Types of home loans

Basic variable home loans

A basic variable loan generally carries cheaper rates, because they lack the extra features of a standard variable home loan. A basic or ‘no frills’ loan is much lower than a standard variable loan, and is ideal for first homebuyers and owner-occupiers. However, beware of higher discharge fees if you choose to close the loan in the first three years.

A basic variable loan is perfect for first homebuyers who wish to keep their costs down, and those borrowers who want a simple mortgage product without any bells and whistles.

INTRODUCTORY RATE/HONEYMOON LOANS

This product is aimed at first home buyers. These loans offer a discounted interest rate for a limited time period. This may range from 6 or 12 months to 3 or 4 years. This introductory rate will either be in the form of a “fixed discount” or a “discounted fixed” rate. Once the introductory period ends, the loan will revert to the standard rates.
It is important to keep in mind the penalty cost should you wish to get out during or at the end of the introductory period. Lenders will either charge a fixed amount or a percentage of the original loan amount.
Although the loan may be effective under certain circumstances, it is important to remember the honeymoon rate is usually just 12 months and the loan can last anything up to 30 years.

LOW-DOC LOANS

Initially, these products were only offered by non-bank lenders but as traditional banks began losing market share in this area they included them in their range of lending products.

There are some major differences between mainstream and low-doc lenders. The main one is that low-doc lenders do not require traditional proof of income such as company financials or tax returns. Instead, borrowers generally complete a declaration that confirms they can afford the loan. This is known as self-certification. These loans are particularly attractive to self-employed or full-time investors who may have difficulty showing a high level of income, as a result of either writing off a number of expenses, reinvesting profits into a business, or being slow in lodging their tax returns.

Borrowers should be aware that interest rates and fees are higher with low-doc home loans. Lenders mortgage insurance (LMI) fees often applies and they are usually capped at 80% of the valuation of the property. While traditional loans typically require LMI if you are borrowing more than 80% of the property’s value, low-doc loans often require LMI if you are borrowing more than 70% – and in some cases 60%.

Borrowers wishing to obtain a low-doc loan will normally need to satisfy three main requirements:

  • Self-certify their income
  • Confirm their self-employment status (if appropriate) – usually with a registered ABN or accountant’s letter; and
  • Have a clean credit history and good repayment record for existing or previous loans

Low-doc borrowers should be aware that as there are only two mortgage insurers in Australia, any income declared in an application with one lender might affect any future applications with another lender or mortgage insurer. If the declared income is substantially different on subsequent applications, the mortgage insurer may question the discrepancy.

A low-doc loan is made to a borrower with a clean credit history. Therefore the most important factor for the lender to consider is the value of the asset being used as security. Because the asset is vital to these loans, the location of the security is also imperative. Hence insurers and lenders alike may not lend in high-risk areas such as inner-city high-rises or large rural allotments.

BRIDGING LOANS

In many cases, vendors (sellers) putting their homes on the market will be selling with the intention to purchase another property, or buyers may be waiting for completion of the sale of an existing property prior to buying a new one.

If there is a mortgage on either of the existing properties, things can get a little tricky if the sale of the existing property will not take place until after settlement of the new one. To ease the strain and allow completion of purchase for the new property, ‘bridging finance’ may be arranged.

Bridging finance allows you to obtain finance to ‘bridge’ the gap between having to pay for a new property and receiving the proceeds from the sale of your existing one.

What will normally happen is that a lender will take security over both properties until the sale of the existing one is complete. Usually the bridging amount or ‘peak debt’ will not be allowed to be above 80% of the value of both properties.

Some lenders will allow you to capitalise the interest payments (add them onto the loan) for a period of time or until the 80% limit is reached, to ease the financial burden on the borrowers. The bridging loan is usually separate from the lender’s normal products, and may be slightly more expensive, however the borrowers nominate which product their loan defaults to after the bridging period is over.

When you sell your existing property you just pay the proceeds from the sale off the balance on the bridging loan, and revert to your nominated loan product.

SMSF Loans

What is an SMSF?

