We get asked a lot about the different types of loans you can take, and there is often a lot of confusion about how these can and should be set up. The golden rule is that it's important to get the structure that's right for you - your family situation, income, and future plans.
There is no one-size-fits-all approach here but it's useful to understand what different types of loans there are and how they work.
Fixed interest rate loans
With a fixed rate home loan the interest rate you pay is fixed for a period of six months to five years. At the end of the term, you can choose to re-fix again for a new term or move to a floating rate.
- You know exactly how much each repayment will be over the term.
- Lenders often compete with fixed rate specials.
- You can lock in lower rates if market interest rates are rising.
- Fixed rates often have limits on how much you can raise repayments or make extra payments without paying charges.
- If you take a long term, there is a risk floating rates may drop below your fixed rate.
- If you choose to sell your property and/or break a fixed loan you may be charged a ‘break fee’.
Floating rate (or variable rate)
Lenders of floating rate loans will lift or lower the interest rate as interest rates in the wider market change, normally linked to the Official Cash Rate (OCR). This is why there is always so much attention to what the Reserve Bank is doing with the OCR, as it can affect mortgage rates, in particular floating rates because it means your repayments may go up or down.Advantages:
- You have more flexibility to make changes without penalty, such as paying off the loan early or changing the loan term.
- It’s easier to consolidate other, more expensive debt into floating rate loans by borrowing more.
- Floating rates have historically been higher than fixed rates.
- When rates go up the repayments also go up, putting a squeeze on your budget.
This is the most common type of home loan. You can choose a term up to 30 years with most lenders. Most of the early repayments pay off the interest, while most of the later payments pay off the principal (the initial amount you borrowed).
You can take a table loan with a fixed rate of interest or a floating rate.
- Table loans provide the discipline of regular payments and a set date when they will be paid off.
- They offer the certainty of knowing what your payments will be, unless you have a floating rate, in which case repayment amounts can change.
- Fixed regular payments might be difficult for people with irregular income.
An offset mortgage setup can reduce the amount of interest you pay on your mortgage. Typically, interest is payable on the full amount of a loan. But by linking your loan to any savings or everyday accounts you already have, you pay interest on that much less.
For example, someone with a $400,000 mortgage and $20,000 in savings would only pay interest on $380,000. Subtract the savings from the total loan amount, and you only pay interest on what’s left.
Only a few New Zealand banks offer this option, not all banks. And it’s only useful if you have a decent amount of savings. The more cash you keep across your accounts from day to day, the more you’ll save, because interest is calculated daily. Linking as many accounts as possible – whether from a partner, parents, or other family members – means even less interest to pay.
- You pay less in interest and pay off your mortgage faster.
- Typically there is no fixed term.
- The linked savings accounts do not earn any interest when they offset a loan. That said, interest on debt is typically higher than the interest you would earn on savings, which makes the offset worthwhile.
We pay the interest-only part of our repayments, not the principal, so the payments are lower. Some borrowers take an interest-only loan for a year or two and then switch to a table loan. With New Zealand banks, this is now moving towards an option which is only really offered to investment (rental property) loans, or those who live in their own home and have a really good reason for requiring interest only (like large renovations or renovating to sell).
- You’ll more cash for other things, like as an investor putting money towards another deposit for a property or doing maintenance
- Ultimately it costs you more. You will still owe the full amount you borrowed until the interest-only period ends and you start paying back the loan.
We decided this one deserves a full explanation, because although these facilities are becoming more and more popular. We’re constantly seeing them not being used to their full potential or being set up wrong and costing people more money than they should. We've actually written a full blog here about revolving credits and how to get the most out of these.
In deciding what loan structure to take on your home loan, it's important to get the right advice for you. We look at a range of different factors and ultimately we like to keep things simple.
For personalised advice about which loan structure to take, please get in touch with us. We're always happy to help.
Adam, Claire, Greg and the My Mortgage Team.