Which type of mortgage should you get?

Essentially, a mortgage is a loan that’s secured by a property. But not all mortgages are created equal; they come in various combinations of interest rate and structure, and each combination has pros and cons.

Complex choice

When it comes to choosing a mortgage for your property purchase, these are the options you’re most likely to encounter.

Interest Rates:

Fixed Interest Rate

With a fixed interest mortgage, you lock in an agreed interest rate for a term ranging from six months to five years. This is a popular option because it means that you know exactly what your repayments will be during that time, which makes budgeting easier. It also helps to protect you from rising interest rates. After the fixed rate has expired, you can choose to fix it for another term or move to a floating rate.

When you agree to a fixed rate, you need to be aware that it limits your ability to make ad-hoc lump-sum principal repayments, although most lenders will allow you to increase your regular repayments by a certain amount. If interest rates fall, you won’t benefit from this until your fixed rate period expires. Also, if you sell the house and wish to repay the mortgage early, or you decide to break the fixed rate term, you may be charged a “break fee”.

Some lenders offer capped rate mortgages, where the interest rate can’t rise above a certain point but can drop.

Floating Interest Rate

When you choose a floating interest rate (also known as a variable rate), this means that the interest you are charged will rise and fall with the market, and changes are normally linked to fluctuations in the official cash rate (OCR). A floating mortgage gives you the flexibility to make ad-hoc principal repayments, repay large portions of the loan without penalty, or add to the loan if you require additional funds for debt consolidation, large purchases or renovations.

However, floating rates are generally higher than fixed interest rates, and if you’re on a tight budget, increases in the interest rate can create a financial pinch.

You can structure your mortgage so that most of it is at a fixed rate and a small portion is at a floating rate. This can be helpful in instances where you may want to make ad-hoc extra principal payments, but still want to be protected from the full impact of interest rate fluctuations.

Loan Structure:

Table Loan

This is a popular option because the repayments on a table loan are the same for each payment (assuming the interest rate stays the same) which makes budgeting easy. Also, the initial payments are lower than those of a reducing loan, making it more affordable at the start. With a table loan, at first most of your payments go towards covering the interest, with only a small portion repaying the principal. With each subsequent payment, the amount of interest you pay decreases, and the amount of principal increases. So, at the end of the loan, your repayments are mostly repaying the principal. Overall, this type of loan costs more in interest, but many customers prefer it because of the lower starting cost. Most lenders offer up to a 30-year term for table loans, and you can choose a fixed or floating interest rate.

Reducing Loan

A reducing loan means that you pay the same amount of principal with every repayment, and the interest payable for that period is calculated on the outstanding amount owing. This means that your payments will start out high, but the interest component will fall with every payment made. Overall, the total cost of a reducing loan is less than a table loan, because you’re paying off more principal earlier on. These mortgages are not very popular in New Zealand, but may be preferable for people who are currently on high incomes but expect that to change (such as couples planning a family in the future). However, if you expect your income to stay high and can manage the higher repayments on an ongoing basis, a more cost-effective option is to pay off a table loan at the higher rate.

Revolving Credit Loan

Having a revolving credit loan is the same as having a huge overdraft facility. Your revolving credit loan is also your day-to-day transactional account; your pay goes in, and your bills come out, and the difference repays the loan. Because the loan interest is calculated daily, you get the benefit of paying less interest for the time between when your pay goes in and your bills come out, which can translate to significant savings on the amount of interest paid overall. You also get the flexibility of being able to repay or draw down large sums whenever you want to. Putting lump sums into your revolving credit loan will save you more in interest than they would earn in a savings account, plus you avoid the tax charged on savings interest. The drawback with this kind of loan is that it requires plenty of discipline. Because there are no fixed payment dates, it’s easy to lose track of how much you’re actually repaying, and you can find yourself in as much debt as you were a year ago.

Interest-Only Loan

If you’re on a tight budget, some lenders will allow you to pay just the interest on a loan for a period of time. This means lower payments, but you aren’t repaying any of the loan itself. In the long run, this kind of loan will cost you more, but it can be a good interim solution if you are expecting your income to increase, or you want extra money in your pocket to do some renovations before you start paying the loan in full.

Whatever kind of mortgage you need, Best Mortgages can help you find it. Call us today to find out more.

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