Self-managed superannuation funds (SMSFs) do pretty much what they say on the tin: rather than paying super contributions into an industry fund or wrap, you pay it into a fund that you run yourself. It allows you to take complete control of building your retirement wealth. The key difference between a SMSF and a standard superannuation funds is that SMSF members are also the SMSF trustees. As SMSF member/trustee you manage the fund for your own retirement benefit, and you are fully responsible for complying with superannuation and tax laws.

You choose what to invest in, and that can include direct property. All the running expenses of the property are paid by the fund, meaning you’re not out of pocket in the same way you would be with a directly-owned investment property, and your fund can take advantage of significant tax benefits.

Although the rules and regulations for SMSFs make them complex to set up, the control and flexibility of investment make them very attractive to many people. It’s a major financial decision and you need the time and skills to manage your own super fund effectively.

What do lenders look for when lending to an SMSF?
Deposit: typically at least 30% of the property value;
Rental income: income expected from the property is factored into the borrower’s ability to make repayments;
Patterns of contribution: how frequently and consistently members make contributions to the SMSF as these will also be relied on to meet repayment obligations;
Structure of SMSF: must be compliant with ATO and ASIC rules;

Investment strategy: direct property investing and borrowing must be permitted under the trust deed and be part of the SMSF investment strategy for the fund to be viewed as an acceptable borrower.

How much tax can be saved?
Capital gains tax won’t be paid if your SMSF purchases an investment property and sells it when fund members are in ‘pension phase’. This could potentially save hundreds of thousands of dollars in tax.

Big tax benefits
SMSFs are encouraging people to engage with their super in a way never achieved by industry and retail funds. The tax benefits that come from holding investments in a super fund can contribute hundreds of thousands of dollars’ worth of capital gains to your retirement savings instead of handing it to the taxman.

Reduce capital gains tax to between 0% and 15%
Tax on SMSF earnings is capped at the same rate as other types of super fund (15%). This means the maximum tax payable on the property’s income is 15%. Any expenses such as interest, council rates, insurance and maintenance can be claimed as tax deductions by the SMSF.
Capital gains tax is capped at 10% if a fund holds the property for more than 12 months and potentially no CGT bill will apply at all if the property is sold after you retire and your SMSF is in ‘pension phase’.

Negative gear to reduce tax paid on earnings
Large industry or private super funds are charged interest on earnings each year which is automatically deducted from members’ accounts. Now that SMSFs are permitted to borrow to purchase assets such as property, negative gearing can be used so interest and other costs related to holding the property can be offset against other taxable earnings and potentially reduce tax payable by your fund to zero.

Standard variable home loans

Standard variable rate loans are the most popular mortgage product in Australia, with almost half of all borrowers opting for this type of mortgage.
These loan are attached to variable interest rates, which means the rate can change at any time, whether the Reserve Bank changes the cash rate or not. Generally, variable rates move in line with the RBA, but banks are increasingly setting their own rate agenda as their cost of raising finance increases.
Standard variable rate loans carry flexible features such as offset facilities, redraw, extra repayments and the ability to split the loan. In order to access these features, however, the borrower generally pays a higher interest rate.
For those who require a little more flexibility, such as property investors, a standard variable rate is often a better choice. This is because the ability to redraw money from the loan, or park their extra cash in an offset account, more than makes up for the extra money they fork out in higher interest payments.
In any event, borrowers may be able to sign up for a professional package with their lender, which provides a discount on standard variable loan rates in exchange for a fixed fee of around $400 per year.

CONSTRUCTION LOANS

Construction of a dwelling is generally divided into a number of stages as follow:

Deposit
This is simply the initial payment due once the contract is signed. For work worth more than $20,000, you shouldn’t pay more than 5 per cent for the deposit. If it’s valued between $3,300 and $20,000, then 10 per cent is your maximum.

Base
This will cost around 10 per cent of your total contract. This is essentially the laying of the floor – the plumbing gets laid, piers or columns are installed and the concrete slab is poured. This process varies depending on the type of floor.

Frame
Wall and roof frames are prepared, delivered to the site, erected and approved by a building surveyor. At this point, you can really start to see the house coming together. This is around 15 per cent of the contract.

