BASIC VARIABLE RATE LOANS AND STANDARD VARIABLE RATE LOANS

A Standard Variable Rate loan usually offers the following features:

• the ability to make additional loan repayments
• flexibility in repayment frequency such as weekly, fortnightly or monthly payments
• offset accounts
• ability to redraw if there are funds available
• interest only periods
• progressive draw downs for construction

Basic Variable Rate loans are very similar to Standard Variable Rate loans. The main area of difference is the number of features offered.

The reduced number of features and benefits has allowed lending institutions to offer Standard Variable Rate loans at a reduced margin. This means that borrowers can receive a home loan at a reduced interest rate (although this is not guaranteed).

A summary of the usual differences is set out below. Please note that this is a general guide and that differences between lenders may arise with specific products.

Feature	Standard Variable	Basic Variable
Redraw	Yes	Yes
Extra Repayments	Yes	Yes
Discounts available for higher loan amounts	Yes	No
Mortgage Offset Account	Yes	No
Line of Credit option	Yes	No
Ability to change to fixed rate	Yes	No

DISCOUNT VARIABLE RATE LOANS OR INTRODUCTORY OFFERS

To attract new borrowers many lending institutions have developed a version of their Standard Variable Rate loans that offers new borrowers with a reduced or discounted rate of interest for a set time period. After the discount period expires, the interest rate usually reverts to the Standard Variable Rate.

The discount periods can range from 6 months to 24 months.

FIXED RATE LOAN

A Fixed Rate Loan refers to the fixing of an interest rate at a set amount for a set period of time. The interest rate is contracted to remain unchanged during the term of the fixed rate, no matter what movements in interest rates occur in the market place.

Traditionally lenders have offered fixed rates terms of between 1 – 5 years; however, recently some lending institutions have offered fixed rates terms of up to 10 years.

Fixed Rate loans normally require the loan to be renegotiated at the conclusion of the fixed rate term.

Thus a 5 year fixed rate loan would normally be required to be repaid in full at the end of year 5. However, most lending institutions provide for the facility to revert to a Standard Variable Rate loan after the Fixed Rate term has expired.

Thus a loan facility can be established for a 25 or 30 year loan term with the interest rate fixed for the first 5 years.

Borrowers who utilise a fixed rate loan should be warned that they are committing to a contract with the lending institution and that they will be required to continue the facility for the prescribed term.

If this contract is required to be broken, if interest rates have decreased subsequent to setting up the loan and the borrower wishes to revert to a variable rate loan or the borrower wishes to change the term, the lending institution may require the borrower to cover its costs involved in the breaking of the contract. These are commonly known as ‘break costs’ and can be very expensive. The break costs are determined by many factors such as the term remaining, the interest rate environment at the time and the amount of the outstanding balance.

In addition to the prohibitive cost is breaking the contract terms, many lending institutions will also restrict how much of the loan principal can be repaid during the fixed rate term. This may vary from a few thousand dollars per year to a percentage of the initial loan amount over the fixed rate term.

These packages offer guaranteed repayments for a period of time but they also offer very little flexibility.

LOW DOCUMENT (LOW-DOC) LOANS

Low-doc loans are loans in which the lender determines eligibility by relying on statements made by the borrower that they can meet the repayments rather than requiring proof of income.

If you take out a low-doc loan you won’t need to give your lender or mortgage broker as many documents to prove your income, assets and liabilities. You still have to apply in writing and sign your loan agreement but you may not be required to produce payslips, tax returns or other proof of income that your lender would normally require. You are usually simply asked to state your income – a process called self-verification.

Low-doc loans can help if you would not qualify for a standard loan. But in a low-doc loan special conditions may apply. You may have to:

(i)         Pay a higher interest rate if you are not able to provide documents about your financial position.

(ii)        Pay additional fees and charges, including ‘risk fees’.

(iii)        Pay for mortgage indemnity insurance.

(iv)       Contribute more of your own money towards the purchase price.

(v)        Offer additional security for the loan, for example, your car.

(vi)       Accept a loan for a shorter period, such as 12 months (which may have to be refinanced at the end of this period with additional costs involved at that time).

Low doc loans have been aggressively marketed to casual workers or self-employed people who may not be able to provide the documentation necessary for a lending institution to make an assessment of their eligibility for the loan. They have also been marketed to people with a troubled credit history who may be in a weaker position when it comes to dealing with the financial risks involved.

With many low doc loans it is up to you to decide whether you can afford the repayments. The lender will base their decision on whether to offer you finance on whether they can recover the loan from selling your home or other security. Just because they’ll give you a loan, doesn’t automatically mean the lender thinks you can afford the repayments – you need to decide for yourself.

Low doc loan packages may suit you but you need to weigh up the extra costs involved. In some cases you may be able to get a lower interest rate if you can give more documentation about your financial history to the lender. Lower costs will usually make you better off in the long run.

REVERSE MORTGAGE

Recent changes in the demographic of the population in Australia have seen an increase in asset rich and cash poor elderly Australians. It is expected that this segment of the market will continue to increase as the ‘Baby Boomers’ start reaching retirement age. The development of this market segment has seen lenders develop packages that will provide consumers with the ability to gain access to the equity that they have in their properties.

Reverse Mortgages allow the borrower to borrow funds for any purpose or for day-to-day living expenses against the equity in their property. The main difference of this package to standard home loans is that they do not require the consumer to make any principal or interest repayments during the loan term. The debt is usually repaid once the property is sold.

Due to the fact that interest is capitalised onto the loan balance until debt is paid out, lenders usually restrict the amount that they will advance against the value of the property. Usually the lenders will only lend 20% of the value of the property in order to ensure the likely sale value of the property will be sufficient to cover the sum of the principal and the capitalised interest that will have accrued by the time the property is sold.

The borrower has the option of repaying the facility through normal means.

SPLIT ACCOUNTS OR COMBINATION LOANS

Split accounts or the ability to split a facility allows the borrower to take more than one package type on offer from the lender. Often borrowers have chosen to take a combination of a fixed rate loan and a variable rate loan in order to minimise the potential effect of an interest rate rise while still maintaining the flexibility of a variable rate loan.