Before you get into individual loan types and their features, you first need to look at what type of overarching loan it is. For example, is it a residential home loan, or is it for a commercial property?
Is it for an individual borrower, or for a business?
There are so many different loan categories and types out there, but for the purpose of this article, let’s look at the most common, the residential loan.
When borrowing for residential property
There are two main types of residential loan; a home loan (as in, an owner-occupier loan for the home you live in), or an investment loan (when you borrow money to buy an investment property).
In both cases, you need to look at what features you require for the loan.
First, consider the type of repayments you will be making. They can be either principal and interest (P&I), where you’re paying down the principal value of the home and also paying interest on top; or interest only (IO), where you pay the interest on the loan only. You access equity when the property grows in value and get the rental income, but the principal amount that you owe the bank for the home stays the same.
In the majority of cases, a home loan for an owner-occupier property would require P&I. If you tried to borrow for an owner-occupier on an IO deal, the bank would require an explanation. But loans for investment properties are usually IO. This allows the investor to maximise cash flow, tax benefits and freedom to move money around.
Variable or fixed interest
Now the type of interest, is it variable? Or fixed?
On a variable rate, the interest you pay will change when the bank decides to change its interest rate.
If it’s fixed, you can lock in the interest you pay at a certain rate for a particular term…usually 1, 2, 3, 4, or 5 years.
Variable rates are good when interest rates are low and potentially still on the way down. Fixed rates are good for people who want to lock in a rate that they are happy with and have certainty over their repayments for a certain time.
The loan features you need
There are various features available with variable loans. You might get 100% offset, where the savings you have offset the interest you pay on your loan. Other features are redraw facilities and the ability to make lump sum repayments. Some loans have a switch feature, where you can switch from variable to fixed.
A lot of banks offer package loans, where you pay an annual fee and that may cover the bank’s valuation fee, the application fee and the monthly fee. Some banks allow you to pay the one annual fee that then covers a number of different loans. Some have an unlimited number, while others cap the number of loans covered by the annual fee.
Basic versus standard variable
When you are looking at variable loans, there is also a difference between a basic variable and a standard variable product.
Say your variable loan option is a package, you might be able to negotiate discounts off the interest rate you pay. Or you may be a great saver and you have $200,000 in savings. You want the offset feature because you want to keep your savings but also be able to use it to offset the amount you owe and reduce the principal amount that you are paying interest on. You can negotiate these things in package loans.
Basic loans on the other hand are different. They are no frills types of loans. They are cheap because they don’t have many features apart from a redraw facility. The bonus is that they often don’t have application fees, or monthly fees. They don’t have an offset, but if your loan is less than $250,000, a basic loan will still be cheaper than a package loan.