Ep5: What are the different type of Home Loans?

Welcome to the Weekend Investor.

00:05

I'm Max Lending, your industry insider, and we're lifting the lid on the finance market, guiding you on how to cut through the jargon, manage your finances and get investing into the property market.

00:24

Welcome back, guys, to another episode.

00:27

Also, looking at the numbers the other day and wow, numbers for the podcast are really starting to pick up.

00:33

So thank you guys to all the listeners out there across all the different platforms.

00:38

We really, really do appreciate it.

00:41

The feedback that's been coming in has been great.

00:43

Now if you think that the information we provide is to the point and can potentially help someone that you know, like, share it, send it to your family and friends, it really helps get the word out there.

00:55

But once again, guys, we really do appreciate it.

00:58

Let's get stuck into this week's episode.

01:00

As you guys may know, I've been a industry insider for many years now, and without a doubt, every week there seems to be a theme.

01:09

I don't know what industries you guys are in, but I'm sure you can relate.

01:12

The same sort of questions that week will be coming through.

01:15

And this week the questions have been all around about the different type of home loan products.

01:19

And I was like, eh, well, everyone's asking me about it, so let's do a podcast on it.

01:24

So there's a sea of home loan products offered by the banks, each with a wacky name, all designed to confuse you.

01:33

As an example, an offset home loan is called across the following different banks.

01:39

They call it the package, the plus, the advantage, the freedom, the flex, the choice, the list goes on.

01:50

They're all the same product.

01:52

Each bank's marketing team's really just trying to justify their job.

01:56

So let's cut through the marketing minefield and really break down what type of home loans are available to you and which one is right for you.

02:04

Just before I get stuck into it, I do want to make mention of one thing of this list.

02:09

I'm going to leave out the no document loans, also known as the low doc loans.

02:15

These sort of loans are where you pretty much make up your own figures if you need this type of loan.

02:22

Let's just be straightforward.

02:23

You're not ready for a home loan and best just to bite your time and get a bit more stable in your financial position.

02:30

We mentioned quite a lot of really jazzy names before, didn't we?

02:34

But in reality, there's actually only three type of home loans.

02:38

There's the variable basic loan, the variable offset loan, and the fixed rate loans.

02:44

Let's start with the variable basic home loan.

02:47

What does the variable part even mean?

02:50

Well.

02:51

Variable loans have the ability for the interest rate to actually fluctuate from month to month.

02:56

So think about it like this.

02:58

When the RBA increases the cash rate, this is typically when your interest rate's going to be adjusted as well.

03:06

This is normally the case, but there has been instances though where the bank increases the interest rate on existing customers home loans outside of an RBA rate rise.

03:17

This is pretty much to improve their net interest margin, which is a fancy way of saying their profit.

03:23

So this leaves us with the basic part in the variable basic home loan.

03:28

It means just that basic.

03:31

It's no frills, normally no monthly or annual fees, and there's no offset feature.

03:36

You can pay directly into the loan and it pays off the loan quicker if you actually make those extra repayments.

03:43

It will sit there as redraw, which you normally can access those funds at any time.

03:49

That depends on the bank though.

03:51

Let's go through the pros and cons of actually having a variable basic home loan.

03:55

I'd say there's probably 3 main pros of this type of product.

04:00

The first one being the cost savings.

04:02

So as it's a basic home loan, there's no annual fee attached to it most of the time, and the variable home loan often is.

04:11

Quite a lot cheaper then say it's fixed counterpart or even the offset counterpart.

04:16

The second one would probably be flexibility.

04:19

Now the variable loans typically offer more flexibility in terms of repayment options.

04:23

It may allow borrowers to make additional payments without incurring any penalties.

04:28

This can be advantageous if you know you're going to be making a lump sum income like a bonus income throughout the year, you can just pay it straight into your loan and reduce that loan balance a bit quicker.

04:39

This can be quite beneficial when you compare it to a fixed rate loan, which only really lets you pay a maximum of $10,000 over and above your schedule repayments without incurring any break cost fees.

04:50

So what's the cons then?

04:52

Well, pretty much the uncertainty that comes along with it.

04:55

Think about it like this.

04:57

It can be a significant drawback if you don't know if the RBA is going to increase that cash rate.

05:03

If they do, it's going to affect your interest rate pretty much straight away.

05:07

Which brings you on to payment instability.

05:09

If you're someone who likes to budget and know exactly what they're going to be paying each month, maybe a variable loan's not for you because it's going to create that anxiety of not actually being able to judge exactly what dollar figure you need each month.

05:24

This brings us on to the next type of loan, which is the variable offset loan.

05:28

This is by far the most popular type of loan in Australia.

05:31

Think about it like this.

05:33

You've got the loan, which is the variable portion, and then you have the offset, which is actually a transaction account that is linked to the loan for offset purposes.

05:44

So how does the offset work?

05:46

Let's imagine you have a loan of $200,000 and in your transaction account you've got, let's say, $20,000 cash.

05:54

For interest calculation purposes, the way it works, they'll take you 200,000 and they'll minus the 20K.

06:02

And they'll calculate interest on 180,000.

06:06

So if you're someone that is going to save quite a lot of money throughout the year, this is probably a really good loan for you.

06:12

Bear in mind though, the typical Australian will save $20,000 a year because this type of loan comes with normally an annual fee as such, or a monthly fee anywhere between $100 all the way up to $500 a year.

06:29

You need to do the calculations to figure out is the amount of money that I'm going to save throughout the year going to generate sufficient interest savings to cover at least the annual fee?

06:40

Because if it's not, then you're going backwards and you're best to go with the variable basic loan instead.

06:46

Another pro you could potentially be saving a lot more money than if it was in a typical high interest bearing.

06:52

Think about it like this.

06:53

If your home loan is at say 6.5% and your savings maximizer account where you put your your money in or maybe a term deposit is only generating 4 1/2%, you're better off putting it against your home loan then, aren't you?

07:06

Because you're going to be generating 6.5% a year on that.

07:09

You won't see any physical cash come into your account each month, but your interest paid on your loan is going to be lower.

07:17

And the third type of loan is a fixed rate loan.

07:19

This comes in normally a 1234 or even five year fixed rate term.

07:26

By far this is the most expensive option.

07:28

A fixed rate home loan is a type of mortgage where the interest rate remains constant or fixed for a predetermined period, typically in the one to five years like I mentioned before.

07:39

During the fixed term, both the interest rate and the monthly payments though remain unchanged, providing you as the borrower a predictable and stable housing cost.

07:50

So if you're someone who loves the budget and know exactly what your monthly outgoings are, maybe a fixed rate loan could be for you.

07:57

Of these three type of home loans, the fixed rate loan is definitely the most expensive.

08:02

So the key features of a fixed rate loan is stable payments, protection from interest rate increases.

08:08

And a predictable interest cost per month for the fixed period.

08:13

Now after the fix, what happens is when it matures, it actually will roll over into a variable rate or you can refix it.

08:21

Some of the cons though are that you will be paying a higher interest rate.

08:25

There's limited flexibility and if you do want to get out of the home loan, there's potentially break cost fees.

08:32

So why would you want to get out the home loan?

08:34

Well, maybe you've sold the house and want to pay off the loan.

08:37

Or you've decided you want to refinance to another bank for a better rate.

08:41

So if you try to break this fixed rate, you could be seeing a bill for into the thousands to be honest, to try and break that loan and refinance it off.

08:52

Now let's move on from the actual home loan product and we'll talk about the different repayment types that are available to you.

08:59

You've got two types of repayments.

09:00

You've got principal and interest, also known as P and I.

09:04

And you've got the interest only, AKA IO.

09:08

Now let's get something straight.

09:09

If you're buying a owner occupied home, this is a house where you'll be living.

09:15

Banks do not like you to go interest only on this type of loan.

09:21

If it's investment though, banks are fine if you go interest only or P&I.

09:27

That's not to say that some banks won't let you have an owner occupied home under an interest only period.

09:34

But they're going to be typically charging an arm and a leg for it, and they would like you to stick to about one to two years interest only maximum.

09:45

OK, So what does principal interest PNI actually mean?

09:50

Well, the principal refers to the original loan amount or the outstanding loan balance.

09:57

So if you have a loan of $200,000, that is your principal.

10:02

And each month you'll be making a repayment being the principal portion against that loan, paying it down.

10:10

The interest is the interest component of that loan that is charged each month.

10:17

So you make two parts of payment.

10:20

So each month you'll be paying a little bit of your principal amount off and then you also make that interest payment as well.

10:27

What does interest only mean then?

10:29

Exactly that.

10:30

It's interest only.

10:31

You never pay off the principal.

10:33

This strategy, though, really only works if the property is an investment property and you're looking to flip the house for a profit down the track.

10:42

This is so you can save your cash flow for other projects.

10:46

Is it a good strategy for your owner-occupied property?

10:49

Hell no.

10:50

Pay that baby off as quickly as you can.

10:53

You know what?

10:53

While I'm all fired up over this question, because I get it so often, let's whip out the weekend investor calculator and do some maths to figure out what you're actually gonna be saving.

11:06

Let's use an Australian bank to source the rate.

11:08

I won't name the bank because, uh, we have no affiliation with them, but uh, let's just say they like the colour yellow.

11:17

Currently it looks like their variable rate for principal interest is about 6.69% and their interest only rate is 6.98.

11:30

So for principal interest again that's 6.69 and their interest only rate is 6.98.

11:39

So let's do some figures here based on the average Australian loan size, which is 600 K if you ever need to know that.

11:46

And it looks like the principal interest repayment at 6.69% is 3800 and sixty-eight dollars.

11:56

That's a month.

11:57

And the interest only repayment will be $3490.00.

12:02

So that's a difference of 300 and seventy-eight dollars a month.

12:09

Or what?

12:10

Let's just times that by 12, which is about 4 1/2 grand a year.

12:16

Are you really saving then?

12:17

Think about it like this.

12:18

For a short-term cash flow boost of about 4 1/2 grand a year, by the time your interest only period has expired, guess what?

12:27

The loan amount's gonna be staying at exactly the same amount from when you started.

12:32

You're pretty much going backwards at that point.

12:35

Anyway, I'll stop there before I get too fired up.

12:37

Thank you for listening to another episode guys.

12:41

Hopefully you learnt something not as scary as previous episodes where I've probably shocked you a little bit too much.

12:47

Bit by bit as you take it all in, you'll slowly become a bit more confident in the home loan process.

12:52

As usual, you stay classy and I'll see you at the next one.

12:58

If you have a question that you would like answered on the show about budgeting, mortgages or finance, then drop us a line either via our socials.

13:07

E-mail or website details available in the show notes.

13:12

Any opinions and views expressed in this program are just that opinions.

13:17

All information is general in nature and should not be seen as financial, economic, legal, investment, accounting or tax advice.

13:27

This program makes no representation or warranty as to the accuracy or completeness of any information contained in this program.

13:35

You should consult a professional advisor in relation to your own personal circumstances.