Enclosed stage
Also known as the lock-up stage, at this point windows, external doors, and internal and external wall linings are installed. This generally makes up the biggest share of the contract – 35 per cent.

Fixing stage
This is the home stretch, when the interior of your house truly starts to look like a home. This means the fitting of items such as cabinets, cupboards, sinks, baths, as well as painting work, the installation of fixtures and work on the kitchen. It’s 20 per cent of the contract.

Practical completion
The final step. At this point, work is finished, and an inspection is carried out to ensure no flaws or mistakes. Only minor sprucing up should be required at this point. You’ll pay the final 15 per cent at this stage.

When building a new home, you will not need the entire amount of the loan drawndown all at once. If you did this, you would be making interest repayments on the entire amount right from the start and not just on the amount needed at the time.

With a construction loan, the drawdowns are aligned with the various stages of the progressive construction phases. As one phase of the construction is complete, you are able to draw down the next portion of the loan.

This means that interest is only being calculated on that amount which has been physically drawn down, and you are only making repayments on the portion you have used.

When you decide to build and apply for a construction loan, the lenders will need to see, at minimum, council approved plans and a fixed-price building contract, before they will unconditionally approve a construction loan.
If you have borrowed to purchase land and are looking to obtain a construction loan, the value at which most lenders will estimate the completed package will be based on the value of the land, plus the cost of the building materials for the dwelling.

If you need to borrow more funds for improvements such as landscaping, you may be able to get your property revalued by your lender once the building is complete.

After each phase is finished, a valuer will normally go out to inspect it to make sure that the phase is complete according to the requirements set out in the fixedprice building contract. Once the valuer is satisfied, they will contact the lender and authorise the next payment.

To ease the financial burden during the construction phase, construction loans are usually interest-only. The interest rate may be slightly higher than that charged on normal residential loans, but should be less than that of a line of credit/equity rate.

NON-CONFORMING LOANS

It is important to be aware of the distinction between low-doc and non-conforming loan products. While both waive the requirement to view and retain copies of the applicant’s tax returns and financial statements, low-doc loans are almost exclusively available to those with an unblemished credit history, are mortgage insured, and generally do not want to borrow more than 80% of the security’s value.

Non-conforming loans, meanwhile, are mortgages that do not conform to a lender’s typical loan underwriting criteria. This may include situations where the applicant has a poor credit history, or who may not have been employed long enough to show a history of earning an income. Non-conforming loans may exceed 80% of the security’s value and the interest rate is based on the severity of the credit history.

Credit-impaired potential borrowers should approach lenders who offer non-conforming low-doc products to see if they qualify. Most low-doc lenders will consider switching the borrower to a full-doc product at no cost, when the borrower can provide the traditional forms of income verification.

REVERSE MORTGAGES

The reverse mortgage loan was introduced to the market to cater for retirees wanting to take advantage of the equity they have in their home and use it to supplement their retirement income. Basically, retirees can use this type of loan to borrow money against the equity they have in their property, and have it paid to them in either a lump sum or in instalments, depending on the lending institution involved.

Generally all repayments, fees and charges will be added to the loan balance each month so that the borrower/s don’t have to make any payments whatsoever. The lender recoups the repayments and fees when the borrower/s pass away, the property is sold or the borrower/s no longer live in the property. Having said this, generally the borrower/s may make payments at any stage if they wish to reduce the loan balance.

There will normally be a minimum amount of around $10,000 and quite often a maximum allowed that will be expressed as a dollar figure, or as a percentage of the value of the property. To qualify, the borrowers will generally need to be over 65 years of age. Some lenders will wear the risk if the end debt amount is more than the property is worth, however this will vary from lender to lender.

These loans are obviously great for older people who may be doing it a little tough financially after retirement, or who may need a large amount of money in a relatively short time for a dream project such as a caravan trip to the Outback or a luxury cruise.

One thing to be wary of is the ‘all care, no responsibility’ method of repayment. Basically, the debt is left to the beneficiaries of the borrower/s to pay, which might come as a nasty surprise to beneficiaries expecting a ‘clean’ inheritance.