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Tips for Home Buyers in Australia

1. Fixed or variable interest rates

Do you choose a fixed or variable interest rate? Each has pros and cons.

Fixed interest rate loans

Choosing this option means your interest rates will be fixed for a set period of time, commonly 1 to 5 years.

Pros: 

  • Budgeting is simpler, as your repayments are fixed.
  • You will have more certainty, as interest rate rises will not affect your loan.

Cons:

  • You won’t benefit from interest rates drops.
  • Charges may apply if you pay out the loan prior to the end of the fixed interest period.
  • Extra payments may not be allowed or could incur fees.

Variable interest rate loans

These offer greater flexibility but also come with greater risk. If interest rates change, your repayments may too, for better or worse.

Pros:

  • Generally your payments will go down when the cash rate drops.
  • You have more flexibility including options to pay off your loan early, make extra repayments, and access redraw facilities and offset accounts.

Cons:

  • You will experience more uncertainty as your payments will generally increase with cash rate rises (or can increase independently of cash rates).
  • Splitting your loan between fixed and variable interest rates is an option and can hedge your risk.
2. Redraw facilities

The ability to redraw funds from your mortgage account depends on the type of loan you have and whether you have made extra repayments that put you ahead in your repayment schedule. Variable interest rate home loans are more likely to offer this feature. There may be restrictions on how often you can redraw funds, maximum and minimum amounts, and limitations on your redraw methods – online, phone or in-branch banking.

3. Offset account

Linking an offset account to your variable rate home loan can reduce your overall interest payments. Normally the interest you pay on a home loan is calculated on the total amount owing – but, by establishing an offset account, the interest will be calculated on your home loan debt less the amount in your linked account. Offset accounts do not earn interest, so it is only beneficial if your home loan interest rate is greater than your savings account interest rate.

4. Mortgage repayment holiday

Life is full of twists and turns, and having the ability to take a temporary break from mortgage repayments can be a godsend. Not all lenders offer this facility, and it is important to consider the ramifications. The length of your mortgage repayment holiday can impact your ability to pay off the overall loan – while interest repayments may stop, interest charges do not.

Pros and cons of a line of credit

A line of credit can be a very appealing idea, with immediate access to the limit of a mortgage and no extra approvals necessary. Used wisely, it can make investment and purchase of commercial equipment simple, but it can also spell disaster for the unprepared. (hide)

A line of credit (LOC), also called a home equity loan, allows mortgagees to access the equity in their property as needed. It can be a standalone product or almost any type of existing loan can be split with an LOC. Interest is usually slightly higher than the standard variable rate.

LOCs may be useful for property investors, who can finance further property purchases or renovations using their existing properties’ equity without applying for new loans, or business owners who can use an LOC in place of a business overdraft to make large equipment purchases at lower interest rates.

Used smartly by owner-occupiers, an LOC can be an ideal way to reduce the total interest paid on a loan. An entire salary can be deposited into the LOC account, with everyday purchases being made with the account balance in the same way as they would with a regular savings account or credit card, as long as the minimum repayments, usually only interest, are maintained.

For the term that the amount repaid stays above what it would be on a regular mortgage, the total interest charged is, obviously, lower. Owner-occupiers, however, can come to think of their LOC home loan as a credit card-like facility. It has risks that must be carefully managed.

While it can be a boon for mortgagees who deposit their entire income and use only what they need, resulting in extra repayments being made each month, the lack of requirements beyond paying the interest when due and staying within the credit limit can spell disaster for those with poor financial discipline. If mortgage payments are treated as available credit for everyday expenses, the loan principle may never actually be paid down.

And, while post-GFC lending criteria has certainly tightened, many lenders are happy to extend an LOC when a property’s value increases. In a best-case scenario, this provides access to cash that can be used as a deposit for an investment property or for renovations that will further increase the property’s value. In a worst-case scenario, a mortgagee can quite easily use this for everyday purchases or a holiday, and be left with a loan they cannot actually service beyond interest payments.

There are many situations where a line of credit is ideal, but as with all mortgage products, the key to assessing whether an LOC suits your needs is to speak to an expert about your goals, financial situation, lifestyle, needs and wants.

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