Types of Mortgage Loans

There are several types of mortgage loans that banks offer to finance your investment property. The most common ones are floating rate, fixed interest rate, or a mix of both.

The next decision you will need to make is how you wish to make the repayments. The choice for this can range from reducing mortgage or an interest-only loan, a table mortgage, revolving credit mortgage.

Choice of Mortgage Loans

Fixed interest rate loans

You can choose to fix your interest for periods ranging from six months to thirty years. When the fixed term expires the loan interest automatically moves to a floating rate until and unless you choose to re-fix it for another term in consultation with your bank.

Advantages

• You have certainty over the period you have fixed your loan. You know the exact amount you have to pay each month.

• Fixed term interest rates are generally lower than floating rates. Banks compete to lock in customers by offering very competitive fixed term interest rates. Even a small difference in interest rate can save you thousands of dollars because the amount of borrowing on real estate purchases are very high.

• If you expect the interest rates to rise then you have the option of locking in your mortgage at reasonable interest rates.

Disadvantages

• You lose the flexibility of making early repayments. Banks impose limits and charge you money if you wish to repay your debt earlier.

• You can not take advantage if the interest rates drop below at what you have fixed because the banks will charge you a heavy penalty if you wish to break your fixed mortgage. There many occasions when floating rates drop below the fixed rate.

Some banks allow a variation wherein the fixed interest rate cannot rise above the floating rates and will adjust if the floating rates where to go the fixed interest rate.

Floating Interest Rate or Variable Rates

Floating rates change depending upon the prevailing market conditions. This means that your repayments will fluctuate and go up or down with the changes in the floating rates.

Advantages

• You have the flexibility of changing your repayment schedule and have the ability to make lump sum repayments without attracting any penalty.

• You can consolidate other costlier debt into the variable rate loan by borrowing more.

Disadvantages

• Variable rates are generally higher than fixed interest rates.

• There is a great deal of uncertainty and it is very difficult to plan your finances. When variable rates move up it puts pressure on you finances because of the reduced cash flow from the investment property.

A Combination of Fixed and Variable Rates

There are investors who like to split a loan between fixed and floating rates. This gives them the flexibility of making extra repayments without penalties and also allows them to take advantage of the lower interest rates that fixed mortgage loans offer.

The amount of split has to worked out carefully depending upon the extra cash you expect from your business or work income that you can use to repay your mortgage loans. This amount can be used to decide the loan amount to be put on floating rate.

You will need to rework these figures every time your fixed part of the loan comes up for renewal.

Repayment Methods

Table loan

This is the most common type of mortgage repayment plan. Most lenders will allow you to choose a term up to 30 years. In this plan most of your initial repayments will go towards interest and most of the later payments will go into paying off the principal amount. You have the option of a table loan with a variable or fixed rate of interest.

Advantages

• With table loans you have schedule of regular payments and you know exactly when your loan will be paid off.

• You know exactly how much you will be required to pay until and unless you have part of the loans on a floating mortgage plan.

Disadvantages

• The biggest disadvantage with this type of loan is for people who have irregular incomes.

Revolving Credit Loan

This also at times is know as the line of credit. Revolving credit loans operate as if you have a large overdraft facility. Your earnings go into the revolving credit loan account. All payments are made from this account on the due date. By doing so you keep the loan amount to the barest minimum. Your interest payments are low because they are calculated on a daily basis.

Whenever you have the money you can make lump sum repayments to reduce the outstanding debt. And whenever you need the money you can re-draw money up to your loan limit.

Banks can charge you fee for day-to-day banking transactions on this account. You should clarify these charges when taking out a revolving credit loan.

Advantages

• You can pay off your mortgage faster with this type of a loan if you are organized and disciplined.

• This type of loan is suitable for people who do not have a fixed income as there is no fixed schedule of repayments.

• By putting your surplus money into the revolving credit account rather than savings account will have much bigger interest savings. In addition you will also avoid the tax on interest earned in the savings account.

Disadvantages

• It can be very tempting to spend out of your credit limit. This way you will stay in debt for a longer duration. You will need to be very disciplined with this type of a loan.

Reducing loan

Reducing or 'straight line' mortgage loans involve same amount of repayment of the principal every month. This results in reduction of interest amount each month. Reduction loans are not very common these days because payments are very high initially and reduce over time.

Advantages

• Because of the relatively high principal amount during the initial stages you pay less interest overall.

• This type of loan suits people who expect their income to drop in next few years e.g people who are about to retire .

Disadvantages

• This loan is not suited for first time home owners and investors because the initial payments are fairly high. If you have the capacity of higher payments then you should opt for a sorter term loan. This will reduce the total interest payable substantially.

Interest-only Loans

As the name suggests you don't repay the principal borrowed amount until an agreed time. Most property investors prefer interest only mortgage loans. Some investors take an interest-only loan for a first couple of years and then switch to a table loan.

Advantages

• Interest only mortgage loans improve cash flow. The money can be used for carrying out renovations or buying more property.

• Interest only loans result in higher tax breaks resulting in higher post tax cash flow.

Disadvantages

• You continue to owe the full amount of loan at the end of the term.

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