Home Loan Basics
Get familiar with home loan typesFixed loan, revolving credit, or offset loan? What are they and which is best for you? We'll explain more about each home loan type down below.
Home Loan Basics
There are several types of home loans on offer in New Zealand. Each of which have pros and cons to consider before selecting as your ultimate choice when structuring your home loan. Understanding your home loan options will help you make a confident decision that ensures your financial success. The below loan types are some of the most common on offer via banks and lenders.
Fixed Loan
A Fixed loan is a loan that has an interest rate offered which will be fixed/locked in for a period. For example, you may be offered an interest rate of 4.45% p.a. over a period of 3 years. If you selected this option, it means that you will fix/lock your loan repayments in for 3 years and you will only be charged at the interest rate of 4.45% p.a. for the duration. While you can have a short term interest only fixed rate loan, in most cases a fixed rate loan will have principal and interest repayments.
Upside
- Locking a rate in can be beneficial in when the interest rates are rising. As you are locking in your interest rate, this is the rate that is applicable to you for the duration of the interest rate term, regardless of how high the market interest rates may get in the meantime.
- This will also mean that your repayments remain unchanged throughout the term of your fixed rate period, thus providing you with certainty of your loan repayments.
Downside
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When interest rates are declining, you would be obligated to pay the rate which you fixed in at, rather than a lower rate that a new borrower could obtain.
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If you wanted to make additional loan repayments and you are on a fixed rate, you may be charged an additional fee to do so. Most lenders allow you to repay up to 5% of the principal balance each year without penalty, however anything above that may cost you. So it’s a good idea not to fix some, or all, of your home loan if you are wanting to make adhoc repayments.
Floating Loan
A Floating loan is one where the interest rate that can move up or down with market fluctuations. For example, unlike a fixed rate which is a guaranteed rate that is locked in for an agreed period, you can be offered a floating rate of 3.00% p.a. for your $100,000 home loan but the rate can change at any time during the loan term, moving up or down. Because the loan repayments are calculated using the interest rate, this means that your floating rate loan repayments are likely to change throughout the life of the loan as well. Often changes in floating loan rates are due to movements in the Official Cash Rate. Floating rate loans can be interest only or principal and interest repayments.
Upside
- A floating rate loan provides you with the flexibility to make lump sum repayments without any extra costs being charged
- If interest rates are declining, you will benefit from the lower interest rates. And if you keep repayments the same during this period, you could potentially pay off your loan faster.
Downside
- Your minimum repayment amount may rise or fall at any time, so if you are on a tight budget, this could be a problem for you.
- If interest rates increase, you will have to pay more interest.
Revolving Credit
Like an account with an overdraft, a revolving credit loan type is one where money can be deposited and withdrawn up to your credit limit, as often as you need. The interest is calculated at the end of the day and charged monthly, which means the lower your daily balance is on the account, the less interest you will be charged.
Upside
- Useful if you have irregular income as there are no fixed repayment periods
- Draw down, repay and redraw money within your credit limit as often as you need to
- If you’re good at managing your finances, you can repay your home loan sooner.
- You can reduce your interest costs by depositing your salary and wages to pay down the balance.
Downside
- If you’re not careful, it’s easy to overspend. It can be tempting to spend up to the credit limit and stay in debt longer.
- Revolving credit interest rates are generally higher than other home loan products. It is also a floating interest rate, so is open to market fluctuations.
Interest Only
Interest only loans are simply that, loans where the interest is the only portion of the loan that you are paying for. The principal, ie your original loan, balance will remain unchanged. By way of example, you have a $200,000 interest only loan, with a 5 year loan term. Each month you will be charged for that months interest and your payments will only go towards that interest; at the end of the 5 years, your principal balance will still be $200,000.
Upside
- Monthly payments during the term are low
- Frees up cash to be invested elsewhere
Downside
- If you’re not disciplined, the extra money could be spent instead of invested
- Interest only loans still need to be paid off at some point
Offset Loan
An offset loan is where you can have multiple bank accounts linked to your home loan. The money you hold in these accounts can lower the amount owed; so instead of earning interest on these savings, you pay less on your home loan.
In essence, it is calculating the interest on your home loan as if your savings had been used to pay down your home loan, while keeping the money available for when you need it.
Upside
- You are likely to save money. While you forgo interest earned on savings, your savings are working to pay off your mortgage which generally has a higher interest rate
- You still have full access to your savings
- You can make additional repayments without penalty because offset mortgages are floating loans
Downside
- Interest rates on these products are generally higher
- The interest rate is floating, not fixed, which means your repayments can fluctuate with interest rate changes
- You won’t earn interest on your savings
- Monthly fees may apply
Related Questions
How do I know what mortgage structure should I choose?
There are many types of home loans, each with its own advantages and disadvantages.
After starting an application you can login to your personalised dashboard and visit our strategy page to review options that may be suitable for you. Alternatively, one of our home loan specialists can help assist you with options around a loan structure and interest rates.
What happens if I sign a rate lock agreement but no longer want that rate?
If you change your mind after you've signed a rate lock agreement, you may be charged a fee by the lender to break the rate.
What is paid off first, the principal or interest portion of my home loan?
This depends on how your loan is structured. You can choose table repayments, which is paying off your principal and interest or choose to have an interest only loan. For a table loan structure, you are paying more interest at the start of the loan term as your principal amount owed is at its biggest. As the loan term progresses, the proportion of your repayments going towards principal will increase.
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