Loan features

 

Fixed rate loans

 

These are loans where the borrower’s interest rate and therefore the repayments are fixed for a set period, usually from 1 to 5 years and sometimes longer.  As the name suggests the rate is fixed so it will not increase nor will it decrease during the fixed period.  These loans usually revert to a standard variable rate or similar product at the end of the fixed period unless “rolled over” for another fixed rate term (at the rates prevailing at the time of the rollover).

Repayments can normally be either, principal and interest or interest only however, most lenders require borrowers

to start repaying the principal after 5 years and you can normally fix all or a portion of your loan.

Fixed rates create certainty for borrowers as they know exactly how much their repayments will be for the duration

of the fixed rate period.

Lenders normally charge a fee or penalty called a “break fee” or “break cost” if a fixed rate loan is paid out early

for any reason. This is because the lender has lent the money to you at a certain rate and depending on rate

movements, may not be able to lend that money out at the same rate (if rates have fallen) and therefore will

incur a loss which is passed onto the borrower in the form of a break fee or break cost. This fee is typically

determined according to a preset formula.  This fee can be considerable depending on how much interest rates

have changed and the remaining fixed rate period. 

 

Although some lenders will allow extra repayments to be made (up to a certain amount without penalty), they will not normally allow access to a redraw facility or offset account whilst the loan is on a fixed rate.   Changes to the loan e.g. altering it from an interest only loan to a principal and interest loan, are not normally permitted.

Interest rates are normally set at the time of settlement, not application, unless the borrower takes advantage of a rate lock facility.  A rate lock facility will lock in the preferred interest rate from the time of payment or processing of the rate lock application for a certain period (typically up to 90 days). There is normally a cost involved to lock an interest rate in at the time of application.  

Fixed rate home loans are suitable for borrowers concerned that interest rates might rise in the near term or those who require certainty as to their repayments.  Unlike capped interest rates, borrowers do not get the benefit of an interest rate reduction should rates drop.

 

Offset accounts

 

What is an offset account?

A mortgage offset account is a savings account that is linked to your home loan.  The offset account is with the same financial institution as your home loan.  Using an offset account is a great way to pay off your home loan quicker and potentially save $000’s in interest over the life of the loan.

 

How does it work?

The savings account is linked to your home loan and your income is deposited into it.  While you still have access to money in your savings account, when the interest is calculated on your home loan, the balance in our savings account is offset against what is owing on your mortgage. 

 

If you had $100,000 mortgage and you had $10,000 in an offset account, interest would be calculated on 90,000 and as a result over a period of time you reduce your mortgage sooner and will pay less interest ver the term of the loan. Interest is not paid on a savings account whilst it is being operated as an offsetaccount and therefore you will not be taxed on any interest that would otherwise be paid. 

 

There are two types of offset accounts available – 100% and Partial.  Most lenders offer 100% offset account in lieu of the less effective partial offset account.

 

Offset accounts are generally considered more tax effective than a redraw facility, especially for investment loans. By maintaining surplus cash in an offset account, it can be drawn out at any time, for any purpose, without affecting the tax-deductibility of the investment loan it was offset against. Alternatively, if you were to redraw funds that had been deposited into an investment loan account, and those funds were for personal use, you have effectively "contaminated" the loan account through mixed use of funds, and it can be quite difficult and costly to track the private/investment use of funds from the loan. For this reason, offset accounts are generally recommended over loan redraw facilities for investment loans.

 

The benefits obtained from an offset account depend on the amount of money that sits in account or passes through the account.  The higher the amount and the longer the amount sits in the offset account the greater the benefit will be.  Few lenders offer offset accounts with their basic loans so you normally have to take advantage of a professional package or a more fully featured loan to secure a loan with an offset account.  Higher interest rates and/or fees on these loans make it necessary to consider whether an offset account will deliver the benefits

 

 A redraw facility is a good alternative to an offset account if lower amounts of funds will be sitting in an offset account.

 

Redraw facility

 

What is a redraw facility?

Firstly, to understand the benefits of a redraw facility, we’ll quickly explain what redraw is and how it works in simple terms. Redraw is a feature of a home loan which allows you to use your home loan like a savings account. It gives you the ability to make extra payments (by putting all or some of your income and savings) into your home loan and then have the ability to "redraw" (or withdraw) on these extra payments whenever you need to with a debit card, cheque book, electronic banking etc. The beauty is, by depositing all of your salary and any extra income you have into your home loan account (which you can

redraw whenever you need it again), you will be reducing the balance of your home loan with all the money you have at any given time, which means you get charged less interest because interest is calculated daily. At the same time, you always have the ability to withdraw any surplus or extra funds you have added (via your redraw facility) whenever you need to with a debit card, cheque book or electronically with phone or internet banking.

If you plan to make extra repayments or lump sum payments into your home loan at any time throughout the term of your loan, having a redraw facility will enable you to put all your extra money into the loan to reduce the balance of your loan (so you pay less interest) and at the same time, gives you access to these extra funds if you ever need to buy things.

 

What are the main benefits of having a redraw facility?

Firstly, by putting all of your extra income and savings into your home loan account (redraw facility) you are effectively earning a much higher interest rate on this extra money than if you were to put it in a normal savings account or term deposit. This is because the interest rate on a home loan is always higher than any savings account and rather than actually earning interest income like you would be in a savings account, you will simply be saving yourself from paying interest on your home loan by having the funds in there.

Secondly, not only will you be earning a much higher interest on the money you have in your redraw account (compared with a normal savings account) but because you're not actually "earning interest", rather you are saving yourself from paying interest, you don't need to pay tax on this "saved interest amount". If you put your extra funds and cash into a savings account, you will actually be "earning interest income" each month and therefore it will become part of your taxable income.

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