Structuring Your Loan Properly

Although interest rates have been getting a lot of media attention in the last few weeks, they are not the only factor to take into account when choosing and setting up your loan. The right structure includes a number of things which will help when things are good or bad.
The main structuring issue that comes up is whether to fix your interest rate or let it float as a variable rate.  Variable rates can increase to the ridiculous and decrease to very low rates, so they can be difficult to plan around, but you can normally make extra repayments, and now come without exit fees. On the other hand, fixed rates give the security of knowing your repayments no matter what is happening with the cash rate, which is often helpful for businesses or investors. The downside is that you are locked in sometimes when the variable rate is much lower, and normally without the ability to make extra repayments, and there are significant fees for breaking the fixed term. A solution to this question is to split your loan between the two when fixed rates are excellent, this way, if interest rates rise, only part of your loan repayments will rise, and if interest rates drop, you will still be able to benefit. Another idea is to make sure that, as part of the conditions of your loan, you can have the option to go into a fixed rate if you want to during the term.

Another common question is whether to pay principal and interest, or interest only. Interest only really should be reserved for investment properties, as you won’t pay down the loan balance, so your interest stays the same – and so you claim the same deduction come tax time. But if your loan is for your own home, principal and interest is the way to go. If you are using your own home to purchase an investment property, you can split the loan into two portions – one for principal and interest and the other for interest only. This way you get the simplest structure and the best economic result as well. Having said that, the security used is also important. If you own more than one property and you’re looking to refinance to take on another home loan using the equity of your existing property, if it’s at all possible you should always try to keep the investment loan away from the family home loan for your own protection if things were to go wrong.

The final point is about fee structure. A monthly or yearly fee can make a large difference to the effective rate you’re paying. Make sure that you also look at the loan’s Comparison Rate, as this is a rate which is derived from adding the standard ongoing fees and charges to the advertised interest rate. You may find this blows out an otherwise attractive looking interest rate. But it is a guide only and you mustn’t look at this number in isolation – the other features of a loan are exceptionally important, as noted above. Plus, you need to make sure you get what you need, for example, free internet transactions, or an offset account, or flexible repayment options.