To the average Australian, home loans can be complicated and overwhelming. However, for you to achieve your property goals, we need to cut through jargon and through the nonsense! The lending environment has changed so much in recent years and the level of complexity when structuring your home loan has never been higher.
Having the correctly structured finance could improve your cashflow and ensure you are achieving your goals quicker than ever. So where do we start? With so many levers to pull it is important to simplify the process. Let’s begin!
Owner Occupied Home Loan vs Investment Home Loan
Whether you choose to utilise an owner occupied home loan or an investment home loan will be largely determined by your overall wealth strategy. To explain it simply, if you are looking to buy your own home, you will use an owner occupied home loan. However, if you are looking to buy an investment property, you will use an investment home loan.
What is the difference?
Owner Occupied Home Loan
Typically an owner occupied home loan will have more competitive interest rates and the ability to borrow to a higher loan to value ratio. However, owner occupied home loans are not tax deductible. Quick rule of thumb: if you are going to be buying your home, use an owner occupied home loan!
Investment Home Loan
On the flipside, an investment home loan will have higher interest rates and the lenders will be stricter on your loan to value ratios. However, investment home loans are typically tax deductible and depending on your personal scenario, can actually work out cheaper than owner occupied home loans on after tax terms! Quick rule of thumb: if you are going to be buying an investment property, use an investment home loan!
Principal and Interest Repayments vs Interest Only Repayments
The decision to make principal and interest or interest only repayments on your home loan will also be largely determined by overall wealth strategy, however there is more freedom of choice in this arena. There has been so much change in this area of lending over the past few years it is now more important than ever to get this decision right.
So what is the difference?
Principal and Interest Repayments
When you make principal and interest repayments, your regular repayment will contain an element of principal and an element of interest. This means you are chipping away at the loan with every single repayment. There are some huge benefits when making principal and interest repayments. First of all, you begin to pay down the debt from day one, essentially manufacturing equity in your property. Secondly, the interest rates for principal and interest home loans are significantly more competitive than those available for interest only home loans. Only drawback is, the actual size of the monthly repayment is typically 20% to 50% higher than its interest only counterpart. Quick rule of thumb: if you have debt on your home, it is best to make principal and interest repayments!
Interest Only Repayments
When you make interest only repayments, you pay only the interest costs each month, and no principal. This is great for cash flow, however you are not reducing the loan amount when you make interest only repayments. Couple of downsides to interest only repayments, first of all it is that the interest rate is likely to be significantly higher than the principal and interest equivalent. Secondly, unless you are strategic in your wealth creation, you won’t pay off your home loan and can be stuck at the same home loan amount for years. Quick rule of thumb: if you still have debt on your home and you are buying an investment property, use interest only lending on your investment property and keep your owner occupied home at principal and interest!
Variable Rate vs Fixed Rate vs Split Rates
This is probably the most common question I get from my clients when taking out a new home loan. Should I fix my interest rate or leave it variable? My answer is always the same. It depends! The decision to go with a fixed or variable rate is a personal one and should be made in line with you overall wealth strategy. There is one thing I can suggest, and that is to choose based on your own personal circumstances, and not by punting against the banks which direction you think interest rates are going.
So how do we help make the decision between a fixed rate or a variable rate?
A variable rate home loan will fluctuate in line with market forces, causing your interest rate to go either up or down over the life of your loan. This will depend on the Reserve Bank of Australia’s interest rates decisions and the commercial banks pricing policies. I like to describe variable rate home loans as having plenty of flexibility, with little amounts of certainty. On one hand, your interest rate is likely to vary considerably over the life of your home loan, and on the other hand, you get all the cool features such as offset accounts and redraw facilities, plus extra repayments. On top of that, if you wanted to refinance a variable rate home loan, it is relatively cheap to do so. So remember, variable interest rates means plenty of flexibility, little amounts of certainty. Quick rule of thumb: if you are planning to pay down your home loan quickly, use a variable rate home loan!
And fixed rates are the opposite. Fixed rate home loans effectively lock in your interest rate for a set period of time, most commonly between 2 years, 3 years or 5 years. Once a fixed rate expires, you could either refinance your home loan to another fixed rate or let it revert back to the standard variable rate. I like to describe fixed rates as having plenty of certainty, with little amounts of flexibility. On the one hand, you know what your repayments are going to be for a set period of time, however on the other hand you will likely not get access to cool features such as offset accounts and redraw facilities, plus if you want to refinance a fixed rate before its expiry date, you could be in for some hefty fees. Quick rule of thumb: if you are concerned about the ‘sleep at night’ factor, use a fixed rate home loan!
There is also a third option, essentially letting you have your cake and eat it too! You can opt for a split rate home loan, which is the ability to have some of your loan fixed and some of your loan variable. Great option for those who want to hedge their bets both ways and get access to to the best of both worlds! Quick rule of thumb: if you really see the merits of both variable rates and fixed rates, use a split rate home loan!