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Home Loan Types

At Birchcorp we can compare and contrast different loan products from a panel of over twenty lenders to best suit your needs. This essentially means we have hundreds of products available to meet the requirements of all our clients.

 

BASIC VARIABLE (PRINCIPLE OR  INTEREST ONLY) HOME LOANS

 

The interest rate charged on a variable loan moves up or down in accordance with movements in interest rates that are governed by the Reserve Bank.  Generally they have fewer loan features than a standard variable loan.

 

STANDARD VARIABLE (PRINCIPLE OR INTEREST ONLY) HOME LOANS

 

As above, but often with a greater flexibility and provision of all your banking needs. This is the most readily used loan type and it is often used in conjunction with a package that provides all the bells and whistles.

 

FIXED RATE (PRINCIPLE OR INTEREST ONLY) HOME LOANS

 

 

Fixed rate loans are loans for which the interest rate charged is constant for a contracted time (typically 1-5 years in Australia). The required repayments on a fixed rate loan do not change over the entire fixed period of the loan, although some banks have variations to this rule. A variable rate loan, on the other hand, is a loan where the interest rate and minimum repayments can change over the period of the loan.

 

Is a fixed rate loan right for you?

 

This question can only be answered on a case by case basis, and you should consult an expert at Birchcorp who can talk you through the pros and cons so you can make an informed decision.

 

Pros

 

  • Repayment certainty particularly when funds are tight.
  • Can work out to be a cheaper option if rates go up over the period you have fixed for.
  • Your lender cannot increase your interest rate during the fixed term.

 

 

Cons

 

  • Paying the loan out in full, or paying more than is allowed under the loan contract can cause significant 'break costs' to be charged. See below for more information:
  • Possibly locked into paying a higher rate with higher repayment than most other borrowers.
  • Often have restrictions on extra repayments and usually have no loan features such as offset accounts or redraw.
  • Usually have more upfront fees.
  • After the fixed rate period, the loan may revert to an uncompetitive variable rate.

 

Break costs explained:

 

When lending money on a fixed rate loan, lenders will usually borrow the funds themselves from the money market for around the same period of time as the fixed rate periods they offer to customers. Lenders will 'buy' the money at wholesale rates and then 'sell' it at retail rates. The difference between the two is the margin from which they derive their profit on the loan.

 

If a borrower then breaks their loan contract early by repaying the loan in full (or by paying more than just a little bit extra off the loan), the lender will have to use that repaid money elsewhere by either lending it to another borrower or by selling it back into the money market.  

 

If market interest rates have gone down in the period between when the loan was advanced and when the loan is repaid early, the lender will be forgoing their margin, and may even lose money. They don’t like that!  Consequently, they will charge their customers an estimate of their lost margin. 

 

Conversely, if general rates go up and the fixed rate loan is repaid early, you won’t hear from the bank, as they will be making extra money by being able to relend at a higher rate! 

 

As you can see from the below example, break costs can be significant. That is why we never recommend taking a fixed rate loan for more than 5 years.

 

Example of a break cost calculation:

 

The easiest way to illustrate a break cost is with an example as below. However, please note this is a simplified example. All lenders calculate the cost differently and their formulas can be very complex!

 

Example:

 

Bill and Mary borrow $400,000 fixed for 5 years with interest only repayments.  At the time of taking out the loan, wholesale rates where 6% pa. After 2 years, Bill and Mary’s situation has changed and they sell the property and repay the loan in full. The wholesale money market rate at the time they pay off their loan is 4.5% pa.

 

Break cost = (loan amount outstanding) x (wholesale rate change) x (term remaining on loan)

 

Break cost = ($400,000) x (1.5%) x (3)

 

Break cost = $18,000!          

 

What is rate lock?

 

When considering a fixed rate loan it is important to understand rate lock and how it works. Fixed interest rates offered by lenders can change between when you apply and when your loan settles. When you apply for a fixed rate loan without 'rate lock' you end up getting the fixed rate on offer the day your loan settles. This means you may or may not be charged a higher rate than you applied for. Most lenders seem to change their fixed rates about every 2 - 3 weeks and if there is a sudden change in the money market, lenders can change them more quickly.

 

'Rate lock' is the term used to describe the process whereby a lender on request of a borrower holds their current fixed rate for a period of time. Usually a rate lock can be for no longer than ninety days. A borrower will normally have to pay a 'rate lock' fee to ensure the rate applied for is held for them.  Typically this will either be a set amount of approximately $750 per loan, or be a percentage of the loan amount borrowed, generally 0.15%.

 

Every lender has slightly different rules and policies relating to rate lock. At Birchcorp we research which lender you would qualify with, and from there work out which of those lenders has the best fixed rate for you. We take into account all aspects including interest rate, fees, rate lock policy and lender suitability.

