Homes Loans and Mortgages come with many different types and forms of repayments to best suit every home owner’s best interests. Choosing the right type of home loan or mortgage repayment may greatly affect the total amount of interest paid over the life of one’s home loan and also the total time it will take to repay their mortgage. Most people when shopping around for a home loan are focusing only on the interest rates and whether they should fix them or leave floating, while the type of their home loan repayments is far more important thing they should be worrying about.
Usually at the beginning of home loan period only a very small portion of the weekly or monthly repayments goes towards the loan principal. The most of it covers the interest. Therefore even a small change in the repayments structure may lead to hundreds of thousands of dollars saved on interest and at the same time cutting years from the entire loan term. In our article we will describe and explain the most common types of mortgage repayments offered by the banks.
(1) Revolving home loan
This type of home loan repayments is the most flexible option, but also the most dangerous one with huge demand on borrower’s discipline. The bank only sets the upper mortgage limit and it’s fully up to you how much and when you pay. The bank will in regular intervals add interest to the loan balance and you will have to make sure that after the interest is added, the loan balance won’t go over its total limit.
The problem with this type of loan is that it places a huge demand on the borrower’s discipline and self-responsibility. Any lack of it and one can easily keep redrawing the loan and ending up never repaying the loan. Only consider this type of loan if you’ve got an iron strong self-discipline!
(2) Revolving home loan with decreasing limit
This type of home loan works similarly as previous one with an exception that the total loan limit is decreasing with time, so it forces you to make higher repayments than just the interest. It is therefore a bit better option. However, there are still few risks. If the limit is decreasing only marginally or if it allows you to increase it back to the previous level easily then it can still take ages to repay the mortgage.
This type of home loan is better suited for self-employed people or people who don’t have stable incomes. In good times you contribute towards your home loan with higher repayments and in bad times with lower. It also requires a lot of discipline to avoid convenient redrawing of the money.
(3) Fixed repayments home loan
This is the most common home loan type. It’s the most conservative, but for majority of people their best option. It has fixed monthly repayments over the whole loan period. The repayments will only change if you move between fixed or floating (variable) interest rates or if the interest rates change. Even with these variations there is certainty about how much goes towards the loan principal and how long it will take to repay your loan, hence in our option it’s the best option for majority of people.
We recommend for all first time home owners to start with this type of home loan. Later, after couple of year when you get more confident with your repayments, you can start experimenting with different types. But always keep let’s say half of the loan on fixed repayments and the other half set up as a loan with variable repayments. If it won’t be working well for you then be prepared to go back on fixed repayments home loan type.
(4) Home loan with decreasing payments
With this type of home loan the repayments are decreasing with time. Repayments are made up of two portions – principal and interest. Over time as your loan balance is decreasing, so is the interest. This type of loan comes with fixed principal portion and decreasing interest. As a result the total repayment amount is also getting smaller over time.
While it may look as an attractive option, in reality it’s not. Structuring your home this way it will take a lot longer to repay it and cost you much more in interest than it could have otherwise. Generally, if you are able to afford initial higher repayment then it is reasonable to expect that you should be able to afford repayments on the same level over the whole home loan term. Considering the fact that people get pay rises every year, you should even be able to increase your repayments with time.
The difference between keeping the repayments at the same level (with principal portion ever increasing) and decreasing repayments is that it may take 30% or even 50% shorter time to repay your mortgage with fixed repayments. We would therefore recommend never to consider this type of home loan with decreasing repayments. It’s one of the best options for the bank, but not the best option for you as a borrower.
(5) Interest payment only home loan
As name of this home loan type suggests, with this type of loan you pay only the interest, no principal. The balance of this loan is never going down. It should be therefore considered only in some very specific situations. For example when you are selling your home and buying new one at the same time.
Example of such scenario is when you have to buy your new home and you haven’t sold your old one, so for some time you need to maintain 2 mortgages. This can be financially very demanding, so you may decide during that temporary period for an interest only mortgage on your new home. However, as soon as you sell your old home, you should move to some other home loan type.
Another example are some property investors ho buy rental properties. They make money on the difference between rent and mortgage repayments. In order to minimize the repayments they elect for the interest only loan. However, no serious home buyer should consider this type of home loan type.
(6) Combination of the above home loan types
Most banks these days are happy to structure your home loan into any repayments type you wish. It is possible to combine all above described types by splitting your home loan into two, three or even more parts and treating each part as a separate home loan.
One of the best option we recommend is the following:
Split your home loan into 2 parts:
(A) 75% loan with fixed repayments (either on fixed or floating interest rate – depends on your preference)
(B) 25% revolving loan
If you can successfully manage to decrease the balance of the revolving loan then you can congratulate yourself for your iron discipline.
Then decide on your comfortable reserve or margin dedicated for any unexpected expenditure, some kind of a safe headroom. If you repay more on your revolving loan and your reserve gets bigger compared to your safe headroom then move some portion of the fixed home loan to the revolving home loan. That way the reserve available for any possible redraw on your revolving loan will never grow too big. So now you can get both benefits – have some reserve money available if something unexpected happens and also avoid temptation to redraw already repaid loan.