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Decisions on home loan type and features can pile up for anyone thinking of signing up for a home loan: Fixed versus variable? Interest only or principal and interest? Packed with features or plain and simple?
Understanding loan types and features are vital to deciding the most appropriate loan for your needs.
The most common type of mortgage is a variable rate home loan, where interest rates move up and down loosely based on Reserve Bank of Australia official rate moves.
Variable rate loans generally allow extra repayments to be easily made, they often have more features and are can be easier and cheaper to easier to switch loans.
However, if official rates rise sharply, borrowers might be hit with budget-busting higher costs.
Fixed rate mortgages offer certainty of repayments, but usually come with less flexibility.
Loans are fixed for a period usually between one and five years, which makes budgeting easier and protects you from rate rises. However, fixed rate loans mean you miss out on RBA rate cuts, the loans generally have fewer features than other loan types, and can come with break fees if you try and exit the loan early.
The Australian Securities and Investments Commission (ASIC) says fixed rate home loans may not be suitable for those thinking about selling their home in the near future or those hunting for a better mortgage deal.1
There is a compromise in the fixed versus variable debate. It’s called a split loan.
Many lenders allow borrowers to have part of their loan variable and part of their loan fixed.
The benefit is you get to experience the positives of both types of loans, but the drawback is you also experience the negatives.
The most common repayment method is by principal and interest, which reduces a portion of the loan principal every payment until eventually the principal repayments exceed the interest repayments.
This means that your mortgage debt falls over time, hopefully while the value of your home is rising – growing your stake in it.
Popular with investors and first home buyers on a tight budget, interest only mortgages have lower repayments than principal and interest loans, but the downside is that no dent is made in the loan principal.
This means that borrowers must rely solely on capital growth to increase their stake in their property.
It should also be noted an interest-only period generally applies to the loans, and they then revert to a principal and interest loan.
Borrowers should understand the different features offered by a home loan, and whether it is worthwhile potentially paying more in fees or the interest rate to access them.
Key mortgage features may include:
1 Moneysmart.gov.au Guide to fixed vs variable rate loans
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