Types of mortgage

When you're choosing a home loan, there are two big decisions you need to make:

• Whether to take a fixed interest rate, a floating rate, or a mix of both.
• How you want to make repayments: through a table mortgage, revolving credit mortgage, reducing mortgage or an interest-only loan.

Choice of interest rates

Fixed interest rate loans

The interest rate you pay is fixed for a period from six months to five years. At the end of the term, a fixed interest loan automatically moves to a floating rate unless you negotiate another fixed term.

For:

• You know exactly how much each repayment will be over the term.
• Rates are often lower than floating rates, as lenders compete with fixed rate specials. A one percentage point difference in interest rates can save you thousands of dollars over just a year or two.
• You can lock in lower rates if market interest rates are rising.

Against:

• Fixed rates often have limits on how much you can lift repayments or make lump sum payments without paying charges.
• If you take a long term, there is a risk floating rates may drop below your fixed rate.

Capped rates are a variation where the interest rate cannot rise, but will drop if floating rates drop below the capped rate.

Floating rate (sometimes called variable rate)

Lenders of floating rate loans will lift or lower the interest rate as interest rates in the wider market change. This means your repayments may go up or down.

For:

• You have greater flexibility to make changes without penalty - e.g. early repayment or changing the term of the loan.
• It is easier to consolidate other costlier debt into floating rate loans by borrowing more.

Against:

• Floating rates have often been higher than fixed rates.
• When rates go up the repayments also go up, putting a squeeze on your budget.

A mix of both

It is possible to split a loan between fixed and floating rates. This lets you make extra repayments without charge on the floating rate portion while you get lower rates on the fixed portion.

How you split your loan is important and can be worked out by considering the total extra cash you're likely to get from work bonuses or the like over the period you've set the fixed rate for. This is the amount you could put on a floating rate.

When the fixed rate part of your loan comes up for renewal, if you've paid off some or all of the floating part, you'll need to repeat the exercise for the next year or two.

Ways of making repayments

Table loan

This is the most common type of home loan. You can choose a term up to 30 years with most lenders. Most of your early repayments go to pay interest, while most of the later payments go to pay off the principal (the lump sum you borrowed). You can take a table loan with a fixed rate of interest or a floating rate.

Application fees for table loans range from nothing to over $1,000. Most lenders which do have a fee, charge around $200 to $400. This is often negotiable.

For:

• Table loans provide the discipline of regular payments and a set date when they will be paid off.
• They provide the certainty of knowing what payments will be (unless you have a floating rate, in which case repayment amounts can change).

Against:

• Fixed regular payments might be difficult to make for people with irregular income.

Revolving credit loan (sometimes called line of credit)

Revolving credit loans work like a large overdraft. Your pay goes straight into the account. Bills are paid out of the account only when they are due. By keeping the loan as low as you can at any time, you pay less interest because lenders calculate interest daily.

You can make lump sum repayments and re-draw money up to your limit. Some revolving credit mortgages gradually reduce the credit limit to help you pay off the mortgage.

Application fees on revolving credit home loans can be up to $500. There can be a fee for the day-to-day banking transactions you do through the account.

For:

• If you're well organised, you can pay off the mortgage faster.
• This suits people with uneven income since there are no fixed repayments.
• Putting surplus funds into this account rather than a separate savings account will give bigger interest savings and also avoids the tax on the savings account interest.

Against:

• You need discipline. It can be tempting to spend up to your credit limit and stay in debt longer.

Reducing loan

Reducing or straight line mortgages repay the same amount of principal with each repayment, but a reducing amount of interest each time. These are relatively rare in New Zealand. Payments start high, but reduce (in a straight line) over time. Fees are similar to table loans.

For:

• You pay less interest overall than with a table loan because early payments include a higher repayment of principal.
• These may suit borrowers who expect their income to drop for example, if one partner plans to give up work in a few years time.

Against:

• If you can afford higher payments, you would be better to take a table loan with payments high for the whole term, thus paying less interest.

Interest-only

You don't repay the money you've borrowed until an agreed time. Some borrowers take an interest-only loan for a year or two and then switch to a table loan; the normal table loan application fees apply.

For:

• You have more cash for other purposes, such as renovations.

Against:

• You still owe the full amount at the end of the term.