to make lump sum repayments without any extra costs being charged
    • Also a variable rate loan may come with an offset feature, which lowers your interest payments and reduces the costs of the loan

  • Downside

    • If interest rates increase, you will have to pay more interest.
    • Your minimum repayment amount may rise or fall at any time, so if you are on a tight budget, this could be a problem for you.

Loan with an offset account

A loan with an offset account allows you to link multiple bank accounts to your home loan. The funds held in these accounts reduce the outstanding balance of your loan, effectively lowering the interest payable. Rather than earning interest on your savings separately, you save on interest payments for your home loan. Essentially, interest is calculated on your home loan as if your savings were directly used to reduce the loan balance, while still keeping the funds accessible for your use whenever needed. This setup provides both interest savings and liquidity.

  • Downside

    • Interest rates on these products are typically higher.
    • The interest rate is variable, not fixed, so your repayments can vary with changes in interest rates.
    • You do not earn interest on the savings in the offset account.
    • There may be monthly fees associated with maintaining the offset account.
    • These features provide flexibility and potential interest savings on your home loan balance, but they come with the consideration of higher interest rates and possible fees.

  • Upside

    • Using an offset account can potentially save you money because your savings help reduce the balance of your mortgage, which typically carries a higher interest rate than savings accounts.
    • While you do not earn interest on the savings in the offset account, you retain full access to these funds.
    • Additionally, since offset mortgages are typically variable rate loans, you can make extra repayments without incurring penalties.
    • This setup offers both flexibility and the opportunity to save on interest costs over time.

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