Mortgage and Non Mortgage Options

Traditional mortgage products:

1. Basic variable mortgage

Basic variable mortgages are no frills mortgages, usually provided for a term of 15 – 25 years (long enough to pay off the property). The interest rate is generally based on the official Reserve Bank Rate and can be revised from time to time, although you generally have the option to fix the rate for a number of years in advance. Borrowers also have the option of repaying interest plus capital, or interest only depending on their needs. These mortgages are reasonably  cheap to exit, e.g. if you win the lottery or find a cheaper source of finance, but if  your mortgage provider  offered you a “honeymoon rate” for the first part of the term, and you quit the mortgage before this, you may be charged an exit  fee equal to the discount you were given.

2. Variable mortgage with extra options

By paying a slightly higher interest rate, you may gain access to more sophisticated options which can actually help you reduce the cost of the property over the life of the mortgage, or pay the mortgage off faster. These include:

  • Payment in fortnightly instead of monthly instalments, since you make 26 payments a year instead of 12 ( with compound interest, every little bit counts over the long term)
  • Ensuring there is the ability to make additional payments off the principle (the amount borrowed) at any time i.e. monthly, annually or as a one off lump sum. The reason mortgages take so long to repay is that for the first few years most of what you are paying is interest. By reducing the capital amount owing, you can pay off the debt much faster – which is why it makes sense to pay in any unexpected bonus, inheritance or windfall that comes along. Some mortgage products allow you to do this, others do not.
  • Setting up a mortgage offset account which is bank account linked to your mortgage. You pay your salary into this account and draw on it as you normally would, and the credit balance of your transaction account is offset against your outstanding mortgage balance daily, reducing the overall interest payable.

3. Fixed rate mortgage

You can always convert your flexible rate mortgage to a fixed rate, freezing your repayments for a period of time (typically up to 3 years). You win if interest rates go up sharply; you pay more if they drop sharply.  Fixed rate loans are traditionally a strategy for coping with periods of rapid interest rate increases, but since today’s mortgage rates are at a historical low, you may feel that it is wise to protect yourself against any increase in the near future. Be warned, however that if you exit a fixed interest mortgage early, you may be charged and exit fee equal to the interest the bank would have earned over the remaining period.

4. Split rate mortgage

With certain loan products, you can choose to have part of your mortgage at the variable rate and the balance at a fixed rate for a period of time (typically for up to 3 years).

5. Construction loan + mortgage

This product was developed especially for home buyers building on a vacant block or undertaking major renovations. The construction loan releases the money to the builder in stages – the first typically when construction begins and the last amount typically prior to completion. As soon as the building work is complete, the loan normally converts to a variable rate mortgage.

Non-conforming loans:

Non-conforming loans are loans to borrowers who are unable to meet the conditions set by a bank or other mortgage company for one of their standard home finance products – despite the fact that these borrowers may have no problem servicing a loan. Two common forms of non conforming loans are “low doc” loans and a line of credit.

1. Low doc loans

A low doc loan of up to 80% of the value of the property is one that bypasses the minimum requirements set by banks building societies and mortgage lenders, thus providing finance to borrowers who can afford the repayments, but do not meet the lender’s criteria regarding income or credit rating. Low doc loans may be useful for:

  • Self employed home buyers who do not have an audited and regular income source;
  • Immigrants who may not have lived in Australia long enough to establish a credit record; or
  • Individuals who may not have a flawless credit rating due to a previous business failure or for any other cause.

2. Line of credit

A line of credit is a pre-approved loan against the value of fixed property or another asset which the borrower can draw down wholly or in part at any time, paying interest only. A line of credit may be useful for:

  • Financing of renovations before a property is placed on the market;
  • Capital for investing in shares or purchasing a large ticket item such as a car which is effectively borrowed at home mortgage interest rates;
  • Short term home finance which can be replaced with a conventional mortgage if the property appreciates, thus increasing the borrower’s equity in the property.