How do I know which loan is for me?

Investing in New Zealand’s property market and taking on loans go hand in hand. However, it can be difficult to work out exactly which type of home loan and structure to choose.

To help you get started, below are explanations for seven common loan types:

1. Variable Rate Loan

A variable loan has an interest rate that goes up and down as the market changes. This means your loan payment will also go up and down.

This loan allows for greater flexibility, because you can make additional payments, and pay lump sums without paying penalty fees. You can usually also pay the whole loan off early, without an early repayment charge (some non-bank lenders may charge for this).

2. Fixed Rate Loan

With a fixed rate loan, you can lock your interest rate in for a chosen period of time. The choices are typically 6, 12, 18, 24, 30, 36, 48,60 months. This means you will have the same loan payment amount during your chosen time period.

Most mortgage advisers will help you choose a fixed rate term based on the following criteria:

a) Economist reviews
b) Other home loans you may have
c) What the future may hold for you
d) The flexibility you need.

Some lenders also allow small extra payments or lump sum payments, with low or no penalty fees.

3. Principal and Interest / Interest Only Loan

While variable and fixed rate loans set the interest rate, principal and interest / interest only loans set the type of loan payment.

Principal and Interest Loan: you are not just paying the interest due on the loan, you will also be making an extra payment to reduce the balance of the loan.

You’ll choose the fixed rate, and you will also choose the term of the loan - normally 30, 25, or 20-year terms, but it can be less. The term will help set the principal reduction portion of your loan.

Interest Only Loan: the opposite of a Principal and Interest Loan. You will only pay the interest due - no additional principal payments.

As with a fixed rate loan, you will choose how long you wish to pay interest only. You will still pay the loan off over a chosen term (just like a fixed rate loan), however, the reduction of the loan will kick in after your chosen interest only period.

4. Revolving Credit Loan

A revolving credit loan is a type of a variable rate loan. The loan you are approved for is also the limit of the loan, which does not reduce over time. However, if you make additional payments to reduce the principal of the loan, you can then access those funds in the future, up to the original limit of the loan.

In other words, money can go in and out as much as you like, up to the approved limit. The loan can even be attached to a transactional bank account! Plus, you will only pay interest on the loan balance owing.

5. Redraw Facility

This is similar to a revolving credit loan - money can go in and out as much as you like. It can also function as a transactional bank account, however, there are two main differences:

a) The limit will reduce over the chosen term of the loan
b) If you are on a fixed rate and overpay the minimum repayment, you can draw on the excess funds

6. Split Loan

If you are looking for the most flexible loan option, you can split your loan into different loan types. For example, you may choose a smaller portion to be on a variable rate that will allow you to make extra payments, with no penalties. The rest of your loan could be on a fixed rate, so that you’ll know exactly how much your loan payments will be, for the majority of your loan.

7. Investment Loan

This could be any of the loans above, but the purpose of the loan is to purchase a residential investment property. Lenders may however, have different lending criteria for investment loans.

Read the Home Loan 101 eGuide

Get an overview of how to apply for your first home loan!