 

3 year fixed rate

 

Three year fixed rates are the most popular fixed rate options for borrowers. Often Three year rates are considerably less than five year rates but more than one or two year fixed rates. When considering fixed rates we often recommend a Three year fixed rate as they offer a competitive rate with a term that is both not too short and not too long. That being said, one and two year fixed rates are currently very competitive.

 

5 year fixed rate

 

Five year fixed rates are the second most popular fixed rate option for borrowers. While five year rates are often offered at a higher rate than three year rates, they remain popular with borrowers who want to 'lock in' certainty for the medium term. .

 

7, 10 and 15 year fixed rates

 

Fixed rate loans with long terms of 7, 10 or even 15 years are available through a select group of lenders. Due to the possibility of extremely large break costs we usually don’t recommend fixing a loan for any more than 5 years. A borrower would have to be almost certain that their situation was not going to change and that they would hold the property for the long term.

 

20 and 30 year fixed rate loans

 

In Australia twenty and thirty year fixed rates are not available. The potential break costs make these loans too risky for both lenders and borrowers. 

 

In the USA, thirty year fixed rate loans exist with no break costs. The trade-off is that in general American borrowers pay a higher margin on their loans.

 

 


SPLIT RATE (PRINCIPLE OR INTEREST ONLY) HOME LOANS 

 

A split rate home loan has one portion of the loan with a fixed rate and the other set as a variable rate.  You are able to allocate the size of each portion.

 

INTEREST ONLY HOME LOANS

 

You are only repaying the interest on the principle of the loan for the term of the loan.  The repayments are lower than with a standard principle and interest loan. Interest is generally calculated daily and billed monthly. Be aware of several products that have a pre-determined interest only calculation. At Birchcorp we have many reasons for recommending interest only loans. The benefits of an interest only loan should be discussed with our Financial Planners. We find far too often people taking on Principal and Interest loans to the detriment of their own finances. Be very careful when selecting a product as these choices indirectly effect long term financial wealth.  

 

LINE OF CREDIT HOME LOAN

 

This type of loan allows you to take advantage of equity built up in your property and gives you the freedom to access these funds when needed, especially for property investments. This has been an over-used product in the past, that must be used carefully to avoid issues with the ATO.  Please consider the following:  A court decision (Domjan and Commissioner of Taxation) [2004] AATA 815 shows how easy it is to get caught. Wilma Domjan of the ACT had a claim for additional interest deductions on an investment loan denied because she deposited the money that she had redrawn from the loan into her personal cheque account to pay a bill for her rental property.

The major concern I have with LOC is how the ATO treats the deposit of salary, income and rents in a LOC as payment of principal and payment of a credit card or like, as a fresh loan for private purposes. The result is; the redraw of a LOC facility reduces the deductible portion of a loan. This is not a good outcome for a client trying to reduce debt and increase a tax deduction.

When using a LOC money, it cannot be divided into personal and business use.  However, by setting up several offset accounts this problem may be rectified. According to Taxation Ruling (TR) 2000/2, you can’t put money into a loan and say it is to pay for the private portion of the loan. It must be apportioned to the monies that are owed. In addition to the loss of deductibility the accounting fees would also be high. The solution to this is either use stand alone loans (renegotiate loans at regular intervals) or preferably use several offset facilities attached to the loan. 

Summary: Not that a LOC is wrong, but often a standard loan with an offset account can reduce the negative outcomes as mentioned above. Please consult Birchcorp Financial Planners to ensure you have the correct loan for your Investment properties.

 

LOW-DOC HOME LOANS 

 

A low-doc mortgage is a home loan suited particularly to investors or self-employed borrowers who are looking to refinance, purchase or renovate.  No financial reports or tax returns are required. A standard rule of thumb is that you are required to be registered for GST and support this application with 12 months of BAS statements to reflect.

 

INTRODUCTORY HOME LOAN 

 

The interest rate for this home loan is generally low.  This is to attract borrowers.  It usually lasts for approximately 12 months before reverting to standard rates.  These rates can be fixed or capped.

 

NON-CONFORMING HOME LOANS

 

Lenders now offer what are known as ‘non-conforming loans’ for people with poor credit ratings and defaults.  A larger deposit than traditional loans will be required.


PORTFOLIO HOME LOAN

 

One of the best wealth creation tools on the market, that allows the flexibility for debt recycling, capitalisation of interest, redistribution of credit limits and up to 10-12 sub-accounts depending on the lender. This should only be used under guidance or for the sophisticated investor. The interest rate is usually 0.1% higher than the Standard variable, but this may be offset by a pricing discretion if you have a loan amount greater than $500,000. Conditions apply.
 


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Birchcorp Pty Ltd ABN 56 132 775 654 is a Corporate Authorised Representative (No. 339299)
of Dover Financial Advisers Pty Ltd ABN 87 112 139321, which is the holder of an AFSL No. 307248. Birchcorp Pty Ltd is an Accredited Member of the FBAA with an ACL No. 376718.