Fixed, Floating, Flexi… flat out confusing? Understanding what they mean and understanding what option is best for you are two different things entirely and the benefits of different loan structures aren’t always made simple to those without industry knowledge. We see this as an issue as people make important decisions regarding large investments without having a full understanding of what they are signing up to. Breaking down the difference between each loan product and discussing the benefits of each seemed like something that needed to be put into words and made accessible, so here it is. Read, soak in, enjoy?
Fixed loans are the industry’s bread and butter, they come with consistent and reliable repayments at the best possible interest rate. A fixed loan has a regular repayment schedule and the amount that is repaid at each interval (weekly, fortnightly or monthly) won’t change during that fixed term. What is important to understand is that the fixed term of your interest rate does not equal the term of your loan. Whilst you agree to pay off the loan over 30 years, you will only have the interest rate fixed for anywhere between 6 and 60 months and choosing how long to fix for is a different question altogether. Rates increase and decrease in the market and you want to take the current market trends into consideration when deciding how long you’re wanting to fix your rate for. Fix for longer when the market is going through the trough and for a shorter period when the market is at a peak. What should also not go forgotten is trying to catch your rate expiry at points that give you the flexibility at the right points in time. If you’re expecting rates to decrease in 12 months, choosing a two-year rate could be better for you as you give the reduction a chance to get below the rate you’re at, and then further to ensure a benefit to yourself.
With fixed loans, your interest is calculated on an annual basis, but is charged to your loan on the same schedule as your repayments (If you were paying monthly, your interest is also charged monthly). Your repayment is calculated in a way that ensures your loan term (usually 30 years) remains intact, and your interest is also covered. You pay off the loan balance (usually called principal) over the agreed loan term, and your interest is charged onto the loan in line with the balance and rate. When your repayment interval comes along you pay both the principal and the interest you’ve accrued since your last repayment together to make up your minimum repayment amount. When your fixed term expires, your new minimum repayment is calculated in line with your new rate (changing the interest portion) and the remaining loan term (changing the principal portion).
All of that seems (and is) very technical, but we deem it necessary so that we can better explain the benefits of paying over and above the minimum set repayment amount. Let’s prefix this by saying that if cash flow is of utmost importance to you, minimum repayments are the way to go. But if you are in a position to repay more than your set minimum repayments, the benefits are substantial. As mentioned above, minimum repayments are calculated on your fixed interest rate and the remaining loan term, the loan term portion of that is usually 30 years from day 1, and will only vary from that if you pay more than your minimum required amount. The amount doesn’t have to be significant either as the following example shows:
Loan amount $750,000
Interest rate 6.5%
Monthly minimum $4,741
Standard term 30 years
Total interest cost $956,584
Increasing repayments by $100 each month saves $88,640 in total interest and reduces your loan term to 27 years and 9 months. Paying $100 extra a fortnight will make that savings figure jump to $135,270 and the loan term goes down to 26 years and 6 months.
Given the current rate environment and often discussed cost of living crisis, simply increasing repayments is not necessarily an option to most average New Zealanders.
This is where offset and flexi facilities become a great way to use cash savings to work against the interest on your loan in order to save you money in the long run. Flexi, revolving, orbit and rapid repay are all fancy names for an overdraft, and not the $2,000 interest free overdraft you likely had at Uni and used to pay for “school supplies” and the like, this is a mortgage backed overdraft, and in most cases you don’t start above the red line, you start below it.
This product is built for customers that are likely to receive large cash injections (bonuses, commission etc),need easy access to these funds and don’t want it to commit to a regular repayment schedule if not necessary. You can structure a portion of your loan into this revolving facility and put money into and take money out of the account as you see fit. It must be noted that you are charged a higher interest rate for the chance to do this, but you’re only charged interest each day on the balance, not necessarily on the limit, so the more you have money in that account, the smaller the interest repayment will be at the end of the month. It is also worth noting that some banks have a decreasing limit, and others do not, so without a decreasing limit over the loan term (usually 30 years) it is left up to the client to manage this. Reducing limits is a way to ensure clients are not left with a big bill at the end of the 30 years and no way to pay it off.
Offset Facility Loans
An offset facility is another product that has a similar concept to the flexi loan, but instead of working as an overdraft where you have the chance to minimise interest paid, it takes money from your accounts to shorten your loan term as much as possible AND reduce overall interest cost at the same time. Much like increasing your loan repayment, comparatively to the flexi loan, this does sacrifice cash flow. Your fixed fortnightly (or monthly/weekly) commitment will not change and will be calculated as the minimum amount similar to a fixed loan. The benefit lies in the breakdown of the amount that is paid to interest charged, and the amount that is paid towards your loan principal. If your offset loan was $50,000 for example (assuming current market offset rates), your repayments will be roughly $390 each month. Of that, roughly $360 will be interest, and your loan balance will reduce by $30… not exactly even! This is where the offset steps in, and if you were to have exactly $20,000 in your accounts, you are only charged interest on the $30,000 that isn’t offset, which shapes up to look as follows:
Monthly repayment of $390
Interest of $216
Loan reduction of $174
Straight away you see your loan amount decreasing by almost 6 times the amount. It then compounds onto itself to also decrease the interest for the next repayment, along with the $20,000 you have in your account, plus any extra funds you have saved since last month’s repayment. The picture should then start to look like a slippery slope down a path to the mortgage free life (Yes, this is hyperbole… but you get the idea).
But I do hear your questions through my keyboard, and they’re all very valid and sound something along the lines of “And what does that mean for me?”. Well, let me tell you in simple terms, no fancy wrapping, branding or frills. You’re going to owe the bank a lot of money. You have purchased something you don’t have the money for right now and you’ve borrowed the difference from a bank that charges you interest for that benefit. They do this in a few different ways in order to entice you to either stay with them longer, keep more of your savings with them, or get your loan paid off faster so they can give it to someone else, so this interest does vary and knowing how you can take advantage of it is key.
If you have a bit of cash, or are expecting a bit of cash in the near future, do yourself a favour and get either an offset or a flexi facility.
If cash flow is your goal, flexi is the way to go. If getting your loan size down ASAP is your No.1 priority, an offset facility is your No.1 amigo. Simple as that.
Both of these options are variable rates, so there’s no cost to changing them at any point so don’t stress about changing your mind if it’s not working for you.
Take fixed terms like pick and mix, spread yourself around just in case the chocolate almonds you thought you were getting end up being raisin… you will always know you can fall back on the fact that coke bottles are coke bottles, no surprises there.
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