July 09, 2014
When considering a home loan, there are three main loan types
to choose from; variable interest rate loan (standard and basic),
fixed interest rate loan and Line of Credit (equity loan) which are
described in detail below.
Variable rate loan
The variable rate loan is the most popular type of loan in
Australia. The interest rate charged on a variable rate loan
moves up or down with movements of the official cash rate set
by the Reserve Bank of Australia (RBA). Each lender will
determine the percentage of the official rate change that is
passed on to borrowers depending on how their institution is
affected by global money market forces. As a result, the
borrower’s loan repayments will increase or decrease
throughout the life of the loan. E.g. if the RBA decides to move
rates by half a percent, then the interest rate on a standard
variable loan may increase or decrease by a corresponding rate.
Generally there are two types of variable rate loans: standard
Standard variable rate loan
Interest rates charged on standard variable loans are generally
higher than those charged on basic variable loans because they
usually offer more features, making the loan more flexible.
Different lenders may include different features with their
standard variable product, so it is important to look at each loan
product carefully in light of the borrower’s specific needs.
Basic variable rate loan
A basic variable loan either does not have the additional features
of the standard variable loan or those features may be
more restrictive or have higher fees attached. Because of this,
the interest rate charged is usually lower, but the loan may not
be as flexible.
Fixed rate loan
A fixed interest rate loan is set at a specific interest rate for a
defined period, e.g. 5.7% p.a. for three years. The borrower is able
to “lock in” their repayments for the fixed rate period. Common
periods for fixing interest rates are 1 year to 5 years, although
some lenders do offer longer periods.
At the end of the fixed rate period the borrower is usually given a
choice of converting the loan to a variable interest rate for the
remaining term of the loan (this will generally happen
automatically if the borrower does nothing) or fixing the interest
rate again for a further period at the current market rates.
Line of Credit loan
A Line of Credit loan combines the borrower’s home loan from
which the borrower can draw cash up to a pre-approved limit
with an everyday transaction account. A Line of Credit loan
requires an interest only repayment as a minimum each month if
the credit limit has been reached. The reduction of the loan
balance is entirely up to the borrower, as there are generally no
set repayments. Each month the loan amount balance is reduced
by the amount of cash coming in and increased by the amount
paid of any drawings, direct debits or cash withdrawals. As long
as there is consistently more cash coming in than going out,
these accounts can work well.
The benefits of a Line of Credit can be maximised by combining
the loan with an interest-free credit card. By using this credit
card for living expenses during the month, the borrower will not
be drawing on the loan. Instead, the loan balance is only
increased once a month when the credit card balance is paid.
Most lenders will have the ability to set this up to happen
automatically and this type of arrangement can result in
significant interest savings.