What is a home loan?
Before we look at home loan features, we need to know what a home loan is. A home loan or mortgage is a loan advanced to you by a financial institution in return for security over the property you are using the loan to buy. Typically a home loan will be a 25- or 30-year term, with regular repayment amounts fortnightly or monthly. You then pay off the loan via these instalments over the contracted term.
However, you secure the loan against your property. This means if you are unable to continue paying the loan you may have to sell the property to settle the debt. Given property prices in New Zealand, most people will be unable to purchase a home without first securing a home loan.
Home loan features
1. Extra repayments
If a home loan comes with this option it means you can make additional payments on your mortgage, on top of your regular repayments. This brings down the principal and you’ll pay less interest. Regularly paying a bit more off your loan is a simple way to pay off your home loan faster. And you don’t have to pay a lot extra to potentially reap valuable rewards. Paying just a dollar a day more into your loan could help you pay it off months earlier.
As an example, on a 25-year home loan of $350,000 with a rate of 3.89%, paying $1 a day extra above the minimum repayment off your loan could see you become mortgage-free up to eight months ahead of schedule. It will also cut the overall interest costs by as much as $5500. Make it $2 a day extra and you could save $10,717 in total interest and cut 15 months from that 25-year loan term.
2. Redraw facility
As mentioned above, making extra payments can be a great way to pay off your mortgage faster. If you find yourself with some extra funds, it can be pretty tempting to chuck it onto your mortgage instead of having it sit around your savings account. But if something unexpected arises, that extra cash would look pretty good to have back. A redraw facility allows account holders to withdraw, or take back, those extra loan payments.
Many loan holders find a redraw account goes a long way towards paying off a loan while still providing a contingency to pay off future debts. They can make extra payments on their mortgage without the fear that they’ll be penniless should an emergency arise.
An example can help here: Sarah makes $4000 in extra repayments towards her floating rate home loan over four months. She then needs some of that money to pay off a credit card debt. Her home loan redraw facility allows Sarah to withdraw the extra payments she made. So Sarah withdraws $1000 to contribute to her credit card. She now has the extra money to pay her credit card debt plus the benefit of the $3000 left in her redraw account for future growth.
However, there can be disadvantages. Interest rates on redraw facilities are usually higher, floating rates. Also some lenders may have fees and withdrawal restrictions tied to each redraw that you make. There may also be limits on how many redraws you can make per year. As such, the money that you pay into a redraw facility ideally shouldn’t be money that you might need to use in the near future. And as you’ll pay higher interest on a redraw facility, it’s a good idea to limit it to a small part of your mortgage, and not the entire sum.
3. Line of credit
A line of credit is a loan borrowed against the equity in your home. It gives you the flexibility to access the loan at any time, up to the agreed limit. You can also pay money into the loan at any time. It is not generally a loan set up to purchase a property, but rather set up against the equity in an existing property. Essentially, a line of credit home loan functions in a similar way to a credit card. You have a pre-approved credit limit and you can borrow as much of this sum as you want. You then pay interest on the outstanding balance. In general, having a good credit history may help you qualify for a lower interest rate.
4. Repayment schedule
Most home loans have a monthly repayment scheduled by default. If you get paid weekly by your employer, you’ll need to do some serious budgeting.
But plenty of home loans offer the option to make repayments weekly, fortnightly, or monthly. Other providers allow borrowers to make repayments more or less frequently, with options such as daily, quarterly, semi-annually, or even annually.
If you plan ahead and choose a home loan with repayment flexibility (e.g weekly, fortnightly or monthly repayments) you can set up your repayments to time it with your pay. Most mortgage calculators allow you to enter in your payment frequency of choice, including Canstar’s, which you can access by clicking here. An extra repayments facility can be found with both fixed and variable rate home loans.
5. Repayment holiday
Some mortgages allow you to take a loan repayment holiday or mortgage holiday for up to three months. This home loan feature means you don’t pay anything during this period, but interest is still charged to the mortgage. Unless you lift your repayments after the holiday, the mortgage term extends and you pay more in interest overall. That’s why you should use repayment holidays only as a last resort.
6. Offset account
An offset account is a transaction account that is linked to your home loan. You can use this account like any transaction account, except with an offset account the account’s balance (or a proportion of that balance) is offset daily against your home loan balance. As a result, you’re only charged interest on the difference. The total home loan balance minus the amount in the offset account. Sounds confusing right?
Sometimes the best way of explaining things is to use an example.
- Let’s say you take out a $500,000 home loan
- You then deposit $10,000 into your offset account
- You’ll now be charged interest on $490,000, instead of the full $500,000
This means the lender charges you less in interest because they are not charging you interest on the full balance of your loan. The more money in your offset account, the lower the amount of home loan you are charged interest on. Offset accounts are usually linked to a variable rate home loan, but they can also be linked to a fixed rate home loan. It’s a good idea to check with the lender to see what conditions or limitations may apply.
Canstar is here to help
If you are considering buying a home, it pays to keep on top of the current interest rates in the market. If you’re interested in comparing rates, just click on the button at the bottom of the page.
Enjoy reading this article?
You can like us on Facebook and get social, or sign up to receive more news like this straight to your inbox.