Types of Mortgages
Getting a mortgage can be daunting, but choosing a mortgage product can be just as daunting!
There are so many to choose from and it can be hard to know which one suits your needs the best. Plus, the banks and other providers all have different names for their products which doesn’t help.
I have done this guide as a quick explanation of the different mortgage products that are out there. There are more options than these but these 5 products are the most common.
Table Loan (Principal and interest) - fixed
This is the most common type of mortgage – and the one that I started with. The payments that are made each cycle (weekly/fortnightly/monthly) remain the same. In the earlier stages of the loan you will pay more interest than principal but in the later stages of the loan you will pay the bulk of the principal.
For example, my loan started with $416,500. In my first payment I paid my fixed payment of $908.14. The amount of interest on this was $477.09. The next fortnight I paid my second payment of $908.14. The interest amount on this second payment was $476.60.
Positives of this structure:
- Great for budgeting, you know exactly what your payments will be each pay cycle.
- They have a set date when the loan will be paid off.
- Can take advantage of a low interest rate if locked in for longer.
- If the interest rates go up you get the benefit of keeping a lower interest rate.
Negatives of this structure:
- If there is a change in circumstances then the payments can’t be changed.
- If there is a rise in interest rates you will get the benefit of keeping your lower interest rate.
Table loan (Principal and interest) - floating
The structure is the same as the fixed rate loan with the exception that the payments will fluctuate as the interest rate goes up and down. The amount you pay is not locked in (fixed) and the interest rate can vary during the term of the loan.
Positives of this structure:
- Lump sum payments can be made at any time. So if come into extra money, this can be put on the loan to reduce the amount owing.
- If interest rates go down, your payments will go down and the amount of interest paid goes down.
Negatives of this structure:
Payments can increase as the interest rates go up.
Revolving credit
Revolving credit acts like a big overdraft. You can have access to the money at any time up to a limit, and can repay or withdraw money whenever you need it. The trick to paying as little interest as possible is by making sure all your money is sitting in this account (like savings). You will also want to make sure that your pay goes into this account and any bills are paid out of it.
Some banks will reduce your limit over the loan term to ensure that you still stay on track to being debt free.
Positives of this structure:
- It gives you the ability to pay your mortgage off faster provided you are able to be well organized.
- Suits people with income that varies (e.g. commission-based roles) as you can manage your day-to-day expenses still.
- You can save a lot of money on interest by keeping your balance as low as possible.
Negatives of this structure:
- You will need to have discipline to make sure you don’t spend up to your limit all the time.
- Interest rates are typically higher than fixed rates.
Tip: you can split your loan and fix some of it and make the rest revolving credit. That way you are paying a low interest rate on the bulk of it and putting your savings in the revolving part.
Offset
An offset loan is used to help reduce the amount of interest payable on a loan. Generally you will pay interest on the full amount of a loan however, with an offset loan you will pay interest on the loan amount MINUS the amount of cash you have in linked accounts.
For example, if you have a $500,000 loan and $30,000 in savings, you will only pay interest on $470,000.
Positives of this structure:
- You can link as many accounts as possible to help reduce the amount to pay. That includes other peoples savings accounts too if you want!
- Interest is calculated daily so the more cash you have the less interest you have to pay.
- Gives you the ability to pay off your mortgage faster.
Negatives of this structure:
- Savings accounts won’t earn any interest – but with interest rates so low right now that isn’t such a problem.
- Interest rates are typically higher than fixed rates.
Tip: you can split your loan and fix some of it and make the rest as an offset. So if you know you will have $50,000 in savings then you can offset $50,000 and fix the rest for a lower interest rate.
Interest Only
This is a loan form that is becoming less and less common but still relevant. You will only pay the interest portion on your loan and nothing for the principal. These loans can typically have a maximum term of 5 years before switching to one of the other loans.
Positives of this structure:
- You are paying less in repayments, freeing up your cash for other things like renovations.
Negatives of this structure:
- Ultimately it will cost you more in the end. You will still owe the full amount and will need to start making payments
Not sure which loan structure works best for you? Then get in touch with me. As a registered financial adviser I can now help with all aspects of a mortgage.
