How Should I Structure My Home Loan?

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By Lateral Partners

29-06-2022

Understanding your loan structure is a very important part of the property investment process, and it can be costly if you don’t set it up right. We explore a few common ways to structure your loan below.

Fixed Rate vs. Floating Rate

Fixed Rate

Fixed rate mortgages offer you certainty. This is when you lock in a given rate for a fixed period of time – anywhere from 6 months to 10 years (although most banks will only go to 5 years). This means that you’ll know exactly how much your loan repayments will be for that period of time, and be able to budget accordingly.

Most people will opt to have the majority of their loan on a fixed rate, but that doesn’t mean you have to. Whether or not you fix, and how long for, will depend on your situation and any potential plans you might have. It could also depend on the interest rate market at the time – we can give you insight into this. One thing to remember with fixed rates is that you are effectively entering into a contract with the bank. If you repay a fixed rate early (like if you sell the house) you may end up having to pay early repayment fees.

Floating Rate

Unlike the fixed rate, a floating rate won’t offer you the same certainty. The rate can go up and down over the duration of your loan. For example, if you had a loan term of 30 years you can expect it to fluctuate multiple times over this period, However, it is often reflective of changes in the OCR (though not always) and because of this, it shouldn’t catch you too far off guard. We’ll keep you informed of that as well.

The benefit of a floating rate mortgage is that it gives you more flexibility to pay your loan off faster. Because it’s a floating rate, you won’t incur break fees and you can therefore pay it off as fast as you like, which can save you a lot of interest. Most of the time this product works really well alongside a fixed term so you get the best of both worlds.

Split Loan Strategy

Splitting your mortgage up into multiple tranches can be a smart way to hedge against interest rate risk and allow you to have more flexibility in paying off your mortgage. For example, if you have a $600,000 mortgage, you could opt to have it in three separate portions of $200k. This way, you could fix one portion for 5 years, one portion for 1 year and keep the other portion on a floating rate. This would mean you can pay off your mortgage in lump sums through the variable portion, and have protected yourself from changes in interest rate by fixing for two different terms.

P&I vs. Interest Only Rates

Principle & Interest (P&I)

There are two ways you can structure your mortgage. The most common type of loan is a principal and interest loan, where each repayment consists of a portion of interest and a portion of the principal. This way, with each payment the overall loan amount decreases until you own the property outright with no debt against it.

Within P&I loans there are two structures you can choose from. The most common is called a table loan, where you make equal repayments throughout the term of your mortgage. To start with, your repayments will be made up mostly of interest and a small portion of principal and as time passes your repayment will include less interest and more principal. The other type of loan is a reducing loan, where you pay an equal amount of your principal off each time. This means your repayments get less over time because as your principal declines, you are paying less and less interest.

Interest Only

The other loan structure that is common with investors is an interest only loan. This is where the loan amount stays the same and you only pay the interest expense each time. It means you pay more interest in the long term, but helps with cash flow in the short term. Investors use these loans to turn negatively geared investments positive.

For more information on loan structuring and the property investment process, download our free Property Investment Guide here.

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