When you’re buying a property, you’ll have lots of decisions to make and one of the most important is choosing the right type of loan.
Different types of home loans are better suited to certain conditions or requirements. For instance, if you’re building your home from scratch, a construction loan might be more beneficial for you than taking out a regular home loan. Therefore, it is worth knowing the different types of home loans and what they might be used for.
What are the different types of mortgage loans?
Just like the fingers in your hand, all home loans are different and the best mortgage for you depends on your circumstances, future plans and how you intend to use the property. It helps to remember a mortgage is a long-term agreement, and having the wrong one can adversely impact your lifestyle and finances. For more personalised advice, you may need to contact a mortgage broker to discuss your requirements in detail.
- Fixed and variable rate home loans
When you take out a home loan, one your first choices will be between a fixed or variable rate home loan. But what does that mean?
Typically, when you take out a variable rate mortgage, the interest rate that you pay on it can change at any time, based on the official cash rate set by the Reserve Bank of Australia. This type of mortgage product is quite popular with borrowers as it offers more financial flexibility than a fixed-rate home loan. For instance, you might find yourself paying less during certain months when the interest rates fall. On the other hand, you must be prepared for rate hikes.
For borrowers who want more interest rate certainty, a fixed-rate mortgage may be a better option. When you choose a fixed-rate mortgage, you make your repayments at a fixed interest rate for a specified period, often up to 5 years, before it reverts to the standard variable rate offered by the lender.
- Owner-occupied and investment loans
You can purchase a property to make it your home or use it as a rental to supplement your income. Depending on how you intend to use the property, you can choose between an owner-occupied or investor loan, both of which come with different sets of features and rates.
Owner-occupied home loans are available to borrowers who plan to live in the home they’re financing. You can take out an owner-occupied loan to purchase an existing home or construct a new property. Both fixed and variable rate options are available, and these loans are typically principal and interest rate loans, wherein you repay a portion of the principal along with interest accrued on the outstanding amount each month.
An investment loan, on the other hand, is used to finance a property you won’t live in - at least initially. You can choose to only pay the interest on the loan, leading to smaller monthly repayments and better cash flow. However, you must remember that the interest-only period is for a limited time of up to 5 years in most cases, and your repayments will jump considerably once that period is over.
- Construction loans
When you take out a regular mortgage, you receive the money you require to buy the property at the start of the loan term as a lump sum. On the other hand, a construction loan is structured to pay you money in instalments to finance the various stages in the construction process. Instead of receiving a lump sum, you only draw down the amount you need to lay the foundation, build the frame, and so on at each subsequent milestone until the house is built.
Usually, the loan is structured in a way that you only pay interest while the house is being built and only on the money you’ve drawn down so far. This minimises your repayments until the construction is complete when the loan reverts to a traditional principal and interest loan.
- Bridging loans
A bridging loan is a short-term financing solution used to ‘bridge’ a brief gap in funding. Bridging loans are often used to finance a new property when the old one isn’t sold yet.
Usually, these loans are interest-only with a limited duration, up to 12 months, and used for managing the repayments for a new property until your existing home is sold.
- Low-doc loans
Lenders require multiple documents like your recent bank statements and payslips to verify your income when applying for a home loan. However, self-employed individuals, freelancers and small business owners might struggle to provide the standard proof of income documentation required for a traditional home loan. If you find yourself in such a situation, you may apply for a low doc loan that doesn’t require standard documentation for approval. Instead, you’ll be asked to provide income proof like:
- Two years of personal tax returns;
- Business activity statements (BAS);
- Profit and loss statements;
- An accountant’s letter verifying your financial position.
Note that low doc loans often come at a higher interest rate, but they can help you get a foothold in the property market if you’re a non-traditional borrower. You may refinance to a regular home loan at a better rate once the required documentation is available.
- SMSF loans
Some lenders offer home loans to self-managed super funds (SMSFs) to purchase investment properties. The returns on the investment property, whether rental income or capital gains, are channelled into the super fund to grow the retirement savings of the trustees.
- Bad credit home loans
If you’ve had credit issues in the past, you might still not be eligible for a mortgage owing to a poor credit score. In such a situation, you may apply for a bad credit home loan with a non-conforming or specialist lender who will assess your application after listening to your side of the story. However, you must be able to convince the lender about your ability to repay the loan and that a mortgage will help improve your financial situation (if you’re looking at debt consolidation) to get approved for a home loan with bad credit.
- Reverse mortgages
If you’re 60 years or above and looking for a way to fund your retirement without selling your home, a reverse mortgage on your home might be an option. A reverse mortgage is structured so that you can continue living in the house after borrowing money against it without making any repayments. However, if you pass away or move out, the property is sold to repay the lender.
Getting the right home loan for your property purchase
As you can see, there are plenty of mortgage loans available to meet the requirements of borrowers. By understanding the various options in the market, you can choose a product that’s best suited to your needs. If you’re confused or need specific information, you can contact a mortgage broker and discuss your situation in detail. A decent mortgage broker will help you identify the right mortgage product and also figure out the right-sized loan for you.