It's easy to get overwhelmed by all of the options available for home loans today. Keeping all of the terminology straight can be a chore for anyone, let alone someone who is not a broker, or even an interested hobbyist.
From honeymoon loans to variable rate mortgages, this guide will bring you through the most common loan types and explain to you exactly what they are in plain English.
Fixed Rate Mortgage
A fixed rate mortgage is fairly straight forward, and often what most people think of when they think of a loan: a mortgage that has the same interest rate for the entirety of the loan. If you have a twenty-year mortgage at a fixed 3.6% interest rate, you are going to be paying the same amount every month – no matter what happens to the interest rates nationally over the duration of your loan, you'll still be paying the same payment every month.
This can make budgeting a bit easier, because you know exactly what you're going to pay every month, and you won't have to worry about the national rate changing. If the interest rate rises, it doesn't affect you. If the interest rate drops, on the other hand, you will still be locked into the interest rate that you agreed to with your lender.
One thing to note: extra repayments are sometimes also discouraged, limited, or otherwise disallowed with a fixed rate mortgage.
Variable Rate Mortgage
If your mortgage rate isn't fixed at signing, you have what is called a "variable rate mortgage", which means that your interest rates can rise and fall along with the market.
Because your mortgage rate can change from month to month, it can be more difficult to predict what your mortgage payments will actually be in advance -- and if the rates rise when you're not expecting it, you could be in for a bad bit of what's called mortgage stress.
On the bright side, there are usually no restrictions on additional or extra repayments, and variable rate mortgages can be easier to swap out if you find a more attractive home loan package later on.
Some lenders will also allow you to split your loan between fixed and variable interest rates. This is unsurprisingly referred to as a "split interest rate" The division does not have to be even – while you can do half of the loan at a fixed mortgage and half at a variable, you could also have the majority of it at a fixed interest rate, or the majority be variable. Be sure to talk to your prospective lender to see if this is something you would like to explore.
A low documentation loan, also known as a "low-doc" or low doc loan, is a specialized type of loan that has been around Australia for a long while but saw a bit of a decline during the global financial crisis.
In brief, a low-doc loan is one that does not require the borrower to submit the usual proof of income, such as a tax return, to prove that they can afford a loan or mortgage. Rather, these are for people who have income and assets but may have difficulties displaying it – if you are self-employed, for example, and have reinvested your profits into your business, or perhaps write-off a number of expenses each year.
Instead, borrowers typically sign a declaration that affirms their ability to afford the loan. Because of their low-documentation nature, low-doc loans typically carry higher interest rates and fees than more traditional loans and mortgages, and LMI, or lender's mortgage insurance, is usually applied at a much earlier rate.
LMI protects the lender in case the borrower defaults on the loan, and while it typically only applies to loans if the borrower is borrowing 80% of the property's value or more, LMI on a low-doc loan can apply on values as low as 60% of the total property value.
In other words, if you are borrowing to pay for a $200,000 property, you will not have to pay a LMI fee unless you are borrowing $160,000 or more under a traditional mortgage. For a low-doc loan, you may have to pay an LMI fee even if you are only borrowing $120,000.
A honeymoon loan, also known as an "introductory rate", is a loan available to a first-time borrower that allows for a discounted interest rate for a given period of time known as the honeymoon period. For example, you may be given a heavily discounted rate for the first 12 months of a loan, after which it reverts to standard. Typically these introductory rates will be discounted fixed or a fixed discounted rate. And no, they're not the same thing.
A "discounted fixed" rate is a fixed rate, as described earlier, but one that is lower than the typical market rate for a fixed loan. So if a normal fixed mortgage would be 3.6%, a discounted fixed could give you the first year at a flat 3%.
A "fixed discount", on the other hand, is a variable rate that is pegged below the standard variable rate at a specific margin. If you have a fixed discount of 1%, for example, your initial rate will always be 1% below the market rate.
If you are looking for a loan in order to build a home from the ground up, literally, a construction loan might be your best bet.
Because building a new home is typically divided into five separate steps – the purchasing of the land, the ground work, the roof, "lock up" (when you can physically lock the home and the windows, doors, etc are added), and the final, finishing step – a construction loan allows you to draw down the loan amount in a similar fashion. This allows you to progressively call on your loan as the construction commences, rather than paying interest on the whole sum for the start-to-finish duration of the build.
After construction is completed, the loan will revert to a different type of loan, which will be agreed to between the borrower and the lender.
Professional packages, originally designed for borrowers who would qualify as "high-income" earners, are specifically crafted loans for people looking to borrow more than $100,000-$250,000.
The specific minimum depends on the mortgage and the lender, but a "pro-pack" bundles the loan alongside other services and products to make an appealing package for a borrower, typically including a percentage-based discount on the standard variable loans as well as fee waivers and discounts on the various types of insurance that could be involved in home-building. There may even be a credit card offer in there, too.
What's the advantage of a pro-pack, as they're now known? As far as the mortgage is concerned, having a discount on a variable interest loan can be very appealing. If you're comfortable borrowing a variable rate mortgage, a .2% discount on that rate can be a nice chunk of change if you're looking at a loan worth over a quarter of a million dollars.
The biggest thing to keep in mind when evaluating a pro-pack is that the more business you have to do with a lender, the more flexible they are going to be. If you only need a mortgage and nothing else, it may not be worth